This Stock Yields 7% and Has a Dividend Safety Rating of “A”

This week, we’re taking a look at your typical low-end cigarette maker/New York City real estate broker.

OK, it’s kind of a weird combination. But it works for investors. Especially those who appreciate the 7% dividend yield.

Wealthy Retirement reader Kendo said he “keeps hearing the payout is unsustainable yet they haven’t disappointed to date.”

[ad#Google Adsense 336×280-IA]Let’s take a look and see if Vector Group (NYSE: VGR) shareholders will be disappointed anytime soon.

Cigarettes and Real Estate
Vector Group owns Liggett Group LLC, the fourth-largest cigarette maker in the United States, with discount brands such as Eve, Grand Prix and Eagle 20’s.

Additionally, Vector Group’s New Valley subsidiary owns 71% of Douglas Elliman Real Estate, the largest residential real estate broker in the New York metropolitan area.

About two-thirds of Vector Group’s revenue comes from tobacco and one-third from real estate.

While 2014 results will be reported in the first week of March, over the 12-month period that ended in September, the company generated $221 million in free cash flow – about flat with 2013.

Also, during the past four quarters, Vector Group paid out $164 million in dividends. That makes for a payout ratio of 74% – right at the limit of my comfort level.

I like to see a payout ratio based on free cash flow of 75% or lower. That gives me confidence that, even if a company has a difficult year or two, there is enough of a buffer in free cash flow that the dividend will not be in jeopardy.

But I don’t expect Vector Group to get into trouble anytime soon.

Adding to Cash Flow
Going forward, Vector Group should generate more free cash flow for investors.

One reason for that is the company will save about $28 million a year in payments to the Tobacco Transition Payment Program, which expired last year. That’s $28 million that will fall right to the bottom line and free cash flow.

The white-hot New York City real estate market should also add to cash flow.

According to Zillow, Manhattan homes will remain in short supply in 2015.

By the end of the year, Manhattan condos are expected to be priced 13% above the market’s peak in 2007.

Furthermore, the company has paid a dividend for 19 consecutive years without a cut and has issued a special 5% stock dividend for the past 15 years.

In other words, if you have 100 shares before the special dividend, you’ll have 105 shares after.

Given the company’s solid dividend track record, reasonable payout ratio and expected free cash flow growth, I see no reason why the dividend would be unsustainable.

Dividend Safety Rating: A

— Marc Lichtenfeld

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Source: Wealthy Retirement