Vector Group Ltd. (NYSE:VGR) Q3 2022 Earnings Conference Call November 2, 2022 8:00 AM ET
Company Participants
Howard M. Lorber – President & Chief Executive Officer
Nick Anson – President & Chief Operating Officer-Liggett Vector Brands
Bryant Kirkland – Chief Financial Officer
Conference Call Participants
Pallav Mittal – Barclays
Ian Zaffino – Oppenheimer & Co.
Karru Martinson – Jefferies
Operator
Welcome to Vector Group Ltd.s’ Third Quarter 2022 Earnings Conference Call. This call is being recorded and simultaneously webcast. An archived version of the webcast will be available on the Investor Relations section of the company’s webcast, located at www.vectorgroupltd.com for one year.
During this call, the terms, adjusted operating income, adjusted net income from continuing operations, adjusted EBITDA from continuing operations 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 accordance with the GAAP reconciliations to adjusted operating income from continuing operations.
Adjusted net income from continuing operations, adjusted EBITDA from continuing operations and tobacco adjusting operating income are contained in the company’s earnings release, which has been posted on the Investor Relations section of the company’s website.
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 or implied by forward-looking statements. These risks are described in more detail in the company’s Securities and Exchange Commission filings.
Now, I would like to turn the call over to the President and Chief Executive Officer of Vector Group, Howard M. Lorber. Please go ahead.
Howard M. Lorber
Good morning, and thank you for joining us for Vector Group’s Third 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 third 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 Element in the fourth quarter of 2021, Douglas Element’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.
First, beginning with Vector Group’s consolidated balance sheet. Our balance sheet remains strong. As of September 30, 2022, we maintained significant liquidity, with cash and cash equivalents of approximately $385 million, including cash of $174 million at Liggett. We also held investment securities and investment partnership interest with a fair value of approximately $160 million.
During the third quarter, we also repurchased and retargeted $12.9 million in aggregate principal amount of our 10.5% senior notes, due 2026 at a discount. This retirement reduces our cash annual interest expenditures by approximately $1.4 million. Some market conditions, we may repurchase additional amounts of our 10.5% senior notes in open market purchases or privately negotiated transactions.
Turning to Vector Group’s consolidated results from operations for the three months ended September 30, 2022. Vector Group’s revenues for the quarter were $378 million, compared to $298.5 million in the third quarter of 2021. Net income attributed to Vector Group was $38.9 million, or $0.25 per diluted common share compared to $48.9 million or $0.31 per diluted common share in the third quarter of 2021. Net income attributed to Vector Group from continuing operations was $38.9 million or $0.25 per diluted common share, compared to $29.9 million or $0.19 per diluted common share in the third quarter of 2021.
The company recorded adjusted EBITDA from continuing operations of $87.3 million compared to $88.7 million in the third quarter of 2021. Adjusted net income from continuing operations was $37.6 million or $0.24 per diluted share compared to $33.9 million, or $0.22 per diluted share in the third quarter of 2021.
Next Vector Group’s consolidated results from operations for the nine months ended September 30, 2022. Vector Group’s revenues for the nine months ended September 30 2022 were $1.08 billion, compared to $907 million in the 2021 period.
Net income attributed to Vector Group was $110.6 million, or $0.70 per diluted common share, compared to $174 million or $1.11 per common share in the 2021 period. Net income attributed to Vector Group Ltd. from continuing operations was $110.6 million or $0.70 per diluted common share compared to $116.4 million or $0.74 per diluted common share in the 2021 period.
The company recorded adjusted EBITDA from continuing operations of $259.5 million compared to $265.6 million in the 2021 period. Adjusted net income from continuing operations was $104.4 million or $0.66 per diluted share compared to $133.4 million or $0.85 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. Liggett delivered another strong performance during the third quarter of 2022, including record quarterly revenues as we continue to capitalize on favorable marketplace opportunities to invest in our Montego brand and expand our foundation for long-term earnings growth.
