Can investors trust the 9.5% income on offer from British American Tobacco (LSE: BATS) shares?
The dividend yield of this FTSE 100 stalwart has risen sharply as its share price has fallen. Should dividend investors consider the owner of Lucky Strike and Dunhill as a buying opportunity — or do the risks faced by this business mean that it’s better avoided?
New boss, clean sweep
British American’s new chief executive Tadeu Marroco took charge in May, shortly after the company paid a record $635m penalty relating to North Korean sanctions violations. This unfortunate episode appears to have cost former CEO Jack Bowles his job.
However, trading information released by the firm since Mr Bowles’ departure suggests other concerns. Most worrying for me was that BAT lost market share in its core US cigarette market during the first half of the year.
The company says spending on its premium cigarette brands is starting to normalise as inflation eases. But new boss Mr Marroco doesn’t seem to be taking any chances.
Since taking charge, he’s carried out a management reshuffle that’s put in place a trusted top team. The executive who was previously in charge of BAT’s US tobacco division has left the business.
Vape growth
One important part of the group’s strategy is the growth of its New Categories business. This includes the Vuse vaping brand and some other reduced-harm products.
For several years, the company has promised investors that New Categories would turn profitable by 2025. Mr Marroco has now brought forward this guidance, telling investors he’s confident “that New Categories will deliver a positive contribution in 2024.”
BAT has lagged behind market leader Philip Morris International in vaping. But even so, New Categories generated nearly £3bn of sales in 2022. I reckon the firm’s 2025 target of £5bn is realistic.
One risk facing the vaping business is that tighter regulation will harm sales. Authorities are rightly worried that the vaping craze is simply getting a new generation hooked on nicotine.
This could be a problem for BAT. But my experience of investing in regulated businesses is that larger companies often emerge as long-term winners from tighter regulation. They’re better able to adapt.
I don’t think it’s a coincidence that Mr Marroco was recently quoted in the Financial Times as saying that “we need to have better regulations” on vaping.
Cheap at £25?
Let’s sum up. The tobacco business may be in long-term decline. We don’t yet know how large and profitable vaping will become globally.
Regulators will probably always target tobacco firms, due to concerns about health and addiction.
On the other hand, British American sold more than 600bn cigarettes last year, generating over £10bn in operating profit. I don’t think this business is going to disappear overnight.
My analysis of the group’s accounts suggests that it has the cash flow it needs to support the dividend and gradually repay some of its debt.
At a price of around £25, the shares offer a yield of almost 9.5% and trade on less than seven times forecast earnings. I think the risks facing this business are reflected in the price at this level.
In my view, the shares look cheap today and are probably worth considering for income.
