Vector Group Ltd. (NYSE:VGR) Q2 2022 Earnings Conference Call August 5, 2022 8:30 AM ET
Company Participants
Howard Lorber – President and CEO
Richard Lampen – COO
Nick Anson – President and COO, Liggett Vector Brands
Bryant Kirkland – CFO
Ron Bernstein – Senior Advisor, Liggett Vector Brands
Conference Call Participants
Ian Zaffino – Oppenheimer & Co.
Karru Martinson – Jefferies
Operator
Welcome to Vector Group Ltd’s Second Quarter 2022 Earnings Conference Call. During this call, the terms adjusted operating income, adjusted net income, adjusted EBITDA and tobacco adjusted operating income will be used. These terms are non-GAAP financial measures and should be considered in addition to, but not as a substitute for, other measures of financial performance prepared in the accordance with GAAP.
Reconciliations to adjusted operating income, adjusted net income, adjusted EBITDA from continuing operations and tobacco adjusted operating income are contained in the company’s earnings release, which has been posted to the Investor Relations section of the company’s website located at www.vectorgroupltd.com.
Before the call begins, I would like to read a Safe Harbor statement. The statements made during this conference call that are not historical facts are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those set forth in or implied by the forward-looking statements. These risks are described in more detail on the company’s Securities and Exchange Commission filings.
Now, I’d like to turn the call over to the President and Chief Executive Officer of Vector Group, Howard M. Lorber.
Howard Lorber
Thank you. Good morning, and thank you for joining us for Vector Group’s second quarter 2022 earnings conference call. With me today are Richard Lampen, our Chief Operating Officer; Bryant Kirkland, our Chief Financial Officer; and Nick Anson, President and Chief Operating Officer of Liggett Vector Brands. Ron Bernstein, Senior Adviser to Liggett Vector Brands, will also join us during the Q&A.
During this call, I will review Vector Group’s consolidated financial results for the second quarter of 2022. Nick will then summarize the performance of our Tobacco business. I will then provide closing comments and open the call for questions.
Before reviewing Vector Group’s consolidated financial results, please note that because of the spin-off of Douglas Elliman in the fourth quarter of 2021, Douglas Elliman’s financial results are presented as discontinued operations in Vector Group’s consolidated financial statements for the 2021 period, and are excluded from our adjusted results.
Now turning to Vector Group’s consolidated balance sheet. Our balance sheet remains strong as of June 30, 2022. We maintained significant liquidity with cash and cash equivalents of approximately $324 million, including cash of $105 million at Liggett. We also hold investment securities and investment partnerships with a fair value of approximately $168 million.
Turning to Vector Group’s consolidated results from operations for the 3 months ended June 30, 2022. Vector Group revenues for the quarter were $387.2 million compared to $337.6 million in the second quarter of 2021. Net income was $39.2 million or $0.25 per diluted common share compared to $93.3 million or $0.60 per diluted common share in the second quarter of 2021.
Net income from continuing operations was $39.2 million or $0.25 per diluted common share compared to $65 million or $0.41 per diluted common share in the second quarter of 2021. The company recorded adjusted EBITDA from continuing operations of $95.1 million compared to $99 million in the second quarter of 2021. Adjusted net income from continuing operations was $40.2 million or $0.25 per diluted share compared to $64.6 million or $0.41 per diluted share in the second quarter of 2021.
Turning to Vector Group’s consolidated results from operations for the 6 months ended June 30, 2022. Vector Group’s revenues for the 6 months ended June 30, 2022, was $699.2 million compared to $608.5 million in the 2021 period.
Net income was $71.7 million or $0.45 per diluted common share compared to $125.3 million or $0.80 per diluted common share in the 2021 period. Net income from continuing operations was $71.7 million or $0.45 per diluted common share compared to $86.5 million or $0.55 per diluted common share in the 2021 period.
