The recent collapse of the industrywide tobacco settlement didn't brighten the near-term future for tobacco industry stocks, money managers say.
Some, though, can't resist the allure of the extremely high yields and low relative prices offered by companies in the sector, and are invested selectively in tobacco company shares.
Managers applauded the companies' decision to withdraw from negotiations with the government, given that the terms proposed by Congress had become too onerous for the industry to bear.
Tobacco stocks are "very cheap, but there's not any immediate momentum going on. They're likely to stay that way for a while," said Dalton Avery, senior vice president with Independence Investment Associates Inc., Boston.
"The issue will bump along here with a lot of posturing" until after the congressional elections, which in the meantime is a negative for tobacco stocks, he said. As of Dec. 31, Independence owned 5.9 million shares of industry leader Philip Morris Cos. Inc., 1.3 million shares of UST Inc. and 949,000 shares of Universal Corp., according to public filings tracked by CDA Investment Technologies, Rockville, Md.
James Margard, principal for Rainier Investment Management said he believes there's a 50/50 chance tobacco shares will outperform in the coming year, "but it will be a bumpy ride."
The current environment is typically more favorable to other more cyclical shares, he said, but tobacco stocks have been beaten down so badly that they are likely to outperform. Rainier owned 1.1 million shares of Philip Morris as of Dec. 31, according to CDA.
Tobacco shares have fallen from levels attained after the settlement's unveiling. The Dow Jones U.S. Tobacco index closed at 1,680.72 on June 20, when the initial agreement was announced.
Last week, the index had fallen to 1,498.65 as of the close April 14, at a time when other stocks were rising. On June 20, the Standard & Poor's 500 stock index stood at 898.70, while it closed April 14 at 1,115.75.
The negotiating process on the settlement with the federal government eventually overshadowed traditional factors used to evaluate share prices, said Ben J. Fischer, managing director for NFJ Investment Group Inc., Dallas.
"It's no longer as much an analytical process, as an exercise in popular psychology," he said.
The current popular thinking regarding tobacco and smoking is questionable from the standpoint of an investor in tobacco shares, Mr. Fischer said, as well as from that of public policy.
A Senate bill under consideration in Congress would bankrupt the weaker companies in the industry, he said, in reference to a bill written by Sen. John McCain, R-Ariz.
Moreover, an exceedingly high excise tax on cigarettes would only lead to a booming black market, and by some estimates would more severely affect low-wage earners, than high-wage earners, Mr. Fischer said.
NFJ owns more than $1 million worth of RJR Nabisco Holdings, based on its high dividend yield of 7%.
"I think the dividend is sustainable," he said.
Others agree Congress had gotten out of hand in its efforts to change the original terms of the agreement.
"This is all about trying to squeeze the tobacco companies for all they can get," said Donald A. Yacktman, president of Yacktman Asset Management, Chicago. "At some point, it's in everybody's best interest to come to settlement. (Congress) can't get what they want without the tobacco companies."
The marketing-related demands of Congress would be limited by First Amendment considerations, while Congress cannot use legislation to force tobacco companies to make reparation payments, even if taxes can be raised, Mr. Yacktman said.
He's bullish on Philip Morris, holding 13% to 14% of equity mutual fund assets under management, about $1.1 billion. As of Dec. 31, Yacktman owned 4.7 million shares, according to CDA.
Some managers lauded the decision by the companies to withdraw from the negotiations, an action that was spurred by RJR's chief executive, Steven Goldstone.
"I think the tobacco industry was willing to pay much too much for what they were going to get back in return, which in the end was nothing," said Mel Hughes, senior vice president for Stein Roe & Farnham, Chicago. Stein Roe, which is neutral on the industry, owned 1.3 million shares of Philip Morris as of Dec. 31, according to CDA.
"It was nice to see Goldstone put his foot down . . . and say 'We can't pay this'," said Gregg Tenser, director of research for Federated Investors, Pittsburgh.
Mr. Tenser said UST looks attractive because it is yielding more than 7%. Federated owns $5 million worth, of UST, he said. Federated owned 1.3 million shares of UST as of Dec. 31, buying most of it in the fourth quarter, according to CDA.
Federated owns about $30 million worth of Philip Morris as well, he said. As of Dec. 31, it owned about 2 million shares.
If standard market valuations are applied to Philip Morris' non-U.S. tobacco business, he said, the stock price effectively assigned a negative value to U.S. tobacco.
It's tough not to own Philip Morris, he said, "even with the turmoil around it."
Tim Drake, senior equity analyst for Banc One Investment Advisors Corp., Columbus, Ohio, said the firm carries a neutral weighting to the four major companies in the industry: Philip Morris, RJR, UST and Universal.
While the withdrawal from negotiations was a step in the right direction, it hasn't led Banc One to start buying shares.
Executives there are looking for some type of catalyst that would propel tobacco shares to more typical valuations, such as an act of legislation or a decision to not create legislation.
They anticipate lackluster earnings in 1998 because the companies have not been able to focus on running their businesses, he said.