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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: 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: What did the spinoff of Kraft (NYSE:KFT) bring to the party for Philip Morris (NYSE:MO)?

Ms. Herzog: I think the partial IPO of Kraft was a very good catalyst. Since that was announced, about a year ago, the stock has done very well. That was one of the main catalysts that helped drive the stock higher. Since it’s been IPO’d, the stock has remained relatively flat or has been down, but I think it now forces the market to put a value on the very attractive food assets, and it makes it easier to value all the different pieces of Philip Morris. Also, I think it highlights the compelling valuation even more because of what I just walked through. It kind of shows the market now that Philip Morris’ US tobacco business is really trading at almost basically zero or negative value, so there’s the opportunity.

TWST: Are further spinoffs of other divisions or acquisitions likely for Philip Morris?

Ms. Herzog: Right now, with Kraft Foods, I don’t expect anything in the short term in terms of a further sale or a spinoff. They have no plans to do that right now. I do expect some food acquisitions. I would expect that more in the international business. In terms of other sales or spinoffs, I wouldn’t be surprised if they were to make a decision to possibly do something with Miller, which could mean selling it or spinning it off. Otherwise, I would like to see the company do something or acquire something overseas in their tobacco business. The reason I say that is, a lot of the analysis I do is return on invested capital work, and the company’s highest returning business behind tobacco in the US (and of course their hands are tied with regard to doing anything more here) is international tobacco, where they generate close to 40% returns. So it would be very attractive for them to do something overseas. The right acquisition would create a lot of value for shareholders.

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.