Vector Group (NYSE: VGR ) has been on a tear since announcing it had purchased an additional interest in its real estate subsidiary. The investment drew investors' attention to the previously unconsolidated earnings that will soon be visible for all to see. The stock is an odd combination of growth company and dividend distributor. The company's real estate business is driving the growth, while the tobacco and real estate earnings allow it to pay a hefty dividend. If growth continues on schedule, Vector could be a bargain that will soon be in plain sight.
Real estate broker with a moat
There are two parts to Vector's real estate business: a real estate broker, called Douglas Elliman, and direct interests in real estate properties. In December, Vector increased its stake in Douglas Elliman from 50% to 70%. The larger stake enables Vector to change the accounting method so that Douglas Elliman's earnings flow directly to the income statement, thereby raising earnings per share.
Douglas Elliman produced $46.6 million in adjusted EBITDA in 2013, but that number could rise significantly in the years ahead. The real estate broker is the fourth-largest in the U.S. and has a strong presence in New York City. Its established base in the city gives it a degree of protection from smaller competitors, and it is growing like crazy. In 2013, Douglas Elliman earned $46.6 million in EBITDA -- up 50% from 2012.
Douglas Elliman's brand name and established sales team should enable it to continue growing at a double-digit pace for many more years. Revenues grew by 37% last quarter. If EBITDA grows 20% in 2014, Douglas Elliman will contribute $56 million to Vector's overall EBITDA. That alone would grow companywide EBITDA by 26% in 2014.
In addition to its real estate brokerage, Vector owns a portfolio of condominiums, hotels, apartments, and office buildings. Vector's interest ranges from 5% to 49.9% in 16 properties that are valued on the balance sheet at $130 million. However, the properties could be worth much more than their stated value.
The real estate portfolio is anchored by a few expensive New York properties: 101 Murray Street, Park Lane Hotel, 11 Beach Street, and 701 Seventh Avenue in Times Square. Each of these properties has the potential to become much more valuable in the years ahead. For instance, the Times Square location is being completely redeveloped to build a 30-story hotel and add 85,000 square feet of prime retail space. If all goes as planned, Vector could own one of the best properties in an iconic New York location.
One need only look at reported earnings to discover that Vector's real estate portfolio may be undervalued. Over the last three years, Vector's real estate portfolio generated between $20 million to $30 million in earnings. Even if you capitalize earnings at just 12 times, the real estate portfolio is worth at least $240 million. That's almost double its carrying value.
Real estate business makes Vector a possible bargain
Douglas Elliman and Vector's owned real estate properties could make the stock an attractive buy for income and growth investors alike. If the properties are worth closer to $240 million, and if Vector's tobacco business is worth 10 times 2013 operating income, then the two segments are worth $1.36 billion. Vector's market capitalization is $2.1 billion assuming a $21 share price, so investors are paying just $740 million for Douglas Elliman.
If Douglas Elliman's EBITDA grows 20% in 2014, investors have to pay just 13 times EBITDA for a real estate broker that's growing at double digits and has a long runway for growth. It's hard to value high-growth companies, but Vector's 7.5% dividend yield will soften the blow if Douglas Elliman hits a speed bump. That's why Vector could be a good investment for growth and income investors alike.
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