When you buy any stock, you need to think about the future. But that's especially true for British American Tobacco (BTI 2.48%), which is one of the world's largest cigarette makers. Here's a look at what's happening to its core business (which is not good news) and what it is doing with the rest of its portfolio (which is showing signs of promise). The next five years could be very important for the company and investors.
British American Tobacco admits there's a big problem
Years from now, British American Tobacco investors will likely look back at 2023 and see two big takeaways. The first is a very troubling admission. During 2023, management changed the way it accounted for its U.S. cigarette brands, which include icons like Camel and Lucky Strike. It's a bit complicated, but the company shifted from assuming that the brands would live on forever to assuming they will be worthless in roughly 30 years.
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Think about that for one second. Making cigarettes is the most important business line at British American Tobacco, a consumer staples company, and it is telling investors that the brands it operates in the world's largest and most important economy are in a terminal decline. To be fair, British American Tobacco operates in markets around the world, so there are potential offsets to the continued weakening of the U.S. market. But you can't ignore the trends.
To put some numbers on that, the company produced around 700 billion cigarettes in 2018 and just 555 billion in 2023, a huge 21% decline. A decline of another 20% or so over the next five years would bring cigarette production down to around 445 billion.
British American Tobacco is working hard to offset the problem
So far, like all tobacco companies, British American Tobacco has been offsetting volume declines by raising prices. That's allowed it to support its lofty 9.6% dividend yield. There's probably no reason to believe this approach will stop working in the near term, but it clearly can't work in the long term if cigarette volumes go to zero over time. Sure, you could sell cigarettes for $1 million a pack, but there probably wouldn't be enough buyers. But that's what the current trends would logically require to happen if nothing else were to change.
NYSE: BTI
Key Data Points
Which is where the good news from 2023 comes in. British American Tobacco's non-cigarette business has grown to account for 17% of sales. That's really a pretty small figure in the grand scheme of things, but it is proof that management hasn't simply put its head in the sand. The goal is to get that figure to 50% by 2035. Ideally, it will do that through growing the business and not through enduring a steep decline on the cigarette side. Only time will tell.
But there's some additional good news here, as the non-cigarette business is now profitable at the division level. It is, more or less, doing well enough to sustain itself. And that will make it easier for British American Tobacco to justify putting more capital into the business. So what's really going on here is a race between the ongoing decline of the core cigarette operation and the growth of the up-and-coming non-cigarette division.
The race won't be over in five years
Here's the thing: The next five years will probably look very similar to the last couple, with ongoing declines in the cigarette business and further growth in non-cigarette operations. How fast each moves in its respective direction will determine where the stock and the dividend go. British American Tobacco won't be able to replace its cigarette business in five years, but it is still highly likely that it will be able to continue bleeding the cash cow business to pay material dividends and to invest in new lines of business.
For dividend investors interested in the huge dividend yield, the next five years should be filled with constant monitoring of British American Tobacco's results. This is not a set-it-and-forget-it stock.
If the company doesn't continue to make solid progress on the non-cigarette side, you should probably consider selling. The dividend won't be supportable over the long term if British American Tobacco can't find a way to offset the ongoing cigarette declines. If the company doesn't make substantial progress with its long-term transition plans over the next five years, even aggressive investors should start to question their commitment to the stock.
