Vector Group Ltd. (NYSE:VGR) is a holding company with two distinctive operating arms in its 'Liggett Group' tobacco business along with the 'Douglas Elliman' real estate brokerage. In some ways, this quirky diversification has its benefits as cigarettes are recognized as highly profitable with steady cash flows while real estate offers ongoing growth opportunities. Indeed, even as the company's real estate portfolio with exposure to New York City was pressured by the pandemic, Vector group was able to remain profitable in 2020 and is now benefiting from an improving outlook. We are bullish on the stock particularly as it relates to a recovery in its real estate business this year and see attractive value at the current level. Notably, VGR yields 5.7% which we believe is well supported by underlying fundamentals.
VGR Earnings Recap
Vector Group reported its Q4 earnings on February 25th with GAAP EPS of $0.21, beating expectations by $0.05. Similarly, revenue in the quarter at $555 million climbed 26.2% year over year and was $105 million above consensus estimates. Net income in the quarter at $32.3 million more than tripled from $10.7 million in the period last year.
Overall, this was a solid quarter for the company, particularly as the real estate business presented a turnaround compared to weaker results in the first half of the year. For the full-year 2020, revenues reached $2.0 billion, up a more modest 5.2% over 2019. The operating income for 2020 at $245 million also climbed 6.0% over last year supported by cost-cutting measures implemented in response to the pandemic.
(selected financials. source: company IR/ annotation by BOOX Research)
By segment, the tobacco business has been a strongpoint highlighting by the 36.9% gross margin, up from 30.8% in Q4 2019. Part of this trend is based on an industry-wide pricing increase Liggett was able to benefit from along with higher volumes. Management commented on the performance of the Liggett group during the conference call pointing to momentum in the 'Eagle 20's' brand. Liggett group retail share in Q4 declined slightly to 4.21% from 4.25% in the same period last year. From the conference call:
During the fourth quarter, Liggett continued its strong year-to-date performance with revenue increases and margin growth contributing to a 33% increase in Tobacco adjusted operating income. As noted on previous calls, we are well into the income growth phase and for our Eagle 20's business strategy and remain very pleased with the results. Our market specific retail programs have proven successful and we remain optimistic about Eagle 20's increasing profit contributions and long-term potential.
For context, the tobacco and cigarette business is the primary earnings driver of the business as the adjusted EBITDA of $328 million in 2020 represents nearly 98% of the $333.4 million firm-wide total. On the other hand, the real estate business included some impairment charges last year along with losses on equity investments from corporate-level real estate ventures.
(source: Company IR)
The story in the real estate segment was the strong turnaround in key markets including New York City. Consistent, with the housing market boom, the Douglas Elliman brokerage business saw strong sales volumes generating commission fees and related revenues to the holding company. Management also noted during the conference call that savings initiatives implemented over the past year supported operating income for the group.
In the fourth quarter of 2020, Douglas Elliman's revenues increased by 50% from the fourth quarter of 2019 as its closed sales continue to improve and all markets complementary to New York City including the Hamptons, Palm Beach, Miami, Aspen and Los Angeles. Our New York City business began to stabilize in the fourth quarter and we are well-positioned in New York City. Furthermore, Douglas Elliman's reduction initiatives continued in the fourth quarter, and as fourth-quarter 2020 operating and administrative expenses excluding restructuring and asset impairment charges declined by approximately $7.9 million compared to the fourth quarter of 2019 and $47.7 million compared to the year ended December 31, 2019. We believe these initiatives have and will continue to provide long-term upside to Vector Group stockholders.
(source: Company IR)
Within Vector Group the company's New Valley real-estate development business also invests in residential, office, and commercial properties across the U.S. which remains a smaller, yet strategic part of the overall business. To that point, the company just announced the launch of the separate "New Valley Ventures" targeting opportunities in property-technologies or "PropTech". The intention is to invest in startups that are emerging with innovative solutions that can benefit the real estate brokerage market based on a shift the company is seeing with agents and brokers utilizing more and more digital assets.
In terms of the balance sheet, Vector Group ended the quarter with $353 million in cash and equivalents against $1.4 billion in long-term debt. Considering the consolidated adjusted EBITDA of $333 million over the trailing twelve months, we calculate a net debt to adjusted EBITDA leverage ratio of 3.1x which is in the context of the real estate business profile. Our take is that the balance sheet position and liquidity profile are stable in the current market environment.
A Sustainable Dividend
Vector Group pays a quarterly dividend of $0.20 per share that represents an annualized payout of about $120 million and yields 5.7%. The latest distribution was just announced for shareholders with a record date on March 19th payable March 30th. This dividend rate was cut in Q1 2020 during the early stages of the pandemic given what at the time was cash flow uncertainties. We believe the updated distribution amount is more sustainable. This is a view shared by management during the conference call:
Vector Group has strong cash reserves, has consistently increased its tobacco market share and profits and has taken the necessary steps to position its real estate business for future success. We are pleased with our long-standing history of paying a quarterly cash dividend, it remains an important component of our capital allocation strategy. While we will continue to evaluate our dividend policy each quarter, it is our expectation that our policy will continue well into the future.
Analysis and Forward-Looking Commentary
Shares of VGR have climbed about 20% year to date in 2021 with a big rally since early November. We believe the trend coincided with the broader market momentum following news of the first COVID vaccine approval from Pfizer Inc. (PFE) and BioNTech (BNTX) which set the stage for the market to look ahead toward an eventual end to the pandemic.
As it relates to VGR, the company's exposure to the New York City real estate market including the brokerage of office space had been a big concern over the past year. In this regard, the outlook has improved with an expectation that over the next year more people will return to the office environment, setting the stage for a recovery in not only commercial real estate in the area but also adjacent residential properties.
Our take is the Vector Group through Douglas Elliman is well-positioned to benefit from the improving dynamics. More broadly, the ongoing economic recovery combined with continued stimulus measures also bodes well for consumer spending which is also a fundamental tailwind for the business.
The attraction here is the stock's 5.7% dividend yield. As mentioned above, we believe the payout is safe and well supported by underlying cash flows. The tobacco business represents a less volatile business segment that we believe can continue to provide a financial backbone to the holding group.
In terms of consensus expectations, the market is forecasting revenues to climb 9.3% this year to $2.2 billion while EPS at $0.81 nearly flat compared to 2020. We believe these estimates can prove to be conservative setting up an upside catalyst for the stock with stronger than expected results in the upcoming quarters.
Overall, we are bullish on VGR with a price target of $16.00 for the year ahead representing a 20% total return from the current level including the dividend income. Notably, shares are currently trading at a forward P/E of 17.2x - at a discount to the 3-year average for the stock closer to 23x. Our price target implies a forward P/E of 20x.
In terms of risks, one concern is the rising interest rate environment and how that can impact both high-yield stocks like VGR along with the real estate sector in general. We believe the company's exposure to real estate more on the brokerage side is less sensitive to these changes mitigating the negative impacts from higher rates compared to the broader industry. Nevertheless, larger market volatility going forward could end up pressuring the stock. It will be important for the company to continue presenting climbing revenues and strong cash flow data. Monitoring points for the upcoming quarters include financial margins while we also like to track the market share data for the tobacco business.
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