Up in Smoke
Cigarette manufacturer Vector Group (VGR) has paid out a 5% stock dividend every September since 1999 in addition to its regular quarterly cash payment. As a result, share count over the past 15 years has grown by 233% to 90 million outstanding at the end of 2012. In the same period, its operating income has increased by just 109%, suggesting that its dividend payouts are increasing at an alarming rate in comparison to its earnings growth.
In 2013, it expects to pay out $246 million for its interest expense and dividends. With only $155 million in operating profits to cover these two items, its debt continues to swell.
At the end of the second quarter VRG had $929 million in total debt — almost 400% greater than when it began its 5% stock dividend back in 1999. The argument for an investment in VRG is that its combination cash/stock dividend program allows you to earn 12%-15% annually.
That’s true enough.
The big downside here is that there doesn’t appear to be any upside to its revenue. Eventually, it’s going to run out of ways to cut costs … and when that happens, its growing interest expense will force it to reduce the cash portion of its dividend payout. Although it hasn’t had to do that just yet, it can only go so long before this house of cards caves in on itself.
Its cash yield of 9.7% plus the additional 5% stock dividend is awfully enticing. At the end of the day, however, it’s important to remember we’re talking about a company that sells discount cigarettes. Eventually people will come to their senses and stop buying them. When that happens, owning 50% of real estate shop Douglas Elliman is not going to be its savior.