Liggett’s third quarter wholesale shipments increased by more than 30% and our retail volumes increased by approximately 23% compared to the same period a year ago. Liggett’s retail market share also increased to 5.7%, driven by the significant growth of our Montego brand. This represents Liggett’s largest market share since 1984, when we originally disrupted the tobacco industry by introducing discount cigarettes.
Our expertise in the discount category continues to be a core competency. Following competitors exit from the US marketplace in December 2021, we quickly capitalized on the opportunity and captured a significant portion of that competitor’s approximately 3% market share.
As of September 30, 2022, we have converted more than 40% of that competitor’s vacated business to Montego volume by leveraging our broad-based — our broad distribution base and strong retail sales execution. Our conversion percentage related to the competitor’s exit is the highest in the market and twice as much as the next competitor.
Our performance is driven by Liggett’s mission to offer the best value proposition in the US cigarette industry, which is particularly relevant in the current economic environment as more consumers shift to the discount segment in search of better value. According to Management Science Associates, retail data for the three months ended September 30, 2022 the discount category represented 28.3% of the total market compared to 26.6% for the same period last year.
Within the discount category, we continue to see momentum and growth for brands in the deep discount segment. For the third quarter of 2022, we estimate that the deep discount segment comprised 43% of the total discount category, compared to 36% in the same period a year ago. We expect this migration to continue as deep discount segment presents a more attractive value proposition for consumers.
As such, we believe that, our value-focused brand portfolio broad national distribution and extensive experience in developing profitable discount brands provides Liggett with a competitive advantage to meet shifting market demands.
Montego, which became our largest brand in 2022 has also grown to become the second-largest discount brand and sixth-largest cigarette brand in the United States. Distribution expanded to nearly 71,000 stores this quarter, compared to approximately 37 stores in the third quarter of 2021.
The brand’s market share increased to 2.8% in the third quarter of 2022, up from 2.4% in the second quarter of this year and 0.7% in the third quarter of last year. We estimate that Montego’s share of the deep discount segment in the third quarter was approximately 24%, a significant expansion from its deep discount share of 7% in the third 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 in our value-based brand portfolio. While our investment in Montego 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 substantial margin and Pyramid’s long-term resilience continues to provide a substantial profit and market presence. As a result, Liggett’s retail shipments for the three months ended September 30, 2022 increased 22.8% from the third quarter of 2021, while industry retail shipments declined 8.5% according to data from Management Science Associates. Further and as mentioned earlier, Liggett’s third quarter retail market share increased to 5.7%, up from 4.2% in the prior year period.
I will now turn to the combined tobacco financials for Liggett Group and Vector Tobacco. For the three and nine months ended September 30, 2022 revenues increased 26.9% to a record $338 million and 18.5% to approximately $1.1 billion respectively compared to $297.9 million and $895.9 million for the corresponding 2021 period.
Tobacco operating income for the three and nine months ended September 30, 2022 was $88.1 million and $254.1 million, respectively compared to $91.8 million and $276.6 million for the corresponding period a year ago. Tobacco adjusted EBITDA for the three and nine months ended September 30, 2022 was $89.6 million and $256.6 million, respectively compared to $93.4 million and $278.9 million for the corresponding periods a year ago.
Strategic investment has accelerated Montego’s significant volume and market share growth and led to an expected decline in year-over-year income in the first nine months of 2022. However, consistent with previous brand expansions we fully expect to realize a significant return on our Montego investment as we move forward.
As always our investment decisions are based on thorough market analysis and adjusted in real-time based on market circumstances and opportunities. Related to this despite an increase in MSA cost per pack from $0.40 in the third quarter of 2021 to $0.57 in the third quarter of 2022, tobacco gross profit for the three months ended September 30, 2022 declined only slightly to $111 million compared to $111.5 million for the corresponding period a year ago, reflecting a gradual transition of our strategy on Montego’s growth from volume to profit-based.
Nonetheless the price gap between Montego and the industry’s leading premium brand has remained stable throughout the year and competently provides a difference that represents close to a 50% discount in average pack prices at retail.
In summary, the operational and financial performance of our tobacco business remains strong. Our historic retail market share gains this quarter validate our long-term profit growth strategy and the competitive advantage we have in the discount segment. Our strategy is underpinned by our broad distribution base, 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. While we are subject to industry, regulatory and general market risks, we are confident that we have the strategy and infrastructure in place to keep our business operating efficiently.
