VideoAt Their Disposal
Overall, however, the tobacco industry isn't quite in ashes yet. Although it "pretty much missed the bull market of the '90s," as Brian Harker, CFO of Dimon Inc., a Danville, Virginia-based tobacco processor, puts it, the current level of income at the companies remains very attractive. Philip Morris's first- quarter operating income for its domestic tobacco business (excluding settlement costs), for example, increased 4.7 percent, to $1.1 billion, and its international tobacco operating income rose 11.3 percent in the same period, to $1.4 billion. And even smokeless tobacco manufacturer UST Inc. registered first- quarter net earnings up 11 percent, to $112 million.
Tobacco companies also have an enviable weapon at their disposal if future legislation or negative public sentiment decreases consumption. As one of the few price- insensitive industries, they can always generate cash quickly by raising prices--an action taken twice this year already. "With 24 billion packs sold annually, a 5 cent increase is a tidy $1.2 billion," notes Jay Nelson, a tobacco analyst at Brown Brothers Harriman & Co. Such action only makes sense, says Imperial's Jobin. "You really can't reserve for the enormous potential costs the U.S. industry faces," he says. "Were we facing the same issues to the same degree in Canada, our position would be to build the cost into the price of the product."
Still, as far as any aggressive action is concerned, finance can do little. "It doesn't take a brain surgeon to figure out what CFOs must do: encourage price increases and run a tight ship," says Nelson. "You don't buy back the stock, you don't raise the dividend, and you restrict costs wherever possible." Adds Marascia: "CFOs can't do anything like spin off parts of the business. They just don't have that luxury." And they can't do anything that will call attention to how well they are doing, says Black, such as producing earnings surprises that help drive up stock price. "They definitely don't want to let on that things are going well," he says. "If they do, most likely they'll be slapped with a tougher settlement."
Old Standbys
Tobacco CFOs have already taken many of the steps available to them. One, of course, is to take out the hatchets. RJR Nabisco's ongoing restructuring, for example, which included nearly 3,000 layoffs last year, is expected to yield approximately $155 million in annual savings beginning in the year 2000. Philip Morris closed several facilities for an estimated annual pre-tax savings of $630 million by the same year. And the company recently extended early-retirement incentive packages to some of its older employees for a pretax savings of $290 million.
Tobacco companies have also been actively selling off low-margin subsidiaries and brands. In recent years, Philip Morris sold its Brazilian ice cream business, along with its flagship Kibon brand, its Lender's line of bagels, Kraft's Entenmann's cakes, and some real estate. The company reported $877 million in gains just from the sale of its ice cream and real estate businesses last year. In addition, companies have been shifting their marketing focus to foreign sales. Last year, more than half of Philip Morris's total tobacco sales came from overseas. "Companies have been successful opening new markets in the Far East, Eastern Europe, India, and Africa," says Jack Kasprzak, an analyst with Richmond, Virginia-based brokerage Scott & Stringfellow.
Of course, it's possible that the most effective CFO contributions to the tobacco industry happened several years ago. Former Philip Morris CFO Hans G. Storr, for example, was the force behind the financing of its $25 billion acquisition of Kraft Foods and other food companies at rates of less than 10 percent in the late 1980s and early 1990s. These profitable nontobacco assets could prove helpful in absorbing any future settlement costs. Both RJR Nabisco's and Philip Morris's food brands constitute a veritable supermarket of products, including Kraft foods, Miller beer, Jell-O gelatin, Oscar Mayer hot dogs, Oreo cookies, and Ritz crackers. Lorillard's parent, Loews Corp., owns a profitable chain of theaters, and Brown & Williamson's parent, BAT Industries, owns insurance companies.
The current crop of tobacco CFOs, however, must simply remain conservative and flexible. Says Marc Cohen, a tobacco analyst with Goldman, Sachs & Co., "They should not overextend the company in terms of buying shares or doing things from an acquisition standpoint," he says. "Philip Morris's Hans Storr always recognized that it was critical for the company to guard its credit rating." In addition, says Imperial Tobacco CFO Jobin, a tobacco company's investments must be positioned so they can be drawn on quickly in the event of need. "That's what we've done here, so if conditions shift, we have flexibility," says Jobin.
Fight to the Death
Even though the tobacco industry won the battle by killing the McCain bill (Democrats vowed to attach it to other legislation in hopes of resurrecting it), tobacco CFOs might eventually regret that victory. That's because having the certainty of a settlement would have allowed them to be much more aggressive in creating shareholder value, say industry observers. Kasprzak, for example, says that in a post-settlement environment, tobacco chiefs could have thought about spinning off their tobacco enterprises altogether--as long as regulators didn't view such action as a so- called fraudulent conveyance. "Separating would enhance the value of the food companies," he says. "If they're [ever] allowed to do it, I think it will happen." And Black says that many of the companies would finally have been comfortable taking on the debt they should have taken on years ago. "It's a crime," he says, "that the UST balance sheet carries no debt."
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