Vector Group Ltd. Earnings: Can Discount Brands Beat Altria and Lorillard?

On Monday, Vector Group (VGR) will release its quarterly report, and the tobacco stock has outpaced peers Altria (MO -0.66%) and Lorillard (LO.DL) in terms of year-to-date returns. Yet, as the environment for tobacco in the U.S. becomes increasingly hostile, the question Vector Group faces is whether relying on its discount-brand business model will give it better staying power than the premium brands that Altria and Lorillard offer.

Vector Group isn't the best-known company in the tobacco industry, and even its brands aren't necessarily household names. Vector Group markets its own cigarettes under brands including USA, Grand Prix, and Pyramid, but it also provides private-label branding for sale through military stores, convenience stores, and grocery and drugstore chains. That gives it some advantages over Altria and Lorillard, especially when economic troubles hurt discretionary income among customers. Yet, increasingly, investors are looking at Vector Group's little-followed real-estate development business as a potential source of revenue if regulators exercise a nuclear option against tobacco. Let's take an early look at what's been happening with Vector Group during the past quarter, and what we're likely to see in its report.

Source: U.S. Food and Drug Administration.

Stats on Vector Group

Source: S&P Capital IQ. * Revenue prior to reduction for excise taxes.

What can send Vector Group earnings higher?
Analysts have generally been more optimistic in their views on Vector Group earnings recently, raising their earnings estimates for both the first quarter and for the full 2014 year. The stock has also done quite well, rising 21% since early February.

Some of those gains came after Vector Group's fourth-quarter earnings report. Revenue climbed more than 6%, but net income almost quadrupled from year-ago levels. In its tobacco business, Vector Group saw general declines in unit volumes, duplicating some of the longer-term trends that Altria, Lorillard, and other tobacco producers have seen over the years. Better pricing conditions offset the volume drops somewhat, but it was clear that Vector's tobacco business was struggling along with the rest of the industry.

What's surprising about Vector Group, though, is that its real-estate business has gotten more important. In the quarterly report, Vector consolidated its majority stake in Douglas Elliman Realty into its overall financials, and revenue included more than $40 million from both Elliman and Vector's Escena development in Palm Springs. As a result of the acquisition, Vector Group's real-estate business now makes up roughly 35% of the overall company's sales, and a similar percentage of adjusted EBITDA.

Nevertheless, tobacco is still a key element of Vector Group's success, and results from Altria and its peers show that in the U.S. market, customers are trading down from premium brands, like Altria's and Lorillard's, to discount brands that Vector Group specializes in producing. Vector has actually responded to the trend by introducing a new deep-discount brand in order to boost its market share in the important sector.

Vector Group is also trying to compete in the electronic cigarette arena. Its Zoom product is designed to go up against similar e-cigs from Altria and Lorillard. With Lorillard having achieved first-mover status, Vector could face challenges building up its share of the market. But if it uses its discount reputation in its favor, then the company could hold off its competition.

In the Vector Group earnings report, watch to see how the company discusses its tobacco and real-estate businesses. Even though Vector Group has done well with its cigarette business over the years, having diversification could prove to be a prescient move if the regulatory environment becomes any more difficult to navigate in the years ahead.

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