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What Dividend Hunters Need To Know About British American Tobacco plc

Today I am looking at whether British American Tobacco (LSE: BATS) (NYSE: BTI.US) is an appealing pick for those seeking chunky dividend income.

Tobacco demand experiencing a hiccup

A backcloth of dependable earnings growth has long made British American Tobacco a safe-haven for dividend hunters. The business has lifted the full-year payout at a compound annual growth rate of 9.4% during the past five years, although recent earnings deceleration has prompted a slowdown in dividend expansion.

The addictive nature of smoking meant that, in days gone by, cigarette manufacturers were sought for strong revenues visibility and british american tobacco / imperial tobaccoconsequently solid dividend prospects. But a raft of adverse factors on tobacco demand, from pressure on consumer wallets through to rising health concerns and changing social habits, has meant that the likes of British American Tobacco have suffered from falling demand.

Indeed, the company’s latest trading statement in April showed that group volumes dipped 1% during January-March, to 158bn sticks, which in turn contributed to a 12% revenue decline.

Dividend growth anticipated to accelerate

These pressures are expected to endure in the near term, as City analysts expect British American Tobacco to punch a 1% earnings decline in 2014. Still, the business is expected to keep dividends ticking higher, with a 3.2% increase anticipated this year to 146.9p per share.

And current forecasts expect recovering earnings from next year — expansion of 9% and 8% is predicted for 2015 and 2016 respectively — to undergird a recovery in dividend growth. The firm is pencilled in to increase next year’s payment 6.9% to 157.1p, with a further 5.2% rise expected in 2016 to 165.2p.

These projections lift the dividend yield from 4.3% this year to 4.6% in 2015 and 4.9% the following year, taking a forward average of 3.2% for the complete FTSE 100 to the cleaners.

Although dividend coverage runs at 1.5 times prospective earnings through to the end of next year, comfortably below the safety benchmark of 2 times, investors should take confidence from the firm’s improving cash position to keep returns rolling. British American Tobacco saw free cash flow improve 3% last year to £3.4bn.

The tobacco specialist’s cash reserves are also allowing it to pledge £1.5bn to share buybacks for 2014 alone, following on from a similar level of repurchases last year.

In my opinion British American Tobacco is a terrific pick for income investors. Although cigarette consumption has taken a whack in recent times, the formidable pricing power of the company’s Global Drive Brands — encompassing the likes of Dunhill, Lucky Strike and Pall Mallshould help it to latch onto recovering demand in emerging markets, home to the vast majority of the world’s smokers.

With its Vype e-cigarette also set to take advantage of galloping demand for vapour-based products, I believe that earnings, and with them dividends, are poised to gallop higher in coming years.

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Royston does not own shares in British American Tobacco.