July 11 2006 - Court ruling ignites tobacco stocks

The Florida Supreme Court lit up a rally in tobacco stocks when it refused to revive a $145 billion punitive damages award against major cigarette companies.

The long-awaited decision Thursday lifted one of the biggest financial clouds over tobacco companies, slapping down a punishment that the companies had said could send them into bankruptcy.

The state high court's ruling upheld the key part of a Florida appeals court ruling three years ago that overturned the punitive damages, which at the time had been the largest award in a U.S. product liability case.

"This is very significant. It was the last major class action out there, and now it's gone," says David Dreman, chairman of Dreman Value Management. A powerful rally swept tobacco stocks including:

*Altria. Shares of Philip Morris' holding company jumped $4.43 to $77.76, accounting for nearly half of the Dow Jones industrials' gain for the day. Investors hope the verdict clears the way for the company to break its food and cigarette business apart as planned, says Timothy Ramey, analyst at D.A. Davidson.

Altria began the break in 2001, when it sold 14.9% of its foods division as an initial public offering of Kraft. It further prepared last month for a clean break when a new CEO was named.

The break won't happen immediately, since there's still pending tobacco litigation, including a $13 billion claim from the Department of Justice, Ramey says. The path is cleared somewhat, though.

*Carolina Group. This maker of cigarettes under brand names Newport, Kent and others, jumped $2.81 to $53.99. The tracking stock of Loew's Lorillard unit is drawing attention in part because it could boost its dividend, Nik Modi, analyst at UBS, told clients.

Modi estimates Carolina Group may pay a $4 a share dividend by 2008, more than double what it's paying now. Carolina, along with the other tobacco companies, will likely enjoy a windfall of millions as it collects cash held in escrow while the ruling was decided.

*Reynolds American. The seller of Camel, Winston and Kool cigarettes gained $4.59 to $118.95. It will likely use the cash returned from escrow to pay down debt and possibly increase its dividend, says Greggory Warren, research analyst at Morningstar.

Investors shouldn't assume tobacco stocks will stay hot, though, because they already reflect much of the good news, says Warren, who rates most of the stocks a hold. Legal risks still loom, too. The Florida decision doesn't prevent individuals from pursuing their own legal actions. And there are lawsuits pending regarding the marketing of light cigarettes, Warren says.

But Charles Norton, portfolio manager of Vice Fund, thinks the Florida decision clears the air for tobacco stocks, which suffered for years due to fears about litigation. "A big legal risk is taken off the table," he says.

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