A Closer Look at British American Tobacco's Dividend Potential

LONDON -- Dividend income accounts for around two-thirds of total returns, the actual rate of return taking into account both capital and income appreciation. Given that share prices are often volatile and unpredictable, the potential for plump dividends can give shareholders much-needed peace of mind for decent returns.

I am currently looking at the dividend prospects of British American Tobacco  (LSE: BATS  ) (NYSEMKT: BTI  ) and assessing whether the company is an appetizing pick for income investors.

How does British American Tobacco's dividend history stack up?

 Metric

2009

2010

2011

2012

FY dividend per share

99.5 pence

114.2 pence

126.5 pence

134.9 pence

DPS growth

15.80%

14.80%

10.80%

6.60%

Dividend cover

1.5 times

1.5 times

1.5 times

1.5 times

Source: British American Tobacco company accounts.

British American Tobacco's ability to generate meaty double-digit earnings expansion over the past five years -- 2012 excepted, when adjusted diluted earnings per share rose a still-healthy 7% -- has enabled it to deliver robust dividend growth over the period.

Dividend cover has historically remained stable at 1.5 times forward earnings, although this is below the watermark of 2 times that generally represents absolute security for dividends. However, the company's traditionally defensive operations in the tobacco sector help protect it against fluctuating earnings in the case of a weakening economic backdrop, and thus ease potential pressure on shareholder payments.

What are British American Tobacco's dividends expected to do?

Metric 

2013

2014

FY dividend per share

149.6 pence

163.3 pence

DPS Growth

10.90%

9.20%

Dividend cover

1.5 times

1.5 times

Dividend yield

4.10%

4.50%

Source: Digital Look.

British American Tobacco announced in last month's interims that revenue increased 5% in the first three months of the year, despite a 3.7% drop in cigarette volumes to 160 billion sticks. City forecasters expect earnings per share to continue heading upwards, increasing 10% and 9% in 2013 and 2014 respectively, which should in turn thrust dividends higher.

Indeed, the company is able to keep growing the bottom line despite material demand declines across the group, owing to the considerable pricing power achieved through its four "Global Brands" -- Lucky Strike, Dunhill, Kent, and Pall Mall.

Crucially, the tobacco giant continues to witness accelerating demand for its products in developing regions, particularly in the Asia-Pacific territories where sales rose 6.7% in January-March to 48 billion sticks. British American Tobacco continues to invest heavily in these areas, and with approximately four-fifths of cigarette demand originating from emerging markets, the company is well positioned to harness galloping consumption from these areas.

How do British American Tobacco's dividend prospects rate against the competition?

 

Prospective Dividend Yield

Prospective P/E Ratio

Tobacco

4.50%

13.5

FTSE 100

3.20%

15.4

Source: Digital Look.

British American Tobacco beats the FTSE 100 in terms of both forward dividend yield and in value-for-money terms, trading on a P/E readout of 15.8 for the current year. The company lags behind its sector peers on both counts, however.

Despite this, I believe that the firm has a more advanced position than most of its rivals in developing markets, a solid long-term growth driver that I reckon makes it a stock worthy of serious consideration.

As well, the company is also committed to returning cash to shareholders through its progressive share repurchase program, which outstrips those of its main competitors. British American Tobacco plans to return 1.5 billion pounds to investors this year alone, which compares with 1.25 billion pounds last year and 750 million pounds in 2011.

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