The company recorded adjusted EBITDA from continuing operations of $172.2 million compared to $176.9 million in the 2021 period. Adjusted net income from continuing operations was $66.8 million or $0.42 per diluted share compared to $99.5 million or $0.64 per diluted share in the 2021 period.
I will now turn it over to Nick to discuss our Tobacco operations. Nick?
Nick Anson
Thank you, Howard, and good morning, everyone. Liggett continued its strong performance during the second quarter of 2022 as we capitalized on favorable marketplace opportunities to invest in our Montego brand and expanded our foundation for long-term earnings growth.
Liggett’s second quarter wholesale shipments increased by more than 16%, while our retail volumes increased by more than 21% compared to the same period last year. Liggett’s retail market share also increased to 5.5%, driven by the significant growth of our Montego brand. This represents Liggett’s largest market share percentage since 1984 when it first disrupted the cigarette industry by introducing discount cigarettes.
Our expertise in the discount category continues over core competency. Following a competitor’s exit from the U.S. market in December 2021, we were able to quickly capitalize on the opportunity and capture a significant portion of its 3% market share.
As of June 30, 2022, we successfully converted more than 40% of that competitor’s vacated business into Montego volume by leveraging our broad base of distribution and strong retail sales execution. This is consistent with Liggett’s mission to offer the best value proposition in the U.S. cigarette industry, a mission that is particularly relevant in 2022 as more consumers shift to the discount segment in pursuit of better value as a result of a challenging economic environment.
Within the discount category, we continue to see momentum and growth for brands priced competitively at lower price points. For the 3 months ended June 30, 2022, the discount category represented 27.5% of the total market compared to 26.1% for the same period last year, based on management finance associates’ retail data.
For the second quarter of 2022, we estimate that the deep discount segment comprised approximately 40% of the total discount category compared to 33% in the same period a year-ago. We expect this migration to continue as the deep discount segment remains a more attractive value proposition for consumers.
As such, we are confident that our value focused brand portfolio, broad national distribution and extensive experience in developing profitable discount brands provides Liggett a significant competitive advantage to meet shifting market demand. Liggett’s competitive advantage is highlighted by its ranking as the second largest discount manufacturer and the largest discount-only manufacturer in the U.S., with Montego and Eagle 20’s now the third and fourth largest discount brands, respectively.
Montego has also grown to become the seventh largest discount brand in the country, with the brand’s distribution expanding to nearly 67,000 stores this quarter compared to approximately 29,000 stores in the second quarter of 2021. Its market share increased to 2.4% in the second quarter of 2022, up from 1.9% in the first quarter of this year and 0.5% in the second quarter of last year.
We estimate that Montego’s share of the deep discount segment in the second quarter was approximately 22%, significantly expanding its deep discount share of 5.5% in the second quarter of 2021. Our strategy with Montego is consistent with our long-term objective of optimizing profit by effectively managing volume, pricing and market share growth in our value-based brand portfolio.
While our investment in Montego’s volume growth expands our foundation for long-term earnings growth, we also continue to reap significant benefits from our income growth brands, Eagle 20’s and Pyramid. Eagle 20’s is now delivering significantly higher margins, and Pyramid’s resilience continues to provide substantial profit and market presence.
Overall, Liggett’s retail shipments for the 3 months ended June 30, 2022, increased 21.1% from the second quarter of 2021, while industry retail shipments decreased 9.4%. As a result, and as mentioned earlier, Liggett’s second quarter retail market share increased to 5.5%, up from 4.1% in the prior year period.
I will now turn to the combined Tobacco financials for Liggett Group and Vector Tobacco. For the 3 and 6 months ended June 30, 2022, revenues increased 13.6% to $374.3 million and 14.3% to $683.4 million, respectively, compared to $329.5 million and $598 million for the corresponding 2021 periods.
Tobacco adjusted operating income for the 3 and 6 months ended June 30, 2022, was $88.4 million and $164 million, respectively, compared to $103.2 million and $182.1 million for the corresponding periods a year-ago.
