Shares of Vector Group (NYSE:VGR) were down 10.8% just before noon EST on Wednesday, following Tuesday's release of the company's third-quarter financial results after market close. Today's sell-off is a bit of a surprise for many investors in the tobacco stock, since the $0.23 in earnings per share it delivered were well above expectations for $0.13 per share.
While it came in well ahead of expectations on the bottom line, Vector Group's $505 million in revenue fell short of expectations by about $22 million. Not only was it short of estimates, but it was also $9 million lower year over year. On the earnings call, management provided a breakdown of revenue across its business units, which include its tobacco business as well as its growing investment in real estate. The company described the decline in revenue as coming from its real estate segment, which can be lumpy from one quarter to the next.
Vector continues to grow its tobacco business in the U.S. Even as total tobacco sales decline, its highly discounted brands continue to take market share.
So why the big sell-off? After announcing that it would pay a $0.40 per share quarterly dividend in December, the board of directors has decided to slash the payout to $0.20 starting in 2020. It was also ending its annual stock dividend.
The dividend cut shouldn't strike investors as too surprising. Vector Group has paid a dividend that's been well in excess of its earnings and cash flow for a number of years, even as it has regularly increased the payout:
It's been able to continue the payout largely because it has taken on steadily more debt. Since 2015, long-term debt has grown from less than $400 million to nearly $1 billion, while cash and equivalents have trended downward.
Instead of remaining on this unsustainable path, the board made what is almost certainly the right choice to cut the payout. This will allow the company to preserve more of its cash flows, reduce its reliance on debt, and focus on continuing to diversify its business -- preferably away from a cigarette market that is likely to continue to decline as fewer young people become smokers as adults (a trend that hopefully doesn't reverse due to the growing popularity of vaping among minors).
Ethical conclusions aside (those are up to each of us as investors), I'm not sure what to make of Vector Group as an investment today. The board's move to cut the dividend is the right call. As painful as it may be for current shareholders, the recent payout is in excess of the company's ability to sustain it, and its core business is still cigarettes, which isn't exactly a good growth business despite its success in growing market share.
But with that said, I don't think this necessary cut, and the market's reaction sending shares down, make Vector worth buying. It will still pay a substantial portion of cash flows in dividends even after the cut, and the combination of tobacco and its real estate companies makes for a more difficult business to evaluate. I think investors could likely do better investing in pure plays in these two industries than in Vector's hybrid of two unrelated industries.