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Why I’d sell FTSE 100 dividend stock British American Tobacco before things get REALLY ugly

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There’s no shortage of terrific income shares on the FTSE 100 that could make you an absolute fortune, both now and in the years to come. I’m afraid that British American Tobacco (LSE: BATS) isn’t one of them, however.

The rapid decline in smoker numbers across the globe means that Big Tobacco’s traditional dividend heroes like British American Tobacco can no longer be relied upon to provide you with the sort of income flows that you’ll need to retire comfortably.

It’s no surprise that the firm’s brands like Pall Mall and Benson & Hedges are helping revenues to keep chugging higher at least for the time being. These labels still command unrivalled customer loyalty and between January and June, sales of British American Tobacco’s so-called ‘Strategic Portfolio’ comprising its core labels (and tobacco heating products (or THPs)) rose 8.5%.

More pain for THPs

Still, the rate at which aggregate cigarette and THP demand is falling. Industry volumes dropped between 3% and 4% during the first half, British American Tobacco has said and that suggests to me that the days of punchy revenue growth could be coming to an end very soon.

As I noted last time I covered the stock in June, the hope that THP and other so-called next-generation products like vaporisers may eventually replace the lost revenues caused by the contracting cigarette market is not exactly concrete. And this is not just because legislators in key territories are also hitting these new-age products with bans on where they can be used, an issue that has really hammered cigarette consumption across the globe.

The outlook here became a hell of a lot rockier for British American Tobacco this month after Philip Morris International filed papers alleging patent infringement against its trade rival in the key Japanese market. The US firm claims that British American Tobacco’s Glo device infringes upon two of its patents, is claiming ¥100m in damages, and is seeking a permanent injunction stopping the sale of the controversial product.

Forget the low valuation

Now City analysts are expecting earnings at the Footsie firm to expand 3% in 2018 and by another 9% in 2019. These solid projections are also expected to keep British American Tobacco’s progressive dividend policy in business too, with last year’s 195.2p per share dividend anticipated to swell to 202.2p in the current period and again to 216p next year.

Subsequent yields of 4.8% and 5.2% look pretty appealing on paper. But I am afraid that these, along with a low forward P/E ratio of 14.2 times, is not cheap enough given the prospect of downgraded profit forecasts by the City.

Indeed, the number crunchers have already been busy scribbling out and amending their medium-term earnings estimates in recent months, and further similar action is quite likely, making this cheap valuation something of a moot point. With the outlook for both its traditional, combustible devices, as well as its next-gen technologies looking less than robust, I am steering well clear of British American Tobacco and will continue to do so.

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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.