Talks a Healthy Sign for Tobacco Firms
The tobacco industry is such a hugely profitable business that it could easily afford a settlement of health-related liability claims far exceeding even the $300-billion figure being suggested as part of the talks that were disclosed Wednesday.
The very news that Philip Morris Cos. and RJR Nabisco Holdings Corp. had begun talks with state attorneys general and plaintiffs lawyers sent their stock prices soaring more than 10%.
The companies’ prime motivation in entering settlement talks is to secure immunity from years of personal-injury and wrongful-death lawsuits and, thus, to avoid being driven into bankruptcy, as the asbestos industry was in the 1980s.
Even preliminary talks about a settlement indicate that the industry will survive.
“Talks mean the government is admitting it isn’t going to ban tobacco,” said Michael Sandler, an investment manager with Pacific Financial Research of Beverly Hills. A ban on tobacco, it is widely believed, would be counterproductive because it would set up a massive illegal cigarette industry.
Thus, odds have begun to turn toward an eventual settlement. In the past, tobacco companies refused to admit that settlements of any health-related lawsuit were possible because they would set a precedent and lead to endless claims from smokers who had contracted cancer or heart disease, or from their survivors.
But recently, with the small Liggett Group having settled with state attorneys general, the tobacco industry has begun to talk of negotiating a deal. The companies know that if a settlement, whatever it costs, grants them immunity from unending lawsuits, they will be able to go on marketing cigarettes, domestically and internationally.
The total cost of such a deal would very likely be more than the $300 billion over 25 years, it was suggested Wednesday. But analysts were quick to point out that the cost of any such settlement over 25 years, in current dollars, would amount to only $12 billion or so a year. And for an industry with cash flow--income plus depreciation--of roughly $20 billion a year, a deal would be feasible.
Product prices would probably have to rise to cover the cost of the settlement, but paying more for cigarettes may deter only 10% or so of smokers, analysts reckon.
Indeed, cigarette prices--swelled by tobacco taxes--are three times U.S. levels in many European countries. Yet cigarette smoking is still a growing activity there.
And excise taxes by themselves won’t reduce the profitability of the business, which is enormous. Philip Morris, for example, last year earned more than $8 billion before income taxes and interest expense, on some $28 billion in worldwide tobacco sales.
To be sure, only the first steps toward an eventual settlement apparently have been taken, and there are many unknowns still to be resolved. First, the kind of agreement being discussed would require an act of Congress. Even then, the courts may not allow immunity from the many health-related lawsuits against tobacco.
Further, as part of any settlement with the federal government, cigarettes would come under regulation by the Food and Drug Administration. But there is a real question of what kind of product the FDA could allow on the market.
“The cigarette is a very dangerous product; its basic ingredient, nicotine, is deadly,” noted Richard Kluger, author of “Ashes to Ashes,” the Pulitzer Prize-winning history of the long fight between government and the tobacco industry.
But whatever modification to the product and restrictions on advertising the companies must agree to as part of a settlement, they know that cigarettes will remain a highly profitable and growing global industry.
Even in the United States, where antismoking legislation and smoking bans in workplaces and public areas have been most extensive, cigarette smoking has begun to grow again after years of decline. That’s despite explicit warnings on cigarette packages that “smoking causes lung cancer, heart disease and emphysema and may complicate pregnancy.”
And overseas markets are growing faster, especially in developing countries, where the cigarette is one of the first small luxuries people turn to when cash incomes rise.
U.S. companies lead the global industry, which also includes B.A.T. Industries, UST Inc. and others, thanks mainly to the strength of Philip Morris’ distribution system and its brand name Marlboro. The company is also one of the world’s most efficient manufacturers.
As if to underline the strength of the business, Philip Morris announced first-quarter sales and earnings Wednesday and noted that income from worldwide tobacco operations climbed 13%, to $2.4 billion, on revenues of $9.9 billion, 8.5% higher than last year.
The company gets roughly half its sales from food products, such as Post cereals, Maxwell House coffee and Jell-O dessert. RJR Nabisco also markets food products, such as Oreo cookies, Planters peanuts and Life-Savers candy. But food is not as profitable as cigarettes for either company.
Still, many people wondered on Wednesday how tobacco company stock prices could rise on news that the industry faced a $300-billion settlement of health claims. But for investment professionals, the answer was simple: The stock market has already penalized tobacco industry stocks by some $360 billion to allow for the cost of potential health claims, explained Sandler of Pacific Financial.
He was referring to the common analysts’ calculation that Philip Morris, with a Marlboro brand that is as widely recognized globally as that of Coca-Cola or Gillette, could be selling at double its current price if there were no threat of lawsuits.
Extrapolating that understanding to the whole tobacco industry, analysts and investors calculate a massive undervaluation of tobacco. And even an early sign that the threat of lawsuits might someday be lifted led them to buy tobacco stocks Wednesday.
Settlement Talks: Proposed deal between Philip Morris and R.J. Reynolds would include tightened rules on marketing to minors. A1
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Lighting Up
Major tobacco stocks were up sharply Wednesday on news reports that cigarette makers are discussing a massive settlement of pending smoking-liability suits.
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Stock 52-week high-low Wed. close and change Pctg. rise Philip Morris $46.50-$28.50 $43.25, +$425 +10.9% RJR Nabisco 38.88-25.13 33.50, +3.25 +10.7 Loews Corp. 112.88-72.50 91.75, +5.38 +6.2 BAT Industries 18.50-13.13 17.88, +1.00 +5.9 Brooke Group 8.75-3.63 4.38, +0.13 +3.0 UST Inc. 35.38-25.50 27.00, +0.38 +1.4
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Source: Reuters
