The British American Tobacco (LSE:BATS) share price is sinking again following last week’s FTSE 100 rally. It’s now down 23% over the past year, meaning the dividend yield smashes the index average based on current dividend forecasts.
Predictions of further dividend growth mean the tobacco giant carries a 9.1% dividend yield for 2023. This sails above the 3.7% forward average for FTSE index shares.
And for 2024 and 2025 yields march to 9.6% and 10.2% respectively. But how realistic are current dividend forecasts? And should I buy the shares for my UK shares portfolio?
British American Tobacco has lifted shareholder payouts consistently during the past quarter century. It’s a proud record built on the predictable earnings that its addictive products, and the immense pulling power of brands like Lucky Strike and Camel, provide year after year.
As I say, City analysts expect dividends here to continue rising steadily too. Last year’s 230.9p per share reward is tipped to increase to 240.5p in 2023, before rising to 251.9p next year and 269.6p in 2025.
However, there are some red flags investors need to consider when it comes to these estimates. Dividend coverage sits at a less-than-ideal 1.6 times through the next three years. Any reading below two times is said to leave dividend projections in jeopardy.
The firm also has a lot of debt on its balance sheet. While this isn’t abnormal for the business, the company’s adjusted net-debt-to-adjusted-EBITDA ratio stood at 2.9 times at the end of 2022. This is at the upper end of the company’s desired range of two to three times and could compromise future dividend growth.
On the plus side, the tobacco manufacturer’s exceptional cash generation means it could still pay big dividends if it so chooses. Free cash flow clocked just above £8bn in 2022, up 8.1% year on year.
On balance, I fully expect British American shares to deliver increasingly large dividends over the next three years. Even if they fall short of forecasts, shareholder payouts are likely to put those of almost all other FTSE 100 shares in the shade.
But that doesn’t mean I’ll buy the company for my investment portfolio. To me, the attraction of market-beating dividends is overshadowed by the prospect that its share price could keep collapsing.
The company will be hoping new chief executive Tadeu Marroco will be able to turn things around here. Some investors are calling on him to launch a new share buyback programme to boost the company’s stock price.
However, I think any buyback scheme would provide only a temporary boost to the share price. The business might be a leader in its industry. But the tobacco sector is in terminal decline, its demise hastened by ever-stricter regulations on the sale, use and advertising of products.
Worryingly for these companies, legislators are also accelerating steps to deter the sale of vapourisers and other next-generation products. Things will be especially bleak for British American Tobacco if products like its Vuse vape kits fail to sell in huge volumes.
So the pull of large dividends in the short term isn’t enough to tempt me to buy. I’d rather buy other FTSE 100 shares for a second income.