The S&P 500 has fallen 22% year to date as the U.S. economy grapples with rising inflation and interest rates, which can make it harder for businesses to raise the capital they need to grow. But down just 3%, tobacco maker Vector Group (VGR) is holding its value relatively well in this challenging economic environment.
What is Vector Group?
Vector Group is the fourth-largest cigarette manufacturer in the U.S. and focuses on the discount market through brands such as Grand Prix, Liggett Select, and Pyramid. The company is also involved in real estate through its subsidiary New Valley, but management significantly reduced real estate exposure by spinning off its New York real estate brokerage, Douglas Elliman, in late 2021.
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Vector Group enjoys a modest top-line growth trajectory and performed well in the first quarter. Total revenue grew 15% year over year to $312 million, mainly because of strength in the core tobacco business, which represented 99% of sales in the period.
While management expects industrywide cigarette sales volumes to face a long-term decline because of health considerations, government restrictions, and the waning popularity of cigarettes, Vector Group can benefit from strong pricing power. Tobacco products are habit-forming, which means producers can increase prices without crushing demand -- allowing them to grow revenue and margins, even when total sales volume declines.
Can the company survive this bad economy?
According to the Bureau of Labor Statistics (BLS), the U.S. inflation rate rose to 8.6% in May. Inflation is the change in prices over a period of time, and it can erode both the saving and spending power of consumers while increasing the cost of doing business for companies. And with a Bloomberg survey finding that 30% of sampled economists expect a recession in the next 12 months, the situation can get significantly worse.
But Vector Group's focus on the lower-end discount market makes it well-suited to thrive in a potential recession because consumers may pick its products over higher-priced alternatives. That said, Vector Group faces some regulatory challenges.
The Wall Street Journal reports that the Biden administration may be pursuing new rules designed to force tobacco companies to reduce nicotine levels in cigarettes to potentially non-addictive levels. While such a drastic policy change could take years to take effect (if it ever does), investors should consider regulation a long-term challenge for the industry.
Is Vector Group a buy?
While regulatory challenges make the future of U.S. tobacco uncertain, Vector Group can thrive in adverse economic conditions because of its focus on the lower-end market. And with a forward price-to-earnings (P/E) multiple of just 10, it trades at a significant discount to the S&P 500's average of 19. A dividend yield of 7.3% is icing on the cake for investors.