Liggett’s second quarter earnings decline was the result of lower gross profit margins associated with the increase in Montego volumes, a challenging year-over-year comparison due to elevated wholesale inventories in the second quarter of 2021 and increased MSA costs. These higher MSA costs were associated with changes in our accounting estimates related to total industry volumes and inflation for the full year of 2022.
Strategic investment accelerated Montego’s significant volume and market share growth and led to an expected decline in year-over-year on income in the first half of 2022. We saw similar income declines during the successful expansions of Pyramid in 2009 and Eagle 20’s in 2013, which were both undertaken with a similar long-term profit growth plan.
This long-term investment strategy has a proven 20-year history, and as such, we fully expect to realize a significant return on our investment in Montego as we move forward. As always, our investment decisions are based on thorough market analysis and are adjusted in real-time based on market opportunities and factors.
Regarding the current regulatory environment, the FDA recently indicated plans to issue a preliminary standard within next year, which would reduce the level of nicotine in cigarettes. The FDA has considered reducing nicotine levels since 2018, and by statute, is required to apply a scientific approach to their ruling, as with any public health matter. The FDA is also required to evaluate potential unintended consequences of any decision.
As a result, we believe this process could take many years before the issue is resolved, as we’ve seen with many previous tobacco industry regulatory decisions. In addition, several large tobacco companies with a presence in the e-cigarette and vapor business recently received marketing denial orders from the FDA for their next-generation products.
While we continue to closely monitor this segment of the market, we remain firm in our belief that there is significant risks surrounding consumer acceptance of these products, which is underscored by the FDA’s recent decisions.
As such, we remain focused on our competitive advantages and core competencies in the growing discount segment of the conventional cigarette market. While we are always subject to — excuse me, to industry, regulatory and general market risks, we are confident that we’ve effective infrastructure in place to keep our business operating efficiently.
In summary, the operational and financial performance of our Tobacco business remains strong. This is evidenced by our historic retail market share gains this quarter, which validate our long-term profit growth strategy and reflect the competitive advantage we have in the discount segment, including our broad base of distribution, our consumer-focused programs and the scope and capabilities of our sales force. Most importantly, it builds on our foundation for long-term earnings potential.
Thanks for your attention, and back to you, Howard.
Howard Lorber
Thank you, Nick. Vector Group is having another outstanding year in 2022. We have strong cash reserves to continue to increase our long-term tobacco revenues and market share. We are pleased with our long standing practice of paying a quarterly cash dividend. It continues to be an important component of our capital allocation strategy, and it is our expectation that our policy will continue.
Now operator, please open the call for questions.
Question-and-Answer Session
Operator
Absolutely. [Operator Instructions] We will take our first question from Ian Zaffino with Oppenheimer. Your line is open.
Ian Zaffino
Hi, great. Thank you very much. Glad to see Montego’s doing so well. Can you guys maybe just give us a little bit more color on some of the share gains there. What is necessarily driving that? Are you seeing maybe the consumer trading down to the lower priced brands? Now is that why Montego is doing so well? Is something else going on there? Just give us a little bit more color maybe in the context of how the consumer is doing. Thanks and I have a follow-up.
Howard Lorber
Nick, do you want to …?
Nick Anson
Yes, absolutely. So, Ian, there’s a couple of things going on. Certainly, you’re right. At this point in time, in the market, we are seeing consumers trading down based on the economic environment that they’re experiencing. When they’re going into stores, they’re having to make tough choices with respect to all their purchases, and cigarettes are no different. They’re down-trading, seeking value. And in some cases, people are cutting back consumption of cigarettes in total, just like other consumer products. Some are doing both. So we are certainly seeing growth in the discount segment.
