Why Vector Group Stock Has Soared 52% in 2014

Source: James Stenberg, Wikimedia Commons.

America's largest tobacco companies are iconic names, with world-renowned brand recognition and huge marketing budgets to keep it that way. In that mold, Vector Group (VGR 0.10%) doesn't seem to fit well at all, as the company behind cigarette brands Pyramid and Grand Prix as well as many private-label brands has a much more focused distribution model supporting its business. Yet even though Altria (MO 0.70%), Reynolds American (RAI), and Lorillard (LO.DL) have all performed well over the past year, Vector Group blows them all away -- and part of the answer comes from Vector Group's efforts to diversify itself beyond tobacco.

For a long time, Vector Group was able to concentrate at the discount end of the cigarette market, as other manufacturers preferred the higher margins available from premium brands. Yet in recent years, Vector has seen more discount competition in cigarettes, and that has forced it to deal with lower volumes and a challenge to its very existence. Perhaps because of tobacco's challenges, Vector Group has taken a larger stake in real-estate subsidiary Douglas Elliman Realty, and investors now believe there could be even more growth potential there. Let's take a closer look at Vector Group to see whether it can recover from its recent losses.

Stats on Vector Group

Source: Yahoo! Finance. 2014 growth rate reflects consolidation of Douglas Elliman Realty into Vector's financials.

The two businesses of Vector Group
One of the biggest surprises in Vector's performance in 2014 is that it comes even as the discount cigarette business has been extremely weak. In its first-quarter results, Vector reported a 6% drop in tobacco-product unit sales, and even with a price increase, revenue fell by about 3%. Those results continued a longer-term downtrend that Vector has suffered, having seen its market share of the discount market fall by more than a full percentage point to just 11.6% in 2013 as it ceded ground to Altria.

All in all, things look like they will get tougher for Vector Group's tobacco business before they get better. The impending Reynolds-Lorillard merger has the potential to create two behemoths in the domestic industry, and although that might tempt some investors into thinking that the discount side of the business would be left open for Vector to exploit, recent experience suggests that the two giants wouldn't hesitate to claim whatever ground they could at the lower end of the market. Meanwhile, the threat of greater regulation and restrictions on smoking has the entire industry worried about its future.

Source: Douglas Elliman Realty.

In that light, the efforts Vector has made to bolster its real-estate business make more sense. Douglas Elliman Realty is the fourth-largest residential brokerage company in the U.S., and more notably, it's the largest broker in the key New York metropolitan area, generating fees from selling more than $14 billion in real estate in 2013. With more than 4,400 agents on the ground in the New York area and fee income of more than $600 million last year, Douglas Elliman promises to deliver substantial income growth to its 70% parent-owner now that its results will be consolidated into Vector's overall financials.

Piling on the assets

In addition to its brokerage business, Vector also now counts a variety of commercial and residential properties among its assets, many of which are located in the New York area. Among them are the Park Lane Hotel, and a property in Times Square that the company is looking to redevelop into a hotel with prime retail space. Some analysts believe that the lack of recognition of Vector's real-estate portfolio has led to those assets being undervalued, but as Vector increasingly emphasizes real estate as a growth source, investors might well start moving away from seeing the company for its tobacco business.

Obviously, real estate is subject to just as many ups and downs as the tobacco industry, and relying on real estate to drive long-term gains will exposure Vector to the vagaries of the business cycle for commercial property. Overall, though, Vector's two-prong strategy gives it more options than simply hoping that tobacco won't continue its slow fade into the sunset in the years and decades to come.