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(Mel Evans)
(Mel Evans)

Much-reviled tobacco still smoking hot Add to ...

U.S. tobacco stocks are demonstrating again that a widely despised product isn't necessarily an obstacle to big profits and a robust share price.

The S&P 500 tobacco index of four stocks hit another record high on Monday, bringing its one-year gains to more than 33 per cent after factoring in the stocks' fat dividends. That's about double the pace of the benchmark S&P 500.

The most recent uptick follows two recent positive developments for the tobacco industry, even as it faces long-term declining smoking rates in North America and tighter marketing conditions. On Monday, a Florida state court ruled in favour of Philip Morris International Inc. and R.J. Reynolds in an Engle case - a series of cases allowing individual smokers to sue tobacco companies after the dismissal of a class-action lawsuit years ago.

That victory comes a little more than a week after a much-anticipated draft report from the Tobacco Products Scientific Advisory Committee (TPSAC) said what needed to be said about menthol cigarettes - their minty flavour can appeal to younger people and can make quitting more difficult for some smokers - but stopped short of advising an outright ban.

"The availability of menthol cigarettes has an adverse impact on public health by increasing the numbers of smokers," the committee said in its report to the Food and Drug Administration. Removing the cigarettes from the U.S. market would be a good move, but the panel said it had "no specific suggestions" on how the FDA should respond, and it recommended more studies.

The result? Given that menthol cigarettes account for about 30 per cent of U.S. cigarette sales, investors breathed big sighs of relief - and then pounced. The tobacco index, which consists of Altria Group Inc. , Lorillard Inc. , Philip Morris International and Reynolds American Inc. , has gained for eight straight days, rising more than 7 per cent in total. Even with the gains to record highs, the dividend yields remain attractive, ranging between 3.9 per cent and 6 per cent. (Full disclosure: I own shares in Altria and Philip Morris.)

Last week, Nik Modi, an analyst at UBS, reiterated his "top pick" recommendation on Lorillard and raised his target price on the stock to $102 (U.S.) from $93. It closed at $95.86, up $1.12.

"Follow-up discussions with our contacts post-TPSAC's menthol report leave us more positive on our stance that the FDA is unlikely to enforce a ban on menthol when it makes its final decision (timeline undefined)," he said in a report on Friday.

That is partly because governments rely upon cigarette tax revenue, especially in today's era of looming budget cuts. Mr. Modi estimated that menthol cigarettes alone account for about $5-billion a year in tax revenue, representing a source of income that governments aren't keen to give up.

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