• Tobacco companies can help reignite your portfolio  

We think the worst-case scenario for the industry under FDA regulation would be a reduction in the amount of nicotine, the addictive component of cigarettes, being forced upon manufacturers. However, it is likely that industry stakeholders would pressure the FDA not to implement such a measure. Just as smokers are addicted to tobacco companies' products, governments are addicted to the tax revenue the products generate. We estimate that total excise tax and MSA payments will be well in excess of $40 billion in 2009, or around 1% of all local, state, and federal taxes collected, and around two thirds of all excise tax receipts. In the case of the MSA payments to states, the states have in many cases already securitized that revenue and therefore are heavily reliant on the payments being made.

The risk of litigation still lingers over the domestic tobacco industry, although it has subsided significantly in the past few years. We expect financial penalties to arise periodically, but we think damages will be manageable.

We think the downward pressure on tobacco stocks over the past 18 months has presented investors with an opportunity to buy the industry leaders. We think Altria has the widest moat in the industry, with a vast distribution network and collection of strong brands. . . .

Although we think Lorillard's Newport is a very strong brand, the firm's exposure to the menthol category is a concern to us, given the threat hanging over that sector. We expect Reynolds American to underperform the industry because it has an older core customer demographic and we expect it to discontinue some of its peripheral brands.

Emerging economies such as Eastern Europe, Africa, and parts of Asia still offer growth opportunities. . . .

We think the best way to exploit the growth opportunities in international tobacco markets is with an investment in the industry leader, Philip Morris. The firm owns Marlboro in international markets, the only true global brand . . .

We rate British American Tobacco similarly to Philip Morris: Both have wide economic moats, both have only a medium uncertainty rating, and their dividend yields are also closely matched, BAT at 4.5% and Philip Morris at 4.9%.

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