The main attraction of British American Tobacco (BTI -0.51%) is the stock's huge 9.7% dividend yield. That's a shockingly high number for a consumer staples maker. It's understandable that income investors would find the yield attractive -- or at least attractive enough to dig into the cigarette maker's backstory.
Here's the thing -- in a year, the story won't change all that much. But the real question (if you want to live off that dividend over the long term) is: How many bad years can the business withstand before something gives way?
British American Tobacco had a bad 2023
There's usually a reason why investor sentiment turns so negative that a stock has a dividend yield of 9.7%. In the case of British American Tobacco, the reason is pretty simple. The consumer staples company's core business is under severe stress. In 2023, the volume of cigarettes sold fell 8.2% on a reported basis and 5.3% on an organic basis. This is British American Tobacco's most important business, and it is clearly struggling right now.
Image source: Getty Images.
The company makes other tobacco/nicotine products, and some of those businesses are doing quite well. But the company's non-combustible products, the bulk of what the company calls its "new categories" businesses, only made up 16.5% of the top line in 2023. That was up just 1.7 percentage points from 2022. And while the division is profitable, it only just achieved that level. This is all good news, but new products aren't anywhere near ready to replace the company's cigarette business. At best, the new products are reducing the effect of the decline in the company's core cigarette operations.
A year from now, that story probably won't change too much. Cigarette volumes will probably be down by mid- to high single digits again. New categories will probably increase in size a little bit more. And the price increases that the company has long been using to offset volume declines in cigarettes will likely allow it to keep paying that big fat dividend. If you are only worried about a single year of dividend payments from this tobacco stock, there's no reason to be too concerned.
BTI Dividend Yield data by YCharts
Small numbers add up over time
The problem for dividend investors is that the negatives here aren't a one-off item. The downward volume trend in cigarettes has been an ongoing issue. To put a number on that, in 2018, British American Tobacco produced around 700 billion cigarettes. In 2023, that fell to 555 billion. That's a huge decline. To be fair, there are a lot of moving parts involved with a consumer staples company that has a global footprint, like this one.
But the negative trend in British American Tobacco's most important business is very clear. It's why the company is focusing so much attention on its new categories division. It has no choice but to find new business lines if it wants to survive over the long term. To the company's credit, it is making progress. Still, you need to put all this into a bigger context.
Most conservative income investors researching a consumer staples company with a weak core business would probably treat the stock with caution. That would probably be true even if it was making progress in the business meant to replace that core, particularly if that progress was just modest. The only thing that changes the equation with British American Tobacco is the huge dividend yield. Is that yield high enough to justify the inherent risk of owning a business facing material secular decline?
Over the next year, that answer is probably a solid "Yes." However, given the longer-term trends in the cigarette business, the foundation behind that "Yes" degrades materially with each year you add to your outlook. For conservative investors who think in decades, that "Yes" should probably flip to a "No." There's no way to know how long British American Tobacco can keep raising prices in the face of volume declines. There's also no way to know if its new categories will grow large enough to replace cigarettes.
The only thing that you can probably count on with any certainty seems likely to be the ongoing declines being experienced in the cigarette business. That's not a great investment thesis, particularly for a dividend stock.
Most investors will be better off elsewhere
If your income time frame is one year, you'll probably be just fine collecting British American Tobacco's dividends over that time. The problem comes when you extrapolate the company's ability to pay a huge dividend yield too far into the future. This is not a "set it and forget it" company, given the negative trends in the cigarette business. Unless you intend to watch British American Tobacco like a hawk, you should probably avoid the stock. And even then, the long-term risk is just as material as the huge yield.
