Vector Group Ltd.: An Attractive Company With A Significant Upside Potential (NYSE:VGR)

Investment Thesis

Vector Group Ltd. (NYSE:VGR) shares have gained about 42.87% over the last 5 years. Despite this significant gain, I am bullish on this stock in the long-term because I find it with strong levers such as its low-cost model and strong market position. Further, the company’s tobacco business segment is very resilient despite strong headwinds. From a valuation perspective, VGR is undervalued on relative metrics and has a double-digit upside potential according to my DCF model. For these reasons, I recommend this stock to potential investors.

Why You Should Consider VGR

Upon evaluating VGR, the company has several attractive attributes that I believe are worthy of your attention as an investor and perhaps, they may justify an investment decision here. To begin with, the company has a very attractive dividend history. It has a track record of paying dividends for 23 consecutive years, compared to the sector median of 14 years. Additionally, the company has a 3-year dividend CAGR of 15.65% which is way above the sector median of 5.45%. Further, its dividend yield is very appealing as well, with a 4-year average dividend yield of 7.42% way above the sector median of 2.41%, and a trailing yield of 8.04% significantly above the sector median of 2.74%. Given this information, I think VGR is a good choice on the dividend front because it beats the sector medians and following its consistent dividend payment, it is a reliable dividend income stock.

Secondly, its major business segment (Tobacco segment) is very resilient and profitable. The division accounts for more than 98% of its total revenue, and therefore, any major downturn here could have a detrimental effect on this organization’s financial health. Despite the declining smoking rates and increased litigation and regulations in the tobacco industry, this segment has remained unshakable. In FY 2022, the segment’s revenue was $1.425 billion, an increment of 18.51% from the previous year.

This resilience has been extended to 2023, with the tobacco adjusted EBITDA for Q3 2023 growing by 7.4% YoY to $96.3 million from $89.6 million in 2022 and for the nine months ending September 30, 2023, adjusted EBITDA grew by 5.6% YoY to $271 million up from $256.6 million in 2022. With this strong ability to withstand headwinds and deliver strong results, I believe the company’s future financial health is almost immune to macroeconomic headwinds, which is very attractive to investors in my view.

The other attractive aspect of VGR is its low-cost business model. This business model serves as a major competitive advantage because it allows the company to offer low-priced products or rather discounted products, which in my view explains the resilience of its tobacco segment. Through its subsidiaries such as Liggett Group LLC, the company sells its low-priced products such as the Liggett Select and Pyramid brands. As of Q3 2023, VGR had a cost advantage of $0.92 per pack. Further, they had a cost advantage ranging between $160 million and $170 million arising from its MSA exemption annual cost on its subsidiaries.

This low-cost model translates to low operating costs, hence higher margins, and the discount pricing alludes to affordable products, and hence higher sales compared to premium brands. As a result, I think this serves as VGR’s MOAT, and it is a compelling reason to believe that this company’s future financials are in haven.

Besides the low-cost business model, VGR has a vast and increasing market share, which bodes well for its future growth. Its market presence has grown due to the company’s growth initiatives, such as repositioning some of its brands in the market. These initiatives have not only grown the company’s market presence, but also its EBITDA over time, as shown below.

From this perspective, the company appears to be a consistent generator of strong cash flows, as exhibited by the solid EBIDTA performance. Further, the growing market share is very promising as far as future growth is concerned and therefore positions this stock as a good investment.

Valuation

Based on relative valuation metrics, VGR is significantly undervalued with a trailing PE ratio of 9.03 which trades a discount of 56.41% to the sector median of 20.71%. Further, its trailing PEG ratio of 0.37, which factors in growth, trades a whopping 54.14% discount to the sector median of 0.81%. This implies that this stock is significantly undervalued based on its earnings and growth potential. To me, this is where value is! To support this undervaluation, I ran a DCF model where I assumed a growth rate of 5% which is conservative considering the company’s 9% 5-years free cash flow CAGR. I also assumed a discount rate of 8% which is the company WACC according to my computation. Using the TTM FCF/share of 1.20 as my base, I arrived at a fair value of $15.35 which represents an upside potential of 56%.

Given this case of significant undervaluation, I believe this is a good entry point for potential investors given the attractive attributes of this company discussed in the preceding section of this analysis.

Risks

While I am bullish on this stock, investors need to be wary of the potential risks of investing here. One of the major risks of investing in VGR is the regulatory and legal risk. The company is currently faced with several legal issues which could significantly affect its reputation and financial performance. For example, it is paying ~4 million until 2028 related to its settlement with about 4,900 Engle Progeny plaintiffs. In addition, it has other pending cases that add to the dynamic regulations, which could affect its performance in the future.

Given this background, I urge investors to keep a close eye on the progress of these cases and regulatory changes and how the company responds to them.

Conclusion

In conclusion, I find VGR a good investment given its attractive attributes, especially its growing market share, resilient tobacco business, and the low-cost model which bodes well for its future performance. Further, the company is significantly undervalued, offering a decent entry point for potential investors. For these reasons, I rate this stock a buy.