And as I mentioned in my earlier remarks, in the deep discount segment, specifically. We are also, obviously, with that competitor’s exit that I mentioned, KT&G, they had about a 3% market share. We’ve done a tremendous job in attaining that share that they’ve left behind. And again, as I mentioned earlier, we’ve obtained over 40% of that growth. So the combination of both KT&G leaving the marketplace and the consumer seeking value, that’s what’s driving the growth of Montego. That’s what’s driving our share gains.
Ian Zaffino
Okay, great. Thanks for the color. And then also, can you guys maybe comment on the real estate market here as far as investments or future investments, just given sort of the state of the market now with rates going up, maybe we’re seeing some signs of that market cracking. How are you positioning yourself there? And what are you guys doing? Thanks.
Howard Lorber
Well, on the real estate side, we’ve only made two new investments. We are really now focused on rental properties, new projects that are rentals. We’ve done very well on that side. We had one investment with Kushner’s and a portfolio in Baltimore County, where we ended up — what was the return, B.K.? What was the …
Bryant Kirkland
It was low 20s. Low 20 — internal rate of return of below 20%.
Howard Lorber
Yes. And how many years were we in it? 8, 9, 10?
Bryant Kirkland
We’re at, yes, 8 years. We made about $22 million on a $5 million investment.
Howard Lorber
So we are not really looking at any investment in any new condo projects now, especially in New York, because there’s still inventory there that has to go away. And although we are looking at a couple of projects, condo and rental, both in — basically in South Florida, where the markets are sort of booming. So that’s pretty much where we are at this particular time.
Ian Zaffino
Great. Thank you very much for the color.
Operator
And we will take our next question from Karru Martinson with Jefferies. Your line is open.
Karru Martinson
Good morning. Very impressive growth in Montego year-over-year. When you look forward to the continued growth of the brand, how much investment do you feel, or how long do you kind of run it in growth mode before you transition it in the life cycle to the harvesting mode, where Eagle and Pyramid have been — are now?
Howard Lorber
Nick?
Nick Anson
Yes. So look, I’m not going to get into specifics here. With respect to our investment decisions, we are constantly analyzing the market and the opportunities available to us in the different segments. And that decision to either continue to invest for growth or to switch, to start monetizing that brand is based on various market factors: distributions, price gaps, et cetera. So we will continue to monitor the marketplace.
But at the moment, we just feel that there’s a tremendous opportunity in growing this brand. We are continuing to see growth in the brand. We have 5.5% market share for the second quarter. But the last 4 weeks, we are continuing to see the brand grow, and we are up to about a 5.7% share for the year, for the last 4 weeks compared to last year. So we are going to continue to invest when we see the opportunities for growth. So that will — the decision to switch and move to monetizing that brand will be based on various market factors.
Karru Martinson
Okay. And then when you look at parts of the country geographically, are you seeing pockets of that trade-down being more accelerated, some of your higher cost markets? Or how is the consumer handling that inflation?
Nick Anson
If you look — I would say, if you look at the industry in total, for the 6 months both from a retail perspective and a CRA perspective, the wholesale perspective, it’s down 9% to 10%. So I think it’s showing that across the country, consumers in general are struggling with inflation and looking for value across all kinds of consumer brands, and cigarettes are no different to that.
Karru Martinson
Okay. And then just lastly, is there any kind of update on the implementation of the FDA’s menthol ban that they were working through the process?
Nick Anson
So the update to that is, just this past — earlier this past week, comments were due from various interested parties. We did submit comments earlier this week. And if I’m not mistaken, they’ve received over a couple of hundred thousand comments as it relates to the menthol ban. So at this point in time, they now need to review all those comments with a view to finalizing a standard.
Karru Martinson
All right. Thank you very much. Appreciate it.
Operator
Ladies and gentlemen, there are no questions — no further questions we have for today. Thank you for joining on Vector Group’s quarterly earnings conference call. This will conclude our call. On behalf of all of us at Vector Group and Liggett, we hope that everyone remains healthy and well. Thank you all for your participation. You may now disconnect.
Howard Lorber
Thank you.
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