Over the past five years, British American Tobacco (LSE: BATS) has seen its share price rise 61%. That strikes me as an impressive return, although it is actually lower than the 74% gain seen in the FTSE 100 index of leading companies over that period.
But a 33% rise in the British American share price so far this year leaves the FTSE 100’s 17% gain during that period in the dust.
The high-yield share has a dividend yield of 6.1%. That is well above the FTSE 100 average of 3.3%.
It has raised its dividend per share annually for decades. Management has stated that the company aims to keep doing so. They understand clearly that the chunky dividend is a critical part of the investment case for what is a mature company in a declining industry.
Managing decline
That decline, of course, is a critical factor to weigh when it comes to British American Tobacco.
The demand for cigarettes is in structural long-term decline in most markets. I do not see that changing over time.
Indeed, British American Tobacco’s own numbers point to the risk that this long-term trend poses to its sales volumes.
In the first half of the year, the tobacco giant saw its cigarette sales volumes fall 8% year on year. That is sizeable. It does not take many years of high single-digit percentage declines for a business to get dramatically smaller.
But despite that fall, revenue only fell 2% year on year. A revenue decline always makes me sit up and pay attention, but I see 2% as manageable.
Revenues declined much slower than volumes because tobacco companies including British American Tobacco have pricing power.
With an addictive product and premium brands, it can raise its selling prices to try and mitigate the ongoing effects of falling sales volumes.
Keeping the cash flowing
That is not the only tool at the firm’s disposal.
After all, it has already been managing cigarette demand decline in some markets for decades.
Some past big acquisitions have helped it build market share even as the total market size falls.
More recently, the focus has been on growing the non-cigarette business while keeping the cigarette business doing what it can. Formats such as vapes offer the opportunity to make up for some of the sales loss due to falling cigarette demand.
With its brand-building expertise and global distribution muscle, British American Tobacco has been in a strong position to develop this part of its business. I expect it will keep doing so.
To date, though, that has been about staking a claim in a newish market. The economics of such formats are so far nowhere near as expensive as cigarettes that are cheap to make and expensive to sell.
That may change over time, though. Meanwhile, the cigarette business continues to pump out cash that can be used to support the dividend.
British American Tobacco has other demands on its cash too, such as servicing its £30bn adjusted net debt.
But with high ongoing cash generation potential and a high dividend yield, I see it as a share for investors to consider.
