There are plenty of reasons cigarettes would seem to be a terrible business.
The number of American smokers usually drops about 1 or 2 percent a year. Government agencies keep adding cigarette taxes and outlawing smoking in restaurants, workplaces and even on public sidewalks. And tobacco companies continue to pay billions of dollars in legal settlements, money that is used in part to produce antismoking ads.
For all the industry’s apparent troubles, however, the future of cigarettes appears to be brighter than ever.
That at least is the message investors are sending as the Altria Group — the company once known as Philip Morris and the maker of the world’s most popular cigarette, Marlboro — prepares to split itself by spinning off its Kraft Foods division to shareholders and become, once again, primarily a tobacco company. Today, Louis C. Camilleri, the chief executive of Altria, is expected to set a timetable for completing the spinoff.
It is a move that Wall Street is responding to with the equivalent of a standing ovation, but it is not because Kraft Foods, the world’s second-largest food company, after Nestlй, will finally shed the taint of tobacco.
Investors are glad that Altria will finally be rid of Kraft Foods, the maker of Oreo cookies, Velveeta and Tang. Since October, when the company announced its plan for the move, its shares have risen 10 percent.
“Something that is forgotten in all of this is people like to smoke,” said David Adelman, an analyst at Morgan Stanley, who noted that United States tobacco stocks have beaten the Standard & Poor’s 500-stock index in each of the last six years. “It’s enjoyable and there’s not an alternative product.”
He added: “If frozen dinners get too expensive, people will try something else. That’s not true with cigarettes — you are not up at night worried about that product that is going to make cigarettes obsolete.”
In the five and a half years since Altria sold 280 million shares of Kraft at $31 each in an initial public offering, the stock has remained relatively unchanged, closing yesterday at $34.83. Altria owns 88.6 percent of Kraft’s stock.
By contrast, shares of Altria have nearly doubled during that period, moving from $47 to yesterday’s price of $87.54.
It is a remarkable turnabout, considering that in late 2001, Philip Morris announced its plan to change its name to the Altria Group (drawn from the Latin word altus, meaning high, to suggest high performance). At the time, executives said the name change was intended to reduce the damage to the company’s reputation that cigarettes were causing, reflected in the long-depressed share price at the time.
Now, it is Kraft that is seen by many investors as a hindrance to the company.
Why is Wall Street so infatuated with cigarettes? Cigarettes have certain advantages over other consumer products, not the least of which is that they are addictive. They are inexpensive to make, require almost no innovation, there is a global market for them, and cigarette makers can raise prices without seeing much of a drop in business.
On top of all that, a recent string of court decisions has convinced investors that the worst of the litigation against tobacco companies is over.
That, in turn, has allowed Altria to move forward with a revamping that begins with cutting Kraft loose and will ultimately allow Altria to use the huge amounts of cash generated by cigarettes to buy back stock or acquire other tobacco companies, particularly overseas.
“You take away Kraft out of Altria and you are left with a balance sheet that is extremely strong,” said Charles Norton, portfolio manager at the Vice Fund, a mutual fund that invests in tobacco, gambling, alcohol and military contractors. Altria is the fund’s biggest holding. “It’s just a cash cow. The free cash flow on this business is just tremendous.”
The future prospects are particularly attractive in developing countries, where smoking has not yet declined as it has in more developed parts of the world like the United States and Europe.
In China, for instance, the Philip Morris International unit of Altria signed a deal in 2005 that allows it to manufacture and sell Marlboro cigarettes to the country’s 350 million smokers. There are an estimated 1.3 billion smokers worldwide.
But even in the United States, with 45 million smokers, the Philip Morris USA unit of Altria continues to generate sizable profits by raising prices. It also hopes eventually to lure consumers with new tobacco products, includinga small tea-bag-like pouch that is smoke-free, spit-freeand tucks into the cheek.
It says it is also working on developing cigarettes that are less harmful.
“The exciting part for me,” said Bonnie Herzog, an analyst at Citigroup, “is that tobacco use today will evolve. It’s unlikely that there will ever be a 100 percent safe cigarette, but we feel that a reduced-risk cigarette is on the horizon.”
But some health advocates say that the diminished social acceptability of cigarettes will hurt the long-term prospects of companies like Altria.
“The industry knows that its days of successfully selling their product in this country are limited,” said Dr. David A. Kessler, who called for regulating the tobacco industry as commissioner of the Food and Drug Administration in the 1990s and is now dean of the medical school at the University of California, San Francisco.
“They may be finding favor on Wall Street, but they’re not finding favor in the public arena,” he added. “There are fewer and fewer places that you can go and smoke in public.”
Still, on Wall Street, analysts are much less enthusiastic about the future of an independent Kraft Foods — which makes a wide range of well-known food products — compared with Altria’s prospects.
Kraft has struggled for several years to find its way in a rapidly changing marketplace, and Irene B. Rosenfeld, the chief executive, is expected to lay out her plans for a turnaround next month.
While many analysts say that Kraft is better off without the taint of tobacco, it still faces formidable challenges in repositioning its products at a time when consumers are less loyal to brands and more attracted to natural products, analysts said.
Investors in Altria are expected to get 0.695 share of Kraft for every share of Altria they own, said Ms. Herzog, who predicted that Altria would distribute the shares early in a 120-day period between the announcement and the distribution.
There is, however, a possibility that the distribution could be delayed by a legal challenge.
Michael D. Hausfeld, a lawyer in a pending class-action lawsuit against tobacco companies, said he might file an injunction to stop a spinoff of Kraft. The lawsuit, first filed in 2004 and known as the Schwab case after the lead plaintiff, Barbara Schwab, contends that cigarette manufacturers defrauded consumers by marketing light cigarettes as safer than regular cigarettes.
The idea behind seeking an injunction is that a judgment could be so enormous that Altria might need Kraft — with a market capitalization of $57.25 billion — to pay off the damages.
“Apparently at this point they have decided to spin Kraft off because they believe there’s a diminishment in their legal exposure,” Mr. Hausfeld said. “We disagree. If anything, the light’s fraud presents the strongest legal merit claims against the industry and Philip Morris.”
He estimated that a judgment in the case could be “several hundreds of billions of dollars” because 30 million to 50 million people who smoked light cigarettes made by several different tobacco companies were affected over more than 30 years. Asked to comment on Wall Street’s affection for tobacco stocks, Mr. Hausfeld said: “Wall Street loves money. And cigarettes are money. You are clearly earning huge returns at the expense of people’s lives.”
Several analysts who track Altria have dismissed the chances of an injunction’s success, and in an October conference call with investors, Mr. Camilleri, the Altria chief executive, said, “We believe that such an action would not have merit and that we would ultimately prevail.”
Altria’s plan to spin off Kraft is part of a long-term revamping plan that may ultimately split the domestic and international tobacco businesses into two companies because Altria thinks they would have more value as independent companies.
For example, Philip Morris International would no longer be dragged down by problems associated with smoking in the United States, like diminished demand and government intervention.
“At times, as a tobacco investor or a tobacco analyst, it seems like an unending stream of negative news,” Mr. Adelman of Morgan Stanley said. “You hear about smoking bans, a new piece of legislation. You hear about criticism from the World Health Organization.
“And then lo and behold, manufacturers release their results,” he said. “And they are good.”