Vector Group Q3 Earnings: It’s Smokin’ (NYSE:VGR)

Vector Group (NYSE:VGR) is coming off of what I consider to be a solid quarter, based upon advancing its strategy to rapidly take market share from KT&G, a major competitor in the deep discount segment of the cigarette sector.

The reason for the increase in spend is in order to grab as much as the approximate 2.8 percent market share KT&G held before competitors get it. It has done well with that and is poised to transition its Montego brand from one that focused on a high-volume, low-priced strategy, to one that grows income, i.e. one that is differentiated to the point it has more pricing power.

It has proven in the past it can do that with its Eagle 20s and Pyramid brands, and I don’t see any reason why it couldn’t do it with Montego; the name lends itself to being a potential higher priced brand in the minds of consumers.

At the end of the last reporting period, the company has grabbed about 30 percent of KT&G’s market share, primarily via its Montego brand. If it can successfully transition to a higher-priced brand, it’ll significantly improve its top and bottom lines, while retaining its successful discount business.

In this article we’ll look at its recent earnings numbers, strategies to improve revenue and earnings, and what the immediate future holds for the company in the current economic environment that has consumers looking for low-price cigarette alternatives, which plays into one of VGR’s major strengths.

Latest earnings

Revenue in the third quarter was $378 million, up from the $298.5 million in revenue from the third quarter of 2021.

Net income in the quarter was $38.9 million, or $0.25 per diluted share, down from the $48.9 million or $0.31 per diluted share year-over-year.

Net income from continuing operations was $38.9 million or $0.25 per diluted common share, against the $29.9 million or $0.19 per diluted common share reported in the third quarter of 2021.

Adjusted EBITDA from continuing operations came in at $87.3 million, slightly down from the $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, up from the $33.9 million, or $0.22 per diluted share in the same reporting period of 2021.For the first nine months of the year, VGR generated $1.08 billion in revenue, up from the $907 million in revenue from the first nine months of 2021.

Net income for the nine-month period was $110.6 million, or $0.70 per diluted common share, measured against the $174 million or $1.11 per common share in the same 2021 reporting period. Net income from continuing operations was $110.6 million or $0.70 per diluted common share, down from the $116.4 million or $0.74 per diluted common share in the same 2021 period. The company had adjusted EBITDA from continuing operations of $259.5 million, down from the $265.6 million generated in the first nine months of 2021. Adjusted net income from continuing operations was $104.4 million or $0.66 per diluted share, also down from the $133.4 million or $0.85 per diluted share generated in the first nine months of 2021.

At a cursory glance, it would appear, outside of revenue numbers in the first nine months of the year, that the company had a weak performance in Q3, but in fact, most of the lower numbers came from an increase in marketing spend to grab the market share vacancy left by KT&G and the change in consumer behavior to gravitate toward discount cigarettes in response to a decline in disposable income.

Concerning its balance sheet, the company had cash and cash equivalents of approximately $385 million, with investment securities of about $160 million.

In the quarter the company repurchased $12.9 million in “aggregate principal amount of our 10.5% senior notes, due 2026 at a discount.” That will save about $1.4 million in interest payments on an annual basis. Management said, under the right market conditions, it could repurchase more of its 10.5 percent senior notes. If it decides to do so, it’s one way it can boost the bottom line of the company, especially if it increases the amount of repurchases by significant levels.

Cigarette brand performances

Before getting into the specifics of cigarette brands in the reporting period, it should be reiterated that consumers are starting to shift to low-cost cigarette alternatives. Citing Management Science Associates, Nick Anson – President & Chief Operating Officer-Liggett Vector Brands, said for the three-month period ended September 30, 2022, the discount segment of the cigarette market increased in market share to 28.3 percent, up from the 26.6 percent in market share it held year-over-year. That’s important because VGR is the market leader in that segment.

Management also estimates the deep discount segment of the market has grown to 43 percent of the overall discount category, up from the 36 percent last year in the third quarter. They expect that trend to continue, and I agree with that assessment. Even if inflation moderates in the near term, it’s not going to do so at the speed or levels consumers will start changing their spending habits and return to higher-priced cigarettes.

