Tobacco stocks like British American Tobacco (LSE:BATS) are popular shares for investors targeting a large and reliable second income.
Their products are highly addictive, which means they remain in great demand across all points of the economic cycle. This provides them with the stable revenues and cash flows to consistently pay a decent dividend.
Capital expenditure also tends to be relatively low, reflecting the mature nature of the tobacco industry and their simple production processes. This gives cigarette makers more cash to distribute among shareholders.
These qualities have allowed British American Tobacco to lift annual dividends for 18 of the last 20 years:
Encouragingly for investors, City analysts expect the FTSE 100 company to keep lifting dividends over the short to medium term. But does this make British American Tobacco shares a buy?
8.1% dividend yield
Although rising trade tensions threaten dividends across the London stock market, predicted payouts at British American Tobacco are tipped to remain exceptionally high, as shown below.
| Year | Expected dividend per share | Dividend growth | Dividend yield |
|---|---|---|---|
| 2025 | 245.10p | 4.1% | 7.6% |
| 2026 | 252.43p | 3% | 7.8% |
| 2027 | 262.59p | 4% | 8.1% |
But just how realistic are current dividend forecasts?
Firstly, it’s worth noting that projected rewards aren’t substantially covered by anticipated earnings through to 2027. Dividend cover of 1.5 times through the period is well below the widely accepted safety benchmark of 2 times and above.
That said, British American Tobacco’s highly stable operations mean that earnings cover typically isn’t as critical as with more cyclical companies. So the company’s balance sheet may be a better guide to the robustness of these dividend forecasts.
Unfortunately, the FTSE firm doesn’t score especially highly on this front either. At 2.44 times at the end of 2024, net debt to adjusted EBITDA remained at the upper end of the company’s 2-2.5 times target.
British American Tobacco also faces considerable costs related to a litigation case in Canada, for which it’s set aside £6.2bn, but could end up shelling out more. All this could compromise the firm’s ability to pay those large dividends analysts are predicting.
Are the shares a buy for me?
So is British American a possible buy? I’m not convinced, despite the potential dividends.
Over the last decade, the share price has dropped 11.3% in value. This means that, even taking into account dividends in that time, it’s delivered a total return of just 41.3%.
That’s less than half the FTSE 100’s total return of 85.1% over the period. And I fear the company could continue delivering index-trailing returns as regulators tighten rules concerning the sale and use of tobacco products, threatening future earnings.
Like other tobacco manufacturers, the business is diversifying into new technologies like vapes to deliver future profits. And it’s making solid progress on this front (sales rose 15.6% over the course of 2024).
Yet products like its Vype e-cigarette face the same regulatory crackdowns as its traditional combustible products. There’s also a huge question markover the profitability of these new products.
So even with its high yields, I’d rather buy other UK dividend shares today.
