What a good year it has been for shareholders in British American Tobacco (LSE: BATS). For starters, the 7.6%-yielder raised its dividend per share, as it has every year this century. On top of that, the share price has soared 31% over the past year. I have been looking for dividend shares to buy for my portfolio – could this be one for my shopping list?
Brilliant dividend record, but with an uncertain future
Let’s start with the dividend. British American is one of the nation’s best payers, doling out over £5bn in dividends to shareholders last year alone. With the FTSE 100 currently yielding an average 3.5%, British American offers comfortably more than double that.
Bear in mind that this is not even unusual for the share. A year ago, the lower share price meant that the share actually offered a higher yield.
So what is behind the high yield? I reckon there are four key factors.
One is the attractive economics of the tobacco industry. Cigarettes are cheap to make and can be sold at high prices, something helped by British American’s portfolio of premium brands. That is good for cash generation — and dividends.
The other three factors are connected, as I see it. One is that many investors shun tobacco companies on ethical grounds, helping keep share prices somewhat in check and maintain yields. Also, British American has consistently grown its dividend and made it clear that that is a priority for the future too.
But that is not guaranteed, due to the final factor I think has helped keep the dividend high: uncertainty.
British American’s products are killing some of its customers. Fewer people are choosing to smoke in most markets. There is a risk that, if cigarette sales keep falling, the dividend will have to be cut at some point. Rival Imperial Brands made that move five years ago.
The share looks cheap – perhaps!
British American has been developing its non-cigarette business more aggressively than Imperial. For now the profitability model does not compel me. Over time though, that may improve.
Meanwhile, the company’s sale of cigarettes continues to fall – but remains substantial. Last year, the firm saw cigarette volumes fall by 9%, but it still shifted over half a trillion cigarettes.
The long-term economics here are shifting though. Higher prices can help mitigate some of that volume loss but there are limits to that approach before even more smokers quit.
British American trades on a price-to-earnings (P/E) ratio of 9, which looks cheap. But net profit last year was less than half what it had been three years before. While the current P/E ratio is cheap, if earnings keep sliding at pace, the prospective P/E ratio may be much higher.
At the right price, British American is one of the shares I would choose to buy for my portfolio. After the past year’s share price growth though, it is not as attractive to me as it once was.
For now, despite that tempting dividend yield, I will not be adding it back into my portfolio. I just reckon there are too many other better bargain dividend shares in the UK stock market for me to buy right now!
