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Cheap Cigarettes Upend Brand Loyalty

Stocks in this article: VGR BTI MO RAI

VERNON, Calif. ( TheStreet) -- Smart investing in times of economic turmoil sometimes means seeking out companies with indispensible products. There may be no more indispensible a product than an addictive one.

Cigarette companies terrify some investors because of the potential for lawsuits, general-public backlash and political grandstanding. But Vector Group (VGR), which traces its roots to the founding of the Liggett brand in 1873, has too many attributes to ignore.

Vector, based in Miami, makes an array of discount-cigarette brands, including Eve, Grand Prix, Liggett Select and Pyramid, and is tapped into real estate and alcohol. Vector's New Valley subsidiary owns half of Douglas Elliman Realty LLC, the largest residential real-estate brokerage in the New York metropolitan area.

Brand loyalty is a difficult hurdle to overcome for cigarette manufacturers. Price, however, is key, particularly with a pack of smokes topping $10 in some states. That could create a windfall for Vector, the fifth-biggest cigarette company in the U.S.

Trading down was widespread during the recession, benefiting the Dollar Store (DLTR) and McDonald's (MCD), among other companies with inexpensive offerings. Some smokers have followed suit and dropped their Marlboros, Camels and Winstons.

There's a simpler reason to buy Vector's stock: The current dividend yield is more than 10%, three times that of the benchmark Treasury yield and four times that of the average for Dow companies.

The dividend yield may be sustainable. In the most recent quarter, Vector increased revenue 6.5% from a year earlier. The dividend costs the company $30 million a quarter, and there's $204 million in cash sitting on the balance sheet. While Vector has high leverage and a negative equity position, it doesn't warrant much concern since that, even without taking in another dollar of revenue, the company could continue to service its debt obligations for another year and a half without a problem.

Vector's price-to-earnings ratio is at a premium versus some of its rivals, such as British American Tobacco (BTI), Altria Group (MO) and Reynolds American (RAI). However, those companies carry smaller dividends. Furthermore, Vector has a beta of just 0.53, which indicates the stock should plot a consistent course and function much like a high-yield bond.

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