Tobacco Debate: Values vs. Value Stocks

An official from a local animal protection society, one of portfolio manager Ronald K. Stribley's favorite clients, called recently with a request. Sometime in the next 90 days, whenever Stribley thought best, the society wanted him to sell all of its tobacco stocks.

Stribley, a vice president at Glenmede Trust Co. in Philadelphia, readily agreed. He understood the health concerns of his client. He knew that as a public fund-raising group with a $30 million portfolio, it could not risk offending the large numbers of Americans disgusted with cigarettes and the companies that sell them.

Yet Stribley also is a value manager, an expert in finding underpriced stocks who is obliged to make the maximum possible profit for his other clients, whose total holdings exceed $1.7 billion. And what is one of the most undervalued and profitable parts of his portfolio?

Tobacco stocks.

At a critical moment in the history of this most American of all industries, when cigarette-making giant Philip Morris Cos. is fighting 125 health lawsuits and the federal government is pushing for heavy regulation, the gap between tobacco-conscious and ordinary investors has become a widening gulf.

On one side are the nonprofit agencies, universities, public pension funds and other politically sensitive investors who are in many cases reducing their exposure to the legal and financial risks of tobacco stocks, tiptoeing away like a hiker encountering a sleeping bear. The American Medical Association pushed this further last week by urging doctors and institutional investors to rid themselves of tobacco holdings.

On the other side are the much larger and more financially powerful money managers and investment advisers who see tobacco stocks as more attractive than ever. The fears about lawsuits cutting into earnings have made the stocks relatively cheap -- Philip Morris's price-to-earnings ratio (where low numbers mean bargains) is only 13, compared with about 19 for the Standard & Poor's index of 500 stocks.

Despite warnings about the dangers of smoking, people who want cigarettes are willing to buy them at a large markup, giving the companies huge cash flows they can use to buy back some of their own stock, expand overseas and generally make their future -- lawsuits or not -- look surprisingly bright.

"The investors' only concern is, is this a profitable business?" said Paul D. Ehrlichman, a managing director and value manager at Brandywine Asset Management Corp. in Wilmington, Del., whose holdings include RJR Nabisco Holdings Corp. and two overseas tobacco companies.

Stribley has a great deal of Philip Morris stock in his portfolio, a natural reaction to the company's earnings growth and its blossoming overseas tobacco sales.

"Philip Morris International has more than doubled its income just since 1991," Philip Morris Chairman Geoffrey C. Bible said at the company's annual meeting April 25, "and we're doing well this year too, with income up another 17 percent in the first quarter."

Bible is not happy that the suits seeking redress for health damage from cigarettes have pushed down the price of his stock. It was above $104 a share in early March when the Liggett Group, a very small competitor, announced that it would try to settle some of the suits against it. Investors fearing this would embolden anti-tobacco forces pushed Philip Morris stock down below $90.

But the low price makes the stock that much more attractive to money managers and investment advisers.

"Philip Morris is really in a strong position," said Steven F. Marascia, a tobacco analyst at the Branch, Cabell & Co. brokerage in Richmond. "It has good cash flow and low debt."

Some analysts, mindful of the gap between health concerns and profit motive, have questioned the rationale offered by some pension funds for dumping tobacco stocks. The Maryland Retirement and Pension System said in March, for example, that it was selling all its tobacco holdings only because of the industry's long-term financial prospects.

But analysts suspect fund officials are getting pressure from politically adept anti-tobacco groups. Marascia noted that Maryland joined the legal assault on the industry shortly after its fund dumped the stock.