Thanks for your attention. And back to you Howard.
Howard M. Lorber
Thank you Nick. Vector Group is having another outstanding year in 2022. We have strong cash reserves and 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. At this time, we will open the floor for questions. [Operator Instructions] And we will take our first question from Pallav Mittal with Barclays. Your line is open.
Pallav Mittal
Hi. Thank you for taking my questions. So clearly the volume gains are impressive and unprecedented. Can you please segregate the volume benefit from the exit of a competitor and the benefit from down trading?
Howard Lorber
Nick, do you want to handle that?
Nick Anson
Sure. Just — let me just clarify the question. The segment the down trading from the gains from the competitor vacated volume? Was that the question? I apologize.
Pallav Mittal
Yes. So, the volume gains of 30% just wanted to understand how much of that is from the exit of the competitor and how much is due to down trading?
Nick Anson
I understand. So, the 40% that we have gained is actually the aggregate of both the vacated volume and also the down trading. So, the increase in volumes itself it’s probably about a 70/30 split between that volume that’s been vacated by KT&G and what we’ve gained through just general down trading and people searching for value in the marketplace.
Pallav Mittal
Got it. Also you mentioned gradually shifting from volume growth to profit growth on Montego. Does that mean the market share has peaked at 5.7%? And how should we think about EBIT progression now over the next couple of years?
Nick Anson
Sure. Well, as you know we certainly don’t give guidance as it relates to EBIT. But overall we’re feeling very good about the performance of Montego and that’s consistent as I mentioned in my earlier remarks consistent with the long-term objective of optimizing profit over the long-term.
So as with our previous deep discount brand developments such as Pyramid and Eagle 20’s, the first critical objective there is to build that broad volume base. And that’s what we’ve done and we’ve certainly exceeded expectations with respect to that.
Ultimately, as we start to monetize that we look at the marketplace and make adjustments in real-time. As I mentioned we have started taking pricing on the brand this year and that’s reflected in the improvement in our margins in the third quarter versus the first half of this year.
But we’re feeling very good about Montego. We have a lot of experience in this. We have a clear track record of these brand developments and turning these brands profitable. So, we’re feeling very good about the future there and ultimately raising our earnings base to a higher level.
Pallav Mittal
Sure. And if I can ask one last question. How are you planning to approach the California flavor ban that could happen sometime in Q4 of this year?
Nick Anson
Sure. Look I think with respect to that proposition that’s up for vote I think it’s probably likely that we will pass. But we think that well almost certainly the industry will challenge that. In fact, Reynolds has already challenged it earlier, but the arguments weren’t deemed right.
From our perspective, though we’re not too concerned. We are heavily under-indexed as it relates to menthol in the California market. And in fact the — our menthol volumes in California represent less than half of 1% of our volumes there. So, there’s — from our perspective almost certainly we expect the industry to challenge it, but we’re not concerned for the longer term.
Pallav Mittal
Got it. Thank you.
Operator
And our next question comes from Ian Zaffino. Your line is open.
Ian Zaffino
Hi, great. Thank you very much. I just wanted to tie in a little bit more on Montego. As you look at where Montego is versus some of your other brands that you were market share takers and then you took up price is there anything different in Montego? And as you think about it is the pricing opportunity better?
Can you maybe capture pricing faster than you did in your other brands? Is the tail longer where you could take price on this brand? Is there anything, kind of, like unique or specific to it that will lead us to believe that it wouldn’t maybe follow the same cadence or might have like a bigger impact than other brands did? Thanks.
Nick Anson
Yes. No we don’t see this being any different. As I mentioned in my earlier remarks, you know, we got the experience of managing brands in the deep discount segment and the discount segment. We’re the leaders of the discount segment. So we know how to manage those brands. Obviously, you look back at our history there with Liggett Select, Grand Prix, Pyramid and Eagle 20’s sure each launch and each development was different. But we’re constantly evaluating the marketplace looking at the nuances and the opportunities there and we make adjustments in real time. So we’re feeling very confident that obviously we’ve got the experience and the knowledge to develop this brand and again ultimately realize a significant return.
