How Strong Are British American Tobacco plc’s Dividends?

If you want a winning formula for a great dividend-paying business, selling something consumable to a very large worldwide customer base with little in the way of research and development costs is a good way to start.

Then make the product something that people are literally addicted to, and you surely can’t go wrong.

british american tobacco / imperial tobaccoIn a nutshell

That’s essentially British American Tobacco (LSE: BATS) (NYSE: BTI.US), and it’s easy to see why investors are prepared to pay good prices for the shares in order to get a reliable income.

For 2013, the company paid a dividend of 142.4p per share, which represented a yield of 4.4% on the year-end share price, and that was covered 1.5 times by earnings.

That’s a pretty good yield anyway, ahead of the FTSE 100‘s (FTSEINDICES: ^FTSE) average of around 3%, but taking into account its reliability cranks up its attractiveness a notch. But what valuation did the markets put on it? Well, the shares ended the year on a P/E of 15, which is only slightly ahead of the FTSE’s long-term average of 14, so not much premium at all.

Shares have risen

For this year we have a modest 2.5% rise in the dividend forecast, to 146p per share — not big, but in line with inflation. Cover should stay close to 1.5 times.

The share price has risen since December 2013 to 3,588p, giving us a forward P/E of 17 and dropping the potential dividend yield to 4.1%.

Some might see that as a bit expensive now, but it still looks reasonable to me because of the very low chances of the dividend being cut any time soon.

Long term?

The longer-term risk, of course, is that the popularity of smoking is waning. But despite telling us that “difficult trading conditions persist in some parts of the world” in its 213 results released in February, British American did go on to say that its strategy “continues to deliver robust profit and dividend growth“.

And at first-quarter time this year, chief executive Nicandro Durante said he was “confident of delivering consistent growth in earnings […], which we will recognise with an increase in the dividend“.

Overall volume sales are slowly falling, but the continuing shift to high-margin brands suggests that rumours of the death of the industry are premature.

The cash looks safe

And although surely one day the world will kick the tobacco habit, it’s not going to be any time soon — and British American Tobacco’s dividends do not look under any threat in the foreseeable future.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool has no position in any of the shares mentioned.