Breaking down its Liggett unit, wholesale shipments in the reporting period were up over 30 percent, while its retail volume jumped by around 23 percent year-over-year. Retail market share reached 5.7 percent in the quarter, up from the 4.2 percent market share it held in the third quarter of 2021, led by the growth of its Montego brand. Anson said it is the largest market share held by the company since 1984, underscoring the growth in consumer demand for discounted cigarette brands.

As for Montego, the marketing spend has been very successful, with the brand now the largest in the company’s portfolio, representing the second-largest discount brand in the U.S., and the sixth-largest overall cigarette brand in all categories.

Market share for Montego in the third quarter was 2.8 percent, up from the 0.7 percent in market share it has last year in the same quarter, and also up from the 2.4 percent share held in the second quarter. That is an impressive growth trajectory by any measure.

For that reason, if the company can transition Montego to a higher-priced, wider margin brand while increasing market share, it’s going to contribute significantly to the companies top and bottom lines in the months and years ahead.

It has been able to do this with its Eagle 20s brand, which the company stated has been “delivering substantial margin,” while its Pyramid brand continues to add to the company’s bottom line.

With that strong brand lineup, retail shipments in the third quarter jumped up 22.8 percent year-over-year, while at the same time retail shipments in the industry were down 8.5 percent.

With the success of Montego, I believe the company should be able to successfully grow that brand into a profitable winner, gradually improving market share and increasing revenue and earnings over time. Anson noted that the price gap between Montego and the leading premium brand in the industry is discounted by about 50 percent in price per pack, suggesting there is room for price increases as premium brands increase prices. That way the brand would retain its discount status while increasing margins and earnings.

If Montego continues to gain market share while gradually increasing its price, that will leverage nicely to the performance of VGR.

The economic factor

Since the current weak economic environment plays into VGR’s strength, it’s important to take a look at how that is likely to play out going forward; most of that will be directly related to inflation and whether or not it remains stubbornly high, and what the Federal Reserve’s response to it will be in regard to raising interest rates.

The other element is whether or not the recession we’re now in will grow deeper for longer, or it’ll be milder and of short duration. There is a lot of dissent on either side of those possibilities, but the fact is we really don’t know how it’ll play out, although I think the general consensus is it’s probably going to of a longer duration than thought.

If it plays out that way, it would probably mean higher prices will continue on, and that would be a positive from the point of view of VGR providing value to consumers looking for cigarette options they can afford. If the company can position Montego as a discounted, but quality brand during this period of time, it could possibly exceed expectations and change the growth trajectory of the company.

In other words, the company has a good chance of continuing to boost market share during this period of economic turmoil, and as things improve, could have a quality brand that has sticking power that retains its customer base even when consumers are willing to spend more on cigarettes.

Conclusion

I think economic conditions play to the strengths of VGR, and so far, it appears it is successfully responding to the opportunity by being willing to temporarily sacrifice some of its bottom line in order to sustainably generate higher revenue, and eventually, increased earnings.

At this point in time, the major thing to watch with VGR is how its rapidly-growing Montego brand performs. How it goes, so will go the company, assuming it’s able to at least maintain market share with its other brands, or even slightly grow them.

If the company is able to increase cash flow it would be a good idea in my opinion to continue to repurchase Senior Notes that are due in 2026. If it does, it’ll be just as good as widening margins and boosting earnings because of the drop in interest payments it would have to make on them.

I like the performance of VGR in the last quarter, and the strategy being employed by management. It appears its dividend is safe, although if the economy remains under duress deeper and longer, it could have to cut it some if cigarettes sales, even at the discount level, start to dry up some.

I don’t think that will happen, but it’s something that should be considered as a low-percentage possibility that could play out in a worst-case scenario.

The more likely scenario is VGR will continue to incrementally grow market share in the quarters ahead, while transitioning Montego into a brand that can command higher prices and margins, adding to the top and bottom lines of the company.