Ian Zaffino
Okay. And then at what point do you then launch another brand beneath Montego? Is that years off? Is that closer than that? What’s, sort of, the timing on maybe an additional brand?
Nick Anson
Yes, certainly, there’s certainly nothing on the short-term horizon there for a new brand. We’re focused on obviously continuing to monetize Eagle 20’s and Pyramid and focusing on the share and ultimately the profit gains on Montego at this point in time. So no plans at the moment.
Ian Zaffino
Okay. And then maybe a question for Howard. On the real estate side how do you think about the environment here as far as your — are you a buyer? Are you a seller? Are you a holder? What are you thinking here? And what should we expect as investors and analysts? Thanks.
HowardM. Lorber
Yes. Well, obviously, that’s a difficult question to answer at this stage not knowing exactly where rates are going and how it’s going to affect the overall market. But on the residential side, we’re in the luxury market. And the luxury markets, I believe are not being hit as hard as the lower end markets because when they talk about the 7%, 8% interest rates those are really — 30-year conforming mortgages.
And I think on the luxury side, the people have a lot more flexibility with private banking and with their stock equity portfolios to be able to borrow very inexpensively. So we really haven’t seen too much. While the industry in general is down and volume-wise, it’s really still performing very well.
And the other issue is that, everyone is going to compare to 2021. Well, 2021 was a market that none of us really understood. It just sort of happened. And so, I don’t think that that’s a good — for comparison, I would say that 2022 is going to be a good year for us, albeit, not the same as 2021.
Ian Zaffino
Okay. Thank you, very much.
Operator
Our next question is from Karru Martinson with Jefferies. Your line is open.
Karru Martinson
Good morning. During the quarter, did you see the consumer behavior shift when gas prices were high, or were the kind of the sales consistent when it came to the discount cigarette channel?
Nick Anson
So, from the — I would say, from the total industry perspective, if we start there, Karru, I mean, throughout the third quarter, if you look at the overall industry decline, the industry was down 8.5% for the quarter. Year-to-date, it’s down 8.5%. So despite, certainly an abating of gas prices there, there’s no doubt the consumer for — the cigarette consumer continues to remain under pressure there.
It’s not just gas prices that are cutting into their disposable income, food prices, energy prices, rental prices remain high. So there’s no doubt the cigarette consumer remains under pressure throughout Q3. And as such, we saw that continued down-trading and people searching for more value in their purchases.
Karru Martinson
Okay. And in terms of the regulatory update, whether it’s the FDA menthol ban or the fixed pricing in Colorado, are there any updates on that front?
Nick Anson
With respect to the menthol, no real updates and the FDA at the moment is sifting through what I think about, 250 — at least 250,000 comment that they received in August. So, I think, again, we feel it’s going to be some time before they get through that and issue any final standard. And ultimately, we believe that will be challenged by the industry.
With respect to Colorado, there was a new judge appointed in the federal case there and she actually did dismiss the case. And based on kind of an evaluation of how we’re performing in the marketplace and the costs to continue to litigate that we decided not to push forward with that case any further. But the main reason behind that is because we feel like we’ve actually performed very well relative to our initial concerns in the Colorado marketplace.
Karru Martinson
Okay. And in terms of the bond repurchase on the 10.5, how are you thinking of that maturity? And how would you look at allocating your cash flows to the debt repurchases in the market?
Bryant Kirkland
Hi. Good morning, Karru, it’s Bryant Kirkland. We obviously were opportunistic in the quarter where we did buy $13 million back at a discount. We’ll continue to be opportunistic. Obviously, that bond does not mature for another four years. So we do have time to be patient.
Karru Martinson
Thank you very much guys. I appreciate it.
End of Q&A
Operator
It appears we have no further questions at this time.
Howard M. Lorber
Thank you for joining our call and we look forward to speaking with you next quarter.
Operator
Ladies and gentlemen, those are all the questions we have for today. Thank you for joining us on Vector Group 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 for your participation. You may disconnect.
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