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How British American Tobacco Plc Will Deliver Its Dividend

I’m looking at some of your favourite FTSE 100 companies and examining how each will deliver their dividends.

Today, I’m putting British American Tobacco (LSE: BATS) (NYSE: BTI.US) under the microscope.

Dividend policy

The directors of British American Tobacco (BAT) tell us:

“The Group’s policy is to pay dividends of 65% of long-term sustainable earnings, calculated with reference to the adjusted diluted earnings per share [EPS]. Interim dividends are calculated as one-third of the total dividends declared for the previous year”.

We also know that BAT’s target is to “maintain free cash flow at over 80%” of adjusted EPS, and that, over and above the dividend, “to the extent we have spare cash, then we’ll give it back to shareholders via a buyback”. In the words of the finance director: “We’re returning, essentially, all of our free cash to our shareholders with the dividend and the buyback together.”

There aren’t too many companies with as well defined a dividend policy as BAT. The dividend is linked to clear and specific quantitative measures, enabling shareholders to hold management to account on delivery of its targets.

Dividend delivery

BAT’s results for 2012 were ahead of market expectations, and the dividend was lifted 7% to 134.9p — giving an increase of close to 250% over 10 years.

Free cash flow for 2012 was £3.26bn, representing 81% of adjusted earnings. The gross dividend payout was £2.54bn and the company spent £1.26bn buying back shares. The dividend and buybacks together amounted to £3.8bn — £0.54bn more than free cash flow. The numbers are balanced by a £0.54bn increase in net debt.

As you can see, shareholders are able get a good handle on what’s going on with their dividends. Net debt increased fairly modestly, but the signs are that management is confident of delivering further strong dividend growth, presumably on the back of expectations of increased free cash flow.

The company said, within the 2012 results, that it intends to increase share buybacks this year to £1.5bn from last year’s £1.26bn. At the same time, analysts are forecasting a 145.75p dividend for the year, up 8% on last year’s 134.9p, giving a prospective yield of 4.2% at a share price of 3,476p — a full percentage point higher than the market average.

To sum up, BAT has been a great share for dividend investors, the dividend policy is admirably transparent, and good dividend growth is forecast to continue. Furthermore, you can currently buy into all this with a relatively high starting income of 4.2%.

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> G A Chester does not own any shares mentioned in this article.