Morgan Stanley issued two research reports on the tobacco industry on Monday -- a bullish one on the sector's future, and a negative one on

R.J. Reynolds



Morgan Stanley analyst David Adelman published a glowing report on the future of the tobacco industry, citing strong financials, sales growth in Europe, consumer loyalty and a reduction in legal risks in America. Meanwhile, he downgraded R.J. Reynolds to underweight from equal weight, saying that it was overvalued.

"The presentations by several leading global tobacco manufacturers reconfirmed our view that the industry, within the staples context, continues to enjoy an above-average fundamental operating outlook," Adelman said in the industry report.

In the R.J. Reynolds report, he noted that the company trades at 12.3 times its 2003 earnings per share projection. "As we have outlined over time, RJR has the industry's lowest profit margin structure and faces the group's most significant competitive challenges," he said. "Relative to the group, in our view, the shares appear overvalued."

Adelman is maintaining an attractive rating on the sector.

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According to the industry report, tobacco manufacturers enjoy structural advantages over other producers of staple goods in the market. It's almost impossible for new, large-scale competitors to enter the market due to the strong brand loyalty held by tobacco consumers, the report said. From their high operating margins to strong cash flow and pricing power, tobacco manufacturers boast solid fundamentals and wield significant sway over distributors, wholesalers and retailers, the analyst said. As the risk of class-action suits against tobacco companies diminishes in the U.S., investors will be able to focus on these positive fundamentals, he added.

Shares of R.J. Reynolds were down 1.8%, or 66 cents, at $36.34 in noon trading.


(MO) - Get Altria Group Inc Report

shares were up 2.7%, or $1.17, at $44.18.



was up 0.3%, or 13 cents, at $39.94.