Do Rjr Bulls Have Smoke In Their Eyes?

Investors have turned wildly enthusiastic over RJR Nabisco Holdings' new stock, making it the market's latest star. Few other stocks have been as active--and gained as much--in the two months that it has been trading. Shares of the newly restructured tobacco and food giant have soared 120%, to 12 from around 5 in February.

Is this the same RJR that leveraged itself to the gills after the Kohlberg Kravis Roberts buyout in 1989? That acquisition required financing of some $26 billion, in addition to the company's existing $5 billion debt. Since then, the maker of Camel cigarettes and Nabisco foods has sold assets worth $6 billion. But debt is still a huge $18 billion. Even so, investors seem eager to buy. They remember the lofty price of the old RJR stock, or imagine that they are buying another Philip Morris.

But watch out. Some savvy pros believe the stock has run way ahead of itself. "Investors are already paying for earnings that probably won't be realized until 1994-95," says a West Coast money manager. Moreover, he warns, RJR will continue to sell stock in order to raise cash, although it already has nearly 1 billion shares outstanding.

John McMillin, analyst at Prudential Securities, agrees. "Compared to Philip Morris and other tobacco and/or food stocks, the RJR shares are overvalued," he says. RJR is trading at 7.5 times its 1990 earnings (before interest, taxes, depreciation, and amortization). "Companies that are more growth-oriented, better capitalized, and have better balance sheets, such as Philip Morris and Ralston Purina, sell at similar multiples," he says. "Philip Morris is definitely a better buy than RJR."

SURPRISE. RJR's stock has already reflected the good news on management's efforts to shrink RJR's high-cost debt. The big concern now is the drop in domestic tobacco sales, particularly for its Winston and Salem cigarette brands. That, McMillin figures, will result in at least a $50 million aftertax loss in the first quarter. The loss will surprise investors, says McMillin, when earnings are reported this month.

RJR's long-term prospects look bright, says the analyst, but he sees short-term risks in the stock. The company needs to boost spending to hold its share of the tobacco market: "After squeezing profit margins to meet interest payments, RJR has lost share in its principal profit area." McMillin expects management to put more emphasis now on brand-stabilizing, rather than profit growth.

So far, there's little unfavorable comment on the Street about RJR. The company has hired many of the big houses--Goldman Sachs, Merrill Lynch, Morgan Stanley, Bear Stearns, Salomon Brothers, and Credit Suisse First Boston--to handle a stock offering of 75 million shares. The underwriting legally bars them from commenting on the stock for several weeks.

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