There's no way to sugarcoat the trade-off being made by British American Tobacco (BTI -0.51%) shareholders. You're getting a massive 9.7% dividend yield, but you are taking on a huge amount of risk for that outsize yield. The big problem is that there is no easy fix to what ails this cigarette giant. Still, it is making progress on key initiatives. Here's a quick look at British American Tobacco and whether it is a buy, sell, or hold.
What does British American Tobacco do?
As its name implies, British American Tobacco makes tobacco products, mostly cigarettes. Smoking causes cancer and, broadly speaking, people are increasingly shunning the habit. That's the big story behind this stock and why investors have such a dour view of it that the dividend yield is getting close to double-digit territory.
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But British American Tobacco doesn't just make cigarettes; it also makes non-cigarette products. That includes things like pouches, vaping products, and heated tobacco offerings. Basically, management is cognizant of the decline in cigarette smoking and is working to find new adjacent businesses to offset that decline. The success of this effort is likely to determine whether British American Tobacco survives over the long term.
Your personal buy, sell, or hold decision will depend greatly on your view of the race between the cigarette segment's deterioration and the growth of the company's non-cigarette offerings.
Sell British American Tobacco
In 2023, British American Tobacco sold 8.2% fewer cigarettes than it did in 2022. That's not good -- and it isn't a fluke, either. In 2022, the company sold 5.3% fewer cigarettes than it did in 2021. In 2021, volume was roughly flat (down 0.1%), but that was largely a result of the coronavirus pandemic. In 2020, volume was lower year over year by 4.6%. And in 2019, volume fell 4.7%. Even in the best recent year, volume was down just a little bit. That's a terrible trend and there's no sign it's going to change.
You probably wouldn't buy a food maker, another type of consumer staples company, where volumes were on a steady downward trajectory, so why would you buy a tobacco maker suffering from such a trend? It would be one thing if cigarettes were a tiny part of British American Tobacco's business, but this product accounts for well over 85% of revenue.
Buy British American Tobacco
That said, given the nature of its products, British American Tobacco has been able to offset volume declines with price increases, so there doesn't appear to be a near-term risk to the dividend. If you have a short time horizon, it might make sense to buy the stock for its hefty yield. That's probably not going to be a large group of people, given that dividend investors are often trying to generate income to live off of over the long term.
However, there's another positive here. The company has been building up its non-cigarette business. It's modestly sized relative to cigarettes, but it is growing. And as of the fourth quarter of 2023, it was profitable. British American Tobacco reached that goal two years ahead of schedule, which is impressive.
This segment is nowhere near large enough to replace tobacco, but management is executing well. The longer it can bleed the cigarette business for cash, the more time it has to grow the new products it hopes will replace it. If you think it can get to a point where non-cigarette businesses do more than just offset the cigarette declines, British American Tobacco stock might be an interesting -- though high-risk -- purchase for you.
Hold British American Tobacco
The argument for holding British American Tobacco is basically the same as the reason a new investor might want to buy it: You believe that the company can eventually build up its new products to the point where cigarettes no longer account for the majority of its revenue. It isn't clear that this can be achieved in time to keep the dividend from being cut, but management does appear to be making important progress. If you choose to stick around and collect the huge yield, you will want to pay very close attention to British American Tobacco's segment-level results. If growth in the non-cigarette business starts to stall, the risk here will increase dramatically.
Not right for most investors
At the end of the day, most investors should avoid companies that are clearly facing long-term secular headwinds in their most important businesses, which is exactly what British American Tobacco is trying to work through. Unless you believe strongly that it will be able to replace cigarettes or have a very short time horizon, you'll probably want to stay on the sidelines here. And if you do buy British American Tobacco stock or choose to hold on to the shares you already own, make sure to watch the company like a hawk. At some point constantly raising prices to make up for volume declines is likely to start exacerbating those declines.
