British American Tobacco (LSE:BATS) has historically been a dividend stock that keeps on giving. During each of the past five years, it has increased its payout to shareholders. And it’s currently yielding around 7.5%. Not surprisingly, the stock has become a firm favourite among investors looking for passive income.
But with increased health concerns about tobacco use, how long can this last?
Addicted to dividends
In cash terms, BAT’s dividend in 2023 is expected to be 18% higher than it was five years ago. It’s also paid quarterly, which is great for the cash flow of shareholders.
| Dividend (pence per share) | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
| Per quarter | 48.80 | 50.75 | 52.60 | 53.90 | 54.45 | 57.73 |
| Annual | 195.20 | 203.00 | 210.40 | 215.60 | 217.80 | 230.90 |
Whether the company can sustain this is entirely dependent upon its revenue and earnings. Neither show any signs of slowing. Last year, profit before tax was £9.32bn — 12% higher than four years earlier. Revenue for 2022 was nearly 8% up on 2021.
But the directors are aware that the company needs to change. Smoking is in decline and investors are taking more of an interest in ethical, social and corporate governments (ESG) issues.
A new era
To combat this, a few years ago BAT embarked on a new strategy to move the company away from traditional cigarettes. The directors are now promoting the sale of reduced risk products (RRPs). These accounted for £2.89bn of revenue in 2022, but were loss-making. However, they are expected to be profitable in 2024, and generate £5bn of revenue in 2025.
But governments around the world are increasingly treating these products like conventional tobacco. The European Union has announced a ban on the sale of heated tobacco flavours. Snus (a modern variant on snuff) can only be sold in Sweden. And over 40 countries have implemented some form of ban on the sale, consumption or marketing of vaping products.
Despite this, BAT continues to grow.
Other considerations
In addition to the level of dividend, there is arguably another reason to invest in my opinion. The stock currently has a price-to-earnings (P/E) ratio of 10.4. This compares favourably to rivals such as Imperial Brands (11.3) and Philip Morris International (16.9). Using this measure, BAT’s shares are cheaper than those of its peers.
One area of concern I have is the company’s level of borrowings. Investing in new products is expensive. This has caused net debt to increase from £39.66bn at the end of 2021, to £43.14bn a year later. At approximately three times its EBITDA (earnings before interest, tax, depreciation and amortisation), this is on the high side for a member of the FTSE 100.
My verdict
Personally, I don’t have an issue with investing in tobacco stocks. The products they sell are legal and nobody is forced into using them. And tobacco products are subject to high levels of taxation, which reflects the public harm they cause.
But I’m not going to buy shares in British American Tobacco.
Although the yield is very attractive, I have doubts about the long-term prospects for the company. Once earnings start to fall, the dividend will be cut. In the short term I don’t think much will change, but I’m looking many years ahead. I can see a world where all forms of tobacco are banned, and any investment I make going up in smoke.
The post Will this high-yield dividend stock run out of puff? appeared first on The Motley Fool UK.
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James Beard has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco P.l.c. and Imperial Brands Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
