Down in Smoke

By Daniel Kadlec

A guy I've known for years who recently left tobacco company R.J. Reynolds said an odd thing to me last week. He's about to roll his 401(k) assets into an IRA, where at last he'll have a pool of money to buy individual stocks. So what's the first thing he plans to buy? No dot bombs for him. A large chunk will go into shares of Philip Morris, his former arch nemesis and a company that Business Week has dubbed America's most reviled--quite a fall from FORTUNE's most admired list of 1990.

Given that this industry seems a court case away from incineration, the choice seems almost masochistic. Forget your wife on Valentine's Day, and you'd still be more popular than a tobacco stock. That's why the stock (MO) has fallen from $60 to $20 in just over a year. Consider: the company's huge, profitable and well-regarded Kraft food division would trade higher than that if it were standing alone. Yet Philip Morris' earnings are on track, and the dividend yield is a mind-boggling 9.7%. Normally, a yield that high suggests the dividend may be cut. Philip Morris raises it, habitually, every August.

The problem, as we all know, is that cigarettes are killers. Many people avoid the stock on moral grounds, opting for such high-performing angels as Citizens Index Fund or Domini Social Equity Fund. Others shun it because they figure the industry is doomed. Last week lawyers hit Big Tobacco with a price-fixing suit. Next month a Florida jury could find the industry liable for damages of $100 billion or so in a class-action case. (Even if the case survives appeal, though no money will change hands for at least a decade.) It's highly unlikely, but possible, that following some huge judgment, a court would freeze Philip Morris' dividend payout. A federal case is next, and there are individual cases. In 1998 tobacco companies settled a suit with the states for $246 billion. It's easy to see why many believe that Big MO is toast.

I do not, and my reasoning is simple: the company has too much money. It spent $7.6 billion last year in dividends and stock buybacks. At today's share price that's enough cash to self-fund a buyout over six years--a good indication the stock won't sink much lower and stay there. Robert Sanborn, manager of the Oakmark Fund, estimates that without raising prices or touching the dividend, Philip Morris could pay $10 million a day--$2.5 billion a year--without twitching. Oakmark has a large stake in Philip Morris (and a small stake of Kadlec dollars) and has doggedly held on to the stock, believing that MO is the ultimate value play. Sanborn figures the company could easily raise prices if needed. For instance, it covered its state settlement with a 75 cents-a-pack price hike. The "armageddon risk" of a jury bankrupting the company is overstated. And Congress won't knock the Marlboro Man out of his saddle. Too many jobs are at stake, and then no one would be able to collect.

Tobacco companies have been remarkably successful defending their interests. Yes, the winds are shifting. Still, the great irony of their past successes is that they've never had to show that they can live with adverse judgments as a matter of course. It sounds wacky, but if Philip Morris lost more often, the market might not worry so much about its stock. If you're patient and can get past the moral issues, Philip Morris is a compelling stock--doubly so if you invest for income or, like my friend, plan to sock it away in a tax-deferred IRA.

See time.com/personal for more on Philip Morris. E-mail Dan at kadlec@time.com See him on CNNfn Tues. at 12:45 p.m. E.T.