British American Tobacco (BTI +0.02%) is one of the world's largest cigarette makers. That places the company in the consumer staples sector, since cigarette smokers tend to keep buying cigarettes no matter what the economic environment looks like. Being in this sector might make the stock's huge 7.5% dividend yield sound appealing.
Here are three reasons why you should be cautious.
1. British American Tobacco is not your typical consumer staples producer
The big reason to worry about British American Tobacco's future is directly related to its most important product, cigarettes. This business accounts for roughly 80% of the company's revenue. That's a huge number and it creates some notable problems for investors to consider.
Image source: Getty Images.
The most notable problem is that cigarette volumes at British American Tobacco have been falling for years. In 2024 the volume decline was 5% for cigarettes. In 2023 the drop was 5.3%. And in 2022 cigarette volumes fell 5.1%. This is clearly not a growing business. If any other consumer staples company were facing volume declines like that investors would probably move on to another stock pretty quickly.
But thanks to British American Tobacco's huge yield, some investors are often willing to overlook the deteriorating fundamentals of the company's most important business.
2. British American Tobacco is specifically propping up the dividend
To be fair, British American Tobacco's cigarette business is facing the same headwinds as most other cigarette makers. So it isn't some sort of weak-performing outlier. The company knows quite clearly that there is a problem, which is why it has been investing in new businesses that it hopes will, someday, replace cigarettes. That's the right plan.
NYSE: BTI
Key Data Points
In the meantime, however, British American Tobacco, like other tobacco companies, is using the reliable demand for cigarettes to pass through price increases. Those price increases help to offset the volume declines and allow the company to support its lofty dividend payment and high yield. In fact, despite the ongoing deterioration of the business, British American Tobacco has been increasing its dividend. The clear, though perhaps unspoken, goal is to make the stock attractive to dividend investors.
At some point, however, price increases seem likely to exacerbate the volume declines. If, perhaps when, that tipping point is reached, the story behind British American Tobacco as an income stock could sour very quickly.
3. A high yield doesn't necessarily mean a stock is cheap
There's another problem with the high dividend yield here, since some investors might view it as a sign that the stock is cheap. This is often the case in the consumer staples sector given the necessity nature of what most consumer staples companies produce. Only cigarettes aren't a necessity.
Data by YCharts.
And if you step back and look at more traditional valuation tools, like the price-to-sales and price-to-book value ratios, British American Tobacco looks expensive. Those two metrics were selected because they both tend to be more stable over time than earnings. This brings up another little wrinkle: In 2023 British American Tobacco took a massive one-time charge because it changed the way it accounted for its U.S. cigarette business. Management basically admitted that this business would likely be worthless in roughly 30 years.
So British American Tobacco looks expensive on key valuation metrics and its earnings trend isn't a useful tool right now because it has been impacted by the company's own admission of the weakness of its core business. That's what investors are buying into when they purchase shares of British American Tobacco for its lofty yield.
There's little near-term risk, but the long-term outlook is troubling
It seems likely that British American Tobacco can keep raising prices to offset volume declines in the near term. And there's a chance that it can do so long enough to build new business lines to replace cigarettes. But if this outcome fails to materialize, is that a risk you are willing to take, especially if you are trying to live off of the dividends your portfolio generates?
Given the negatives, from the core business deterioration to the specific effort to support the dividend to the valuation, it looks very much like British American Tobacco isn't a good option for long-term dividend investors.
