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There are compelling reasons for investors to consider British American Tobacco (NYSE: BTI) as a potential source of long-term income. With a substantial yield of 7.9%, compared to the approximately 1.2% yield from the S&P 500, the stock warrants a closer look, especially for those focused on dividends. However, it is essential to weigh the risks associated with investing in British American Tobacco.
The company, based in Europe, reports its financial performance semiannually, which means investors have a limited view of its financial health with only six months of data at a time. Nonetheless, these reports reveal significant insights. Approximately 80% of British American Tobacco’s revenue is generated from its combustibles division, with cigarettes alone contributing nearly 98% of its sales volume, indicating the company’s heavy reliance on tobacco products.
On a positive note, around 20% of revenue originates from alternative products such as vaping devices and nicotine pouches, part of the company’s new categories division. This diversification effort is crucial for its long-term viability as management seeks to extend its market reach beyond traditional cigarette sales.
Cigarette markets typically exhibit customer loyalty, making tobacco companies members of the consumer staples sector. While nicotine addiction fuels this loyalty, it has not prevented a gradual decline in cigarette consumption over the years.
The first half of 2024 saw British American Tobacco’s cigarette sales drop by 6.8% compared to the same period in 2023. For the entirety of 2023, the company reported a 5.3% decline in cigarette volumes, which followed a 5.1% decrease in 2022. This trend of dwindling sales highlights the challenges facing the company’s core business.
In response to falling volumes, British American Tobacco has increased prices to maintain revenue levels. This strategy has allowed the company to sustain its generous dividend and even raise it in previous years. However, there is a limit to how effective this tactic can be, as continuous price hikes may exacerbate the decline in sales volumes. Thus, finding new growth avenues is critical for the company’s future.
Currently, the new categories division contributes about 20% of total revenue, indicating some progress in diversification. However, growth within this segment seems limited; only one product line within that category saw sales rise in the first half of 2024, and overall revenue actually fell by 1% year over year. Even after adjusting for currency fluctuations, revenue was up by only 2.3%, which is insufficient to counterbalance the ongoing declines in traditional cigarette sales.
This situation underscores a fundamental challenge for investors. Although British American Tobacco’s high dividend yield may initially appear attractive as a source of passive income, its sustainability hinges on the company’s ability to navigate the shrinking market for cigarettes. If the company fails to successfully pivot away from its declining core business, its generous dividends may come under pressure, potentially leading to diminished returns for investors.
Before committing to shares of British American Tobacco, investors should consider this critical situation:
The Motley Fool Stock Advisor recently highlighted their view that the strong dividend and yield from British American Tobacco do not outweigh the risks involved, as the stock was not included among their current recommendations. They have instead identified 10 best stocks for investors considering long-term growth, which may yield more fruitful returns.
Remember, market dynamics can shift significantly—historically, stocks like Nvidia have proven to deliver remarkable returns; for instance, an investment made following its recommendation in April 2005 would have grown significantly by December 2024.
The Stock Advisor provides investors tools and insights for strategic portfolio development, including regular updates and stock picks aimed at outperforming broader market indices.
For those contemplating an investment in British American Tobacco, further insights into its stock and operations are available for those looking for a comprehensive analysis of this iconic, yet challenging, player within the tobacco industry.
Source
finance.yahoo.com