When a dividend share surges 42% in just 12 months while still offering a yield north of 5%, it tends to catch my attention.
That’s exactly what has happened with one FTSE 100 stock that I was sceptical of just a couple of years ago. So what’s changed?
A surprising comeback story
British American Tobacco (LSE: BATS) has staged a remarkable recovery. As I write on 4 March, the stock trades at 4,489p. That would have been a surprise to many investors investors as little as 12 months ago when the share price sat at 3,156p.
The stock now boasts a dividend yield of 5.3% as I write. That’s comfortably higher than the broader Footsie average of around 3.5%.
Growth and income? I wanted to dig into what’s been behind the recovery.
The company has shifted its product mix aggressively away from traditional tobacco products toward ‘next-gen’ alternatives. This strategic pivot appears to be paying off.
These new category products are now generating meaningful revenue streams. Cash flow has been strong, which has underpinned the company’s strong dividend payouts.
Why the valuation looks appealing
At a price-to-earnings (P/E) ratio of just 12.7 right now, I think the stock looks like good value. Even better when you consider the non-cyclical demand for its products. I think that’s a potential bonus for investors given how markets are poised right now.
The company continues to generate billions in annual cash flow, which funds both shareholder returns and investment in growth categories.
Management’s strategic clarity around reduced risk products also gives me some comfort around its visibility.
Vaping and heated tobacco products are expanding rapidly in key markets which gives the company exposure to a growing market segment as traditional cigarette volumes decline.
Of course, investors need to be comfortable with the ethics of investing in tobacco stocks such as this given the potential health and social impacts.
Risks remain substantial
Those considering British American Tobacco need to also weigh up the risks.
Regulatory pressure shows no signs of easing. Governments worldwide continue to impose stricter controls on tobacco advertising, packaging, and sales. This can have a material impact on sales growth and profitability.
The transition to reduced risk products is also not guaranteed to succeed at the pace management anticipates. Consumers are notoriously fickle. Demand trends can change quickly and competition is fierce.
My verdict
British American Tobacco has delivered impressive share price gains for investors of late. The company’s above average dividend yield and strong cash flow generation may also be also compelling for those hunting additional yield.
With a relatively low P/E ratio and its defensive qualities. I think its a stock for investors looking for a combination of income and growth to consider further.
