For decades, the leaders of Philip Morris sought to insulate their company from the costs of smoking-related lawsuits by accumulating a stable of other consumer products. But early this decade they did an about-face, concluding that their tobacco and food businesses could prosper better as independent companies.

When the separation was finalized on March 30, investors acted as if Altria had handed out bricks of Limburger cheese (Altria shareholders received 0.692 shares of Kraft for each Altria share they owned). Many dumped Kraft, maker of Cheez Whiz, Kool-Aid, Oreo cookies and other packaged foods and beverages, in the first few days after its liberation. Kraft's stock fell 3%, to $31, before recovering to $33 in mid April. Altria soared 7%, to $71, in the first week after the spinoff and closed at $70 in mid April.

The initial reaction seemed to make sense. Altria, now essentially a pure play on tobacco, comes away from the transaction with a stronger balance sheet, says Charles Norton, manager of Vice fund. That's because many of the combined company's liabilities were shunted over to the newly independent Kraft. A financially stronger Altria could buy back as much as $40 billion worth of its shares, says Norton, whose fund invests mainly in tobacco, alcohol, gaming and defense stocks. That would bode well for shareholders.

Moreover, the industry has won many key court cases in recent years, so the liability risk for tobacco companies has receded. As evidence of a more favorable climate, Norton notes U.K.-based Imperial Tobacco's entry into the U.S. market with its recent purchase of Commonwealth Brands, a Bowling Green, Ky., company.

Altria's stock (symbol MO) sells at a reasonable 16 times estimated 2007 earnings and will probably yield a lush 4% or so once the company announces a new dividend rate that adjusts for the Kraft spinoff.

Cash cow

Wall Street's view of the liberated Kraft (KFT) ranges from tepid to bearish. Many analysts fear that rising commodity prices and competition from private-label brands will squeeze Kraft's profit margins. But food producers can increase prices to deal with higher commodity costs, says Donald Yacktman, who co-manages Yacktman fund and Yacktman Focused fund. He calls Kraft a "cash cow" and thinks the threat from generics is overblown because quality-conscious consumers will still buy brand-name products.

Keep in mind, too, that spinoffs often deliver superior returns once unshackled from their parent companies. That's because newly independent managers have incentives to help their company catch up with its peers in sales, earnings and stock price. The spinoff gives Kraft the flexibility to tap the prodigious amount of cash the company generates (an estimated $2.3 billion in 2007) for acquisitions, says Bear Stearns analyst Terry Bivens. One potential target might be the candy business of Cadbury Schweppes, he says. Bivens gives the stock a neutral rating.

At least one analyst, JPMorgan's Pablo Zuanic, is bullish on Kraft. He says that Kraft's price-earnings ratio -- 18 based on estimated 2007 earnings -- is below that of other packaged- food companies. And he believes that Kraft can exceed the low earnings targets that executives have set. He rates the stock "overweight" and thinks it will be worth $40 by June 2008.

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