Tickers in this Article: MO, RAI, LO, PM, BTI
The year 2009 was relatively uneventful for the tobacco industry. And that's not necessarily a bad thing. Altria Group (NYSE:MO), Reynolds American (NYSE:RAI) and Lorillard (NYSE: LO), which together control 90% of the U.S. cigarette market, continued to deliver high operating margins and significant free cash flow. As a result, all three benefited from double-digit stock price increases in 2009. Even international competitors Philip Morris (NYSE:PM) and British American Tobacco (NYSE:BTI) saw their stocks jump this year, despite an increase in federal excise taxes. The increase brought higher prices and lower volumes to everyone in the industry. Fitch Ratings expects that this will continue into 2010 due to increases in state excise taxes and nagging high unemployment.

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Menthol Ban
In June, the Family Smoking Prevention and Tobacco Control Act was passed into law banning all cigarette flavoring with the exception of menthol, which accounts for 29% of all cigarettes sold in this country. Because minorities are heavier users of menthol cigarettes, the federal government asked the FDA to look at the menthol situation and come up with a recommendation, expected sometime in 2010. Lorillard would suffer greatly from an outright ban, as its Newport brand accounts for 85% of its cigarette volume. Investors need to keep an eye on these developments heading into the middle of 2010. Smokeless Joe
In early January, Altria completed its $10.4 billion buyout of smokeless tobacco company UST Inc. This gives it a dominant position in the fastest growing segment of the tobacco industry. Because of the acquisition, Altria made no share repurchases in 2009, opting to conserve cash for debt repayment instead. The company likely will do the same in 2010. However, it did return to shareholders more than 70% of its net income in the first nine months of the year in the form of dividends, providing investors with a good combination of income and capital gains.

No Litigation
In November, Florida's Broward County Circuit Court awarded $300 million in damages to a wheelchair-bound 61-year-old ex-smoker with emphysema. It was the largest award to date of 8,000 cases originating from the 2006 class action suit that was thrown out. Philip Morris believes the punitive damages awarded were a violation of state law and, therefore, is seeking a review of the judgment. Other than this case, there was minor action on the litigation front in 2009 and 2010 looks equally quiet, which is good news for investors.

Bottom Line
The cigarette makers continue to be a great place to put your money. (To learn more about investing in tobacco companies and other "sin" stocks, read A Prelude To Sinful Investing.)

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