10% dividend yield! Is British American Tobacco one of the greatest FTSE 100 bargains?

British American Tobacco continues to pay its 10% dividend yield! But here’s why Zaven Boyrazian remains untempted by the payout.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Young Caucasian woman with pink her studying from her laptop screen

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

It’s been a rough 12 months for the British American Tobacco (LSE:BATS) share price. Despite being one of the leaders in the tobacco industry, investors seem keen to jump ship, with shares falling more than 30% in the past year. This downward trend has continued so far this month, with the stock price tumbling to its lowest point since 2010 following a strategy update from the management team.

As a result of all this, the dividend yield now stands at just over 10%. But is this reaction justified? Or are investors secretly looking for a terrific buying opportunity?

The future of tobacco looks bleak

For years, regulations surrounding cigarettes have been getting stricter. With more research revealing the negative long-term health impacts of these products, pressure against the likes of British American Tobacco has been rising. And following the reveal of a ‘smoke-free generation’ policy by the UK government, management appears to have come to the conclusion that the traditional tobacco market has no long-term future anymore.

As such, the company has re-evaluated some of its brands, most notably the ones it acquired through its £40bn acquisition of Reynolds in 2017, such as Pall Mall, Camel, and Newport. The end result is a planned £25bn write-down, whipping out around 16% of the firm’s total assets.

Needless to say, this isn’t an encouraging sign for shareholders. The write-down itself isn’t too problematic in regards to dividends. After all, impairment charges don’t affect cash flow or the affordability of dividends. But it’s a clear signal that management has lost faith in the future of its core product portfolio.

So is this the end of the road for British American Tobacco? Not necessarily.

What’s next?

The company hasn’t been blind to the threat of regulation and consumption shifts over the last decade. Management has been rigorously investing in alternative, non-combustible products that can satisfy customers without causing severe health problems.

Examples include vapour-based products, oral pouches, and various heated tobacco products. The progress made so far, in my opinion, has been quite encouraging.

Its New Category division is on track to break even two years ahead of schedule. And by 2035, 50% of the group’s revenue stream is expected to derive from its non-combustible products. For reference, the sales contribution stands at around 12% today.

With this business accelerating its internal investments to transition the product portfolio away from traditional tobacco, the recent sell-off in the share price might be a bit overinflated.

Time to buy?

Typically, seeing a double-digit dividend yield is a clear sign of unsustainability. But in the case of British American Tobacco, that doesn’t appear to be the case. The company is still generating lots of cash flow from its existing product portfolio, which is more than enough to cover its dividend payments.

However, that doesn’t necessarily make it a great investment. After all, even if dividends are maintained, a continually declining share price will offset any gains.

This downward trajectory appears to be largely fuelled by uncertainty. And, in my opinion, caution may be warranted. The company is venturing into new territory whose long-term health impacts are still being investigated by scientists.

Therefore, personally, I’m keeping this business on my watchlist until the smoke clears.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco P.l.c. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Trading at a 10-year low, this FTSE income stock now yields a chunky 6.99%!

Harvey Jones has been watching from the sidelines as shares in this FTSE 100 income stock just fall and fall.…

Read more »

Dividend Shares

Is a Bank of England rate cut good for the Lloyds share price?

Ken Hall analyses what the latest interest rate cut could mean for the Lloyds share price with the UK bank’s…

Read more »

Investing Articles

2 brilliant bargains I’m considering for my Stocks and Shares ISA!

These FTSE 100 and FTSE 250 shares offer exceptional value on paper. Here's why I'm considering them for my Stocks…

Read more »

Shot of a senior man drinking coffee and looking thoughtfully out of a window
Dividend Shares

How much passive income could I generate with just £10 per day?

Ken Hall wants to create his £10,000 yearly passive income dream by investing just £10 every weekday day in Footsie…

Read more »

Investing Articles

Is the Rolls-Royce share price too high? Here’s what the experts say

The Rolls-Royce share price has surged over two years, representing one of the FTSE 100’s greatest success stories. But is…

Read more »

Smart young brown businesswoman working from home on a laptop
Investing Articles

A top S&P 500 growth share and an ETF I’d buy this November!

I think this S&P 500 share and exchange-traded fund (ETF) could be brilliant additions to my ISA or SIPP right…

Read more »

US Stock

Here are the best-performing S&P 500 stocks after the US election result

Jon Smith notes some of the largest gainers from the S&P 500 yesterday and explains how the election result has…

Read more »

Growth Shares

2 UK stocks knocking on the door of promotion to the FTSE 100

Jon Smith points out a couple of UK stocks that he feels could be ready for the big league based…

Read more »