Tobacco companies are generally seen as dinosaurs, inching closer to extinction as fewer people smoke. Today, companies like British American Tobacco (BTI -0.51%) are working to evolve beyond cigarettes, hoping to recapture the market with reduced-risk products (still bad for you) such as vaping and nicotine pouches.
The negative sentiment toward tobacco has driven British American Tobacco's stock low enough to yield more than 8% on its dividend, making it a potential target for value investors or those seeking passive income.
So, is British Tobacco a buy, sell, or hold? I've done the homework to find out. Here is what you need to know.
Successfully evolving to new products
British American Tobacco is a global tobacco and nicotine conglomerate with more than £27 billion ($32.9 billion USD) in annual revenue. Combustible products account for £23 billion ($28 billion USD), so it's still the core business. However, that's slowly changing; British American Tobacco, or BAT, sells new category products, including vapes, heat-not-burn tobacco, and oral nicotine pouches.
These are deemed potential reduced-risk products and are being pushed as the company's future core business. Progress is being made; approximately 100 million adults are using these products, up from 46 million five years ago. Noncombustibles contribute more than 30% of BAT's revenue in 23 markets worldwide.
Image source: British American Tobacco.
There's more work to do, but long-term investors want to see users adopt these new products to help BAT grow as smoking declines over the coming years. BAT estimates there are 1.1 billion potential consumers worldwide, meaning its new products have penetrated less than 10% of the market. The company aims to switch its smokers (and competitors' customers) to its new product brands.
Can you trust the dividend?
Common wisdom says that high dividend yields are a potential trap, that they're that high because investors see risk and are demanding a high yield in return for owning the stock. Given BAT has a dividend yield of 8.7%, it's probably fair to question how safe the payout is.
But as you can see, the dividend payout ratio is consistently between 50% and 60%, leaving plenty of margin of safety for a consumer products company like BAT that sees little volatility in its business performance. Management would think long and hard before cutting the dividend because it's typically essential to the shareholder base, and the healthy payout ratio should only reinforce your confidence.
BTI Cash Dividend Payout Ratio data by YCharts
Better yet, management is guiding for mid-single-digit earnings growth, so investors can probably expect slow and steady dividend growth moving forward without threatening the payout ratio.
Should you buy, sell, or hold the stock?
Shares of BAT trade at a forward P/E of under 7 using analyst estimates for this year. Considering the company's guided for mid-single-digit earnings growth, the stock could be undervalued for the growth investors can get -- the PEG ratio is just 1 at the current share price. The stock's valuation could stay the same, and investors might still see double-digit total returns from the earnings growth and dividend yield.
Long-term returns will have more to do with how BAT grows its vaping, heat-not-burn, and nicotine pouch products over the years ahead. Still, investors have time to gauge that and collect dividends because cigarette use has been on the slide for decades.
BAT is a reliable dividend stock with a bargain-basement price on it. It won't make you a millionaire overnight, but its slow and steady nature is likely to produce solid returns.
