RJR Has New Look; but Still Top Cookie?
By George Anders and Roger Lowenstein

02/13/1991 The Wall Street Journal PAGE C1

NEW YORK -- Of the scores of stockbroker inquiries now flooding RJR
Nabisco, none better summarizes the public's knowledge of the company
than a recent call from a broker in Tampa, Fla.

Does RJR Nabisco still make Oreos?, the broker asked. Assured that it did,
he promptly put the stock on his buy list.

Two years after going private in the biggest ever leveraged buy-out, RJR has
returned to the New York Stock Exchange. The stock, now trading on a
"when issued" basis, topped the most-active list for seven days in a row as it
surged to 7 1/4 from 5 1/2 on Feb. 1.

RJR is especially hot with brokers catering to small investors. Some of these
brokers are pushing the stock as the best thing since, well -- the old RJR
Nabisco.

But investors will need to digest a lot more than RJR's trademarked ,
cream-filled cookie to understand the company's new look. Though the Oreo
hasn't changed, practically everything else about the company has.

Naturally, the new RJR has much more debt. Total debt, even after some
repayments the past two years, is $17.9 billion, more than triple the
pre-buy-out level. More tellingly, the company's product mix is changed. The
pre-buy-out RJR, like Philip Morris today, diversified itself by funneling
tobacco cash flow into food company acquisitions. Today RJR relies on
tobacco for 78% of its operating profit -- up from 63% in 1988 -- and its
dependence on tobacco is expected to increase in years ahead.

RJR also has cut a lot of waste. Most, though not all, of the corporate jets
and glitzy sports promotions are gone, as is the openhanded spending style
of F. Ross Johnson, RJR's former boss.

But the real magic has come at the operating level. Profit margins in
domestic tobacco have risen by 31%; in overseas tobacco by 17%. And in
food, shrunken by asset sales, margins have climbed by 22%.

On the down side, RJR's share of the U.S. tobacco market has slipped, in
part because archrival Philip Morris has concentrated on marketing its
dominant Marlboro brand while RJR has had its ears pinned to the task of
paying down debt.

All these changes have sharply altered how the public ought to size up RJR
as an investment. Before the buy-out it was a so-called safe stock -- clip the
dividend, watch earnings grow, and pray that management didn't make a
mess of reinvesting profits.

Now RJR has become what one fan calls a "high-octane" stock. It pays no
dividend, and won't for a good while. It hasn't any per-share earnings and
won't have significant net income for at least a couple of years. What RJR
has is the octane of leverage, harnessed to a business almost wholly
dependent on tobacco.

If, as analysts predict, RJR's operating profit increases 10% or about $300
million annually, a bit less than its rate since the buy-out, the bottom line
should improve much faster. Kidder Peabody's Roy Burry looks for negligible
per-share earnings this year, a dime or two in 1992 and as much as $1 in
1994.

In a way, the buy-out by Kohlberg Kravis Roberts & Co. solved the
tobacconist's perennial problem of what to do with excess cash flow. RJR is
on a forced march to reduce debt, a better use of cash than it might have
found outside the lucrative tobacco business. And last week Moody's
Investors Service upgraded RJR's junk-rated senior debt to one notch below
investment grade. If cash flow keeps rising, RJR might be able to win an
investment-grade rating and refinance its costliest debt, which pays 15% to
17 3/8%. Such a move is likely to be years rather than months away, but is
being explored by KKR. The potential saving -- on the order of $400 million in
annual interest -- does tend to grab an investor's eye.

High octane, of course, can backfire. Though RJR seems to have avoided the
graveyard of many late-1980s LBOs, a small disappointment in operating
profit would leave the company with much less in net income than investors
expect. Given RJR's recent rally, Mr. Burry and some of his peers believe too
much optimism is already factored into the stock. Other analysts, such as
Salomon Brothers' Diana Temple, are gung-ho. But the Street remains unsure
of how to value RJR. If meaningful earnings are years away, what is the stock
worth now?

RJR, in the midst of a bond swap offer, won't comment. Equally silent is KKR
-- which owns about 59% of the stock on a fully diluted basis and isn't
expected to sell shares for many years. And so it is up to the public -- which,
with 175 million shares and warrants, has a 17% stake -- to value the
company.

One way is to compare RJR's cash flow with its stock and outstanding debt.
For $25.9 billion, for instance, a mythical investor could buy all of RJR's stock
and retire all of its debt. That would mean paying about seven times RJR's
1991 estimated cash flow, or earnings before interest, taxes and
amortization, of $3.68 billion. Philip Morris, measured by the same yardstick,
trades at a slightly more pricey multiple of 7.4 times cash flow.

Philip Morris, with its stronger balance sheet and stronger cigarette brands,
probably deserves a higher multiple. Thus, relative to Philip Morris, RJR
hardly looks cheap.

A more serious question involves the decline of RJR's top two cigarette
brands, Winston and Salem. So far, the industry's ability to raise prices has
enabled RJR to boost cash flow from tobacco even as the number of packs
sold fell. If that pattern continues, RJR's lack of diversification might not be
the negative that analysts suggest. In financial terms, tobacco is a dream of
a business; the product is addictive, and the threat of litigation deters
competition.

But according to Wheat First Securities analyst Jack Maxwell, the combined
market share of Winston and Salem tumbled to 14.9% last year from 18% in
1988. Even in tobacco, such slides can't be long endured. RJR's easy gains
from cost-cutting are behind it. With U.S. cigarette consumption shrinking a
steady 2% to 3% a year, shoring up Winston and Salem becomes all the
more urgent.

RJR's old management tried to revive Winston for years and failed. Its new
management aims to do better. A touched-up Winston featuring new paper,
new filter and new packaging is in the works. Most important will be RJR's
marketing -- aiming at capturing some of Marlboro's market and ridding
Winston of its stodgy image. After that, it will be Salem's turn.

It will be years before the results of these campaigns are known, and on them
rests much of RJR's future. RJR's de-leveraging plan hinges on its ability to
cut interest expense and return to investmentgrade status. In large part, says
William Wetreich, senior vice president of Standard & Poor's, that depends
on "stabilizing market share" in tobacco.

---

A Much-Changed RJR Nabisco Returns to the Stock Market

SIZE PRE-BUY-OUT RJR NOW 1988 1990

Revenue $17.0 billion $13.9 billion Operating profit $2.97 billlion $3.43 billion
Total employees 116,881 64,000* Tobacco market share 31.8% 29.6% Share
of Operating profits from tobacco 63% 78% Whosesale price of 1,000
Winstons $43.65 $55.75 Price of 20-oz box of of Oreos $2.49 $2.61

EFFICIENCY

Corporate Jets 11 4 Domestic tobacco profit margins 30.2% 39.7% Corporate
expense $166 million $105 million Tax expense $893 million $60 million

FINANCIAL STATUS

Credit rating Single-A Double-A Operating profit/interest coverage ratio 4.9
times 1.5 times Net income (loss) $1.4 billion ($0.43billion) Market value of
common** and preferred $25.3 billion# $8.0 billion## Face value of debt** $5.2
billion## $17.9 billion## Total enterprise value $30.6 billion $25.9 billion

*Excludes work force at Del Monte and other divested units **Assumes
completion of current exchange offer #As of Feb. 9, 1989 ##As of Feb. 12,
1981

Sources: RJR Nabisco Inc; Wheat First Securities Inc.; Kidder Peabody &
Co.