The big reason to buy British American Tobacco (BTI +0.96%) is its lofty 7.1% dividend yield. That's an attractive yield, but the broader market is yielding something around 1.2%, and the average consumer staples stock's yield is 2.6%. That suggests there's additional risk surrounding an investment in British American Tobacco.
Indeed, there is, and this one division of the company highlights what you need to be watching.
What does British American Tobacco do?
As its name implies, British American Tobacco is a tobacco company. It sells tobacco and other nicotine-related products across various different delivery forms. However, combustible tobacco items make up around 80% of its revenue. Cigarettes account for about 97% of the volume of the combustible products it sells. So, for the most part, British American Tobacco is a cigarette company.
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Tobacco is classified as a consumer staple. Consumer staples stocks generally make products that people need to buy on a regular basis, like toothpaste, toilet paper, and food. Given that using nicotine products is a choice, not a necessity, it seems like an odd fit. But the addictive nature of nicotine changes the game a little since consumers tend to keep buying their smokes no matter what is going on in the world.
This is a big positive for British American Tobacco with regard to its dividend. Its cigarette business provides reliable cash flow to support the large payout. In 2024, the company's adjusted earnings payout ratio was roughly 66%, which is on the high side but not unreasonable. The dividend is likely to be safe over the near term.
NYSE: BTI
Key Data Points
What does the long term look like for British American Tobacco?
The risk that British American Tobacco faces is that it is dealing with a long-term decline in cigarette volumes. In 2024, volume dropped 5%. In 2023, the decline was 5.3%. And in 2022, it was 5.1%. This is an ongoing problem, and it isn't unique to British American Tobacco.
That said, British American Tobacco's volume declines are half the level of Altria (MO 1.11%). In 2024, Altria's volume fell by 10.2%, which was painful. However, there's a nuance here that's important when making this comparison. Altria only sells cigarettes in North America. If you dig into British American Tobacco's fourth-quarter 2024 earnings release, you'll see that its U.S. cigarette business experienced a volume decline of 10.1%. That's basically right in line with what Altria is seeing in its business.
NYSE: MO
Key Data Points
Both companies are offsetting their volume declines with price increases. However, that can go on for only just so long before a tipping point is reached, and the price increases end up making the volume declines worse.
There are two things for investors to watch with British American Tobacco in the U.S. market, which is its most troubled division. First and most directly, watch how the volume trends develop. If volumes keep dropping, that's bad. If the decline speeds up, that's worse. Unlike Altria, British American Tobacco has exposure to other countries to soften the blow, which is good. But that leads to the second issue to monitor.
The United States is a developed market and sometimes ends up leading the world with regard to social issues. Smoking could be just such an issue. Note that in 2023, British American Tobacco changed the way it accounts for its U.S. brands, basically assuming that they will become worthless in 30 years or so (that's down to around 28 years at this point). If the trouble being faced by the U.S. division begin to spill over into the company's exposure in other countries, there could be big problems ahead. Watch closely to see if that happens.
A high yield that comes with a big long-term risk
British American Tobacco's dividend looks safe for now. However, given the long-term trends in the company's most important business, this is not a stock that a conservative investor will probably find attractive. The rapidly declining U.S. business could, in fact, be the canary in the coal mine. If that pain spreads, this high-yield stock could have a hard time supporting its dividend over the long term.
