Over the years, some investors have done well by owning British American Tobacco (LSE: BATS) shares. For some, price movements have helped. But the key attraction for many is the dividend. It has grown annually for decades.
A big dividend cut announced today (25 February) at another company has nothing to do with the cigarette maker.
So why do I think it could ultimately spell bad news for the British American Tobacco dividend?
Swingeing dividend cut at FTSE 100 firm
The cut in question was at Diageo (LSE: DGE). Until recently, it also had raised its dividend per share annually for decades.
Business has been getting trickier over the past couple of years for the distiller and brewer. Weakening consumer sentiment makes people less likely to splash the cash on expensive premium spirits.
A new boss with a consumer goods and retail background has come onboard and his approach is to slash the dividend and try to make the company more competitive. I interpret that to mean cheaper pricing among other things.
That might work at Tesco or Unilever – and perhaps it will turn out to be the bitter medicine Diageo needs.
But for now it strikes me as the wrong fix for a premium spirits company. As a Diageo shareholder I am livid about the cut, which I see as the wrong financial priority.
Costly dividends can be an attractive target for cuts
But Diageo is not British American Tobacco. So why has my mind turned to that company’s payout, currently yielding 5.2%?
Raising dividends annually for decades is costly. Last year, British American Tobacco spent £5.2bn on dividends. That was well over double the £2.3bn Diageo spent on shareholder payouts.
Shifting demand landscape
Over at Diageo, there is an ongoing debate about whether the company is in a bad spot because of temporary economic pressures, or its market has changed for the long term as fewer people drink alcohol.
When it comes to tobacco, that debate has long since been settled. Few people would argue that the tobacco industry is going to see anything other than falling cigarette sales over the long term.
British American still shifted 465bn sticks last year – but that was 8% lower than the prior year.
And this is a best-in-class operator, with strong distribution networks, premium brands like Lucky Strike, and longstanding industry expertise.
Will the dividend last?
Current management has stated it aims to keep growing the dividend annually. If it fails to do so, I think it would need to fall on its sword.
But what if a new boss comes in and slashes the payout, as we have seen at Diageo and also saw at tobacco rival Imperial Brands in 2020?
It is definitely a risk.
If Diageo’s move ends up paying off, that could make it easier for a fellow FTSE 100 firm like British American to sell investors on a big dividend cut. I see that risk as higher today than it was yesterday, before Diageo’s cut.
Still, British American remains a cash generation machine and it has also been growing its non-cigarette business. Even weighing the risk of a cut, I continue to see it as a share for income investors to consider.
