Tobacco Stocks Gain on Calif. Tax Defeat

... Under the California proposal, Proposition 86, the tax would have been raised by $2.60, resulting in a total tax of $3.47 on each pack of Cigarettes. ...

NEW YORK — The Big Tobacco companies came away from Tuesday's midterm election with a collective sense of relief, as Californians voted down a ballot initiative that would have quadrupled the state's cigarette taxes to the highest level nationwide.

Of three other states that had excise tax proposals pending Tuesday, one in Missouri was also rejected while two others, in Arizona and South Dakota, passed.

But given those two states represent just 1.6 percent of the industry's volume, the damage from those taxes is lesser than the threat from the other two states, Merrill Lynch Analyst Christine Farkas wrote in a research note titled, "Tobacco breathes easier in California."

California and Missouri together account for about 9 percent to 10 percent of overall sales volume for the industry. Under the California proposal, Proposition 86, the tax would have been raised by $2.60, resulting in a total tax of $3.47 on each pack of Cigarettes. The average price of a pack of Cigarettes would have been $6.55.

Analysts cited the failure of the initiative as being "a remarkably favorable development" for the industry.

"The industry faced a very significant uphill battle, given California's anti-tobacco bias and smoker's natural minority status," Morgan Stanley Analyst David Adelman wrote in a research note on Wednesday.

The leading domestic cigarette producers, Altria Group Inc.'s Philip Morris USA and Reynolds American Inc., spent More than $54 million to oppose Proposition 86. Their opponents raised less than $13 million.

"The key implication is that currently strong and pRedictable US tobacco industry fundamentals should now be able to persist throughout 2007," Adelman wrote.

Philip Morris USA and Reynolds are likely to get a boost in profits, Deutsche Bank Analyst Marc Greenberg wrote in a research note. The lower tax rate would move Philip Morris, maker of Marlboro, from a profit decline for 2007 to growth in the domestic market, Greenberg pRedicted. PM USA's earnings per share could be boosted by 2 cents to 3 cents next year.

"We had assumed its passage in domestic profit forecasts for both PM USA and Reynolds," Greenberg wrote. "Hence, its rejection would likely imply some upside to our forecasts."

Reynolds, which Greenberg said is a More purely domestic play, may have an even steeper upside, with a 13 cent to 15 cent earnings per share increase.

Outside of the defeat of the California proposal, Reynolds had already been faring quite well. Shares in the Winston-Salem, N.C.-based company are up 46.2 percent year-over-year. Loews Corp.'s Carolina Group, maker of Lorillard-brand Cigarettes like Newport and Kent, has had a 40.7 percent gain in its stock in the past year. Altria is up 8.3 percent, and the Dow Jones U.S. Tobacco Index has risen 11.4 percent over the year.

In Wednesday afternoon trading, Altria shares rose $1.37, to $81.70 on the New York Stock Exchange. Shares of Reynolds American gained $1.48, or 2.3 percent, to $64.88 on the NYSE and Carolina Group shares were up $1.69, or 2.8 percent, to $61.18, after hitting a new 52-week high of $61.35 earlier in the session.



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