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Two analysts and top management from three sector firms examine the Tobacco sector in this special 22-page issue from The Wall Street Transcript, available at (212/952-7433) or http://www.twst.com/info/info408.htm.

TWST: How should investors interpret the legal challenges that the companies are facing today?

Ms. Herzog: Importantly, I think investors should look at the overall trend: it is upward. It’s improving. However, there have been some minor setbacks. I sort of look at it like climbing a hill. There are potholes, there are bumps in the road. It’s not going to be smooth sailing, but again, it’s an upward trend. And that’s why the stocks have done well. Over the last 12 to 18 months, they’ve clearly outperformed the market. I continue to expect the stocks to do well because I do believe that they’re very attractive in terms of valuation.

TWST: Looking at the outlook for the tobacco industry going forward, let’s start with demand in the US and other regions of the world. What effect have public health campaigns and higher prices had on demand for tobacco products, and specifically for cigarettes?

Ms. Herzog: Interestingly, the way I look at consumption is, it’s not a one-factor model, meaning it’s not just pricing that impacts the cigarette business. There are several factors, and you mentioned two: pricing and the anti-tobacco movement. There are also health concerns that have impacted consumption. There’s also the issue of smokers not having many places left to enjoy a cigarette, which makes it harder. There are several factors that impact consumption, and if you look at the last eight to 10 years, the secular demand trend has been anywhere between -1% and -2%. Recently, we’ve actually seen consumption move a little bit higher. It’s maybe closer to flat to down 1%. So I think when you look at this industry as an investor, you have to understand that volume is declining and has been for several years. However, importantly, you get pricing. This industry has been able to increase prices on average by mid- to upper single-digits every year for the last 30 years. This is key to the story and one of the main reasons why the fundamentals are so strong. The companies are able to generate very attractive profits in the US and that’s why this market is still very important.

TWST: In which markets will that volume growth be achieved?

Ms. Herzog: We see a lot of the growth coming from the emerging markets. I would point to some of the developing markets such as Eastern Europe. I also look at Asia as a fast-growing market. I primarily focus on the top 20 markets globally. In terms of some of the faster-growing markets, I would say Russia, Indonesia (and these are, again, top markets) and Turkey are growing. There are a lot of these types of markets that are fast-growing and attractive.

TWST: Bonnie, you also follow US Tobacco. Does US Tobacco face any of the same or similar litigation issues that the cigarette manufacturers face?

Ms. Herzog: The nice thing about UST (NYSE:UST) is that it has limited litigation risk, but unfortunately, a lot of times, the stock trades with the cigarette manufacturers. That does present some opportunity for investors. I am neutral on the shares right now. The stock has had a nice run. When I look at valuation, I think it’s pretty close to fair value. Yes, they do have the benefit of limited litigation, so if you want to play in tobacco or invest in tobacco without litigation risk, that’s the place to be.

This special issue includes:

1) Tobacco Stocks - In an in-depth (4,400 words) Analyst Interview, David Adelman, Principal at Morgan Stanley Dean Witter, examines the outlook for the sector and shares specific stock recommendations.

2) Outlook for the Tobacco Industry - In an in-depth (3,800 words) Analyst Interview, Bonnie Herzog, Vice President at Credit Suisse First Boston, examines the outlook for the sector and shares specific stock recommendations.

3) CEO interviews (average 2,500 words). Top management of three sector firms examine the outlook for their firm and the sector.