Shares in FTSE 100 tobacco companies come with some eye-catching dividend yields. And I think they’re worth considering seriously for investors seeking passive income.

Cigarette volumes might be in more or less terminal decline, but this might not be a problem for British American Tobacco (LSE:BATS) and Imperial Brands (LSE:IMB) given their moves into new product areas. But which is undergoing this transition more successfully?

Beyond cigarettes

Dividend yields of 8.3% from British American Tobacco and 7% from Imperial Brands are high by anyone’s standards. And this action to keep shareholders happy arguably reflects the declining industry they operate in.

The decline of cigarettes doesn’t have to mean the end of tobacco companies, though. Elsewhere in the industry, Philip Morris (NYSE:PM) is demonstrating this impressively. 

The company has been having a lot of success in growing its next-generation products, which now account for 36% of overall sales. The most successful of these has been ZYN – its nicotine pouches.

Philip Morris is expecting 60% annual growth from ZYN going forward. And while some recent issues have opened the door for competitors, the overall growth picture is clear enough.

The future for tobacco companies is about such next-generation of products, especially nicotine pouches. So the issue is which of the UK firms is in the best position to make the most of this.

Market positioning

There are a few reasons I have British American Tobacco firmly ahead on my scorecard. The first is that its own nicotine pouch – called Velo – is the leading product in its category outside of ZYN.

Velo has a strong presence across Europe and the Americas and generated £539m in sales during 2023. That’s more than the entire next-generation products division at Imperial Brands. 

British American Tobacco clearly has the bigger market share, but to some extent this reflects the fact it’s a larger company. Even as a proportion of total revenues, though, it’s still ahead.

With Imperial Brands, next-generation products account for around 6.8% of total revenues. At British American Tobacco, that number is 12.26%. 

To my mind, this indicates that one company is significantly ahead of the other at the moment. If the future for tobacco companies is smokeless products, I think there’s a clear leader.

Long-term growth

Both British American Tobacco and Imperial Brands are expecting strong growth from their smokeless products. That’s partly because the market for these is expected to grow significantly.

If next-generation products are going to justify the current market cap of either company, there had better be a lot more to come. But the recent performance of Philip Morris gives reason for optimism.

Neither of the UK companies has a product that has been as spectacular as ZYN. But British American Tobacco comes closest with Velo.

More generally, I think the business is further ahead in the race to transition to the new world of non-tobacco products than Imperial Brands. That’s why it’s the stock I’d choose for long-term passive income.

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1. AT&T

First up is AT&T (NYSE: T). Telco companies tend to underperform the overall market during normal times. But as the US braces for a recession, the likes of AT&T are likely to outperform due to having defensive attributes. It’s for this reason that the S&P 500 stalwart’s share price has remained steady this year.

As such, this dividend stock could be an attractive place for me to invest my money. That’s because telecommunication services have rather inelastic demand. Management confirmed this in its latest earnings report, as it saw customer demand remain relatively healthy.

For that reason, I’m expecting its current dividend yield of 5.8% to remain robust. Meanwhile, Morgan Stanley is projecting the firm’s dividend yield at 6% in 2023. This minuscule growth isn’t too far fetched considering the state of its current balance sheet, which can barely cover its dividends at -0.4 times.

2. Philip Morris

Next is Philip Morris (NYSE: PM), one of the world’s most popular dividend stocks. Although operating in a sunset industry, the tobacco giant has performed admirably this year, beating the S&P 500 by 22%. The company has also been diversifying its business model to venture into other industries, such as food and beverage. This acts as a bonus for me, as it allows the conglomerate to hedge against the tobacco industry’s declining prospects.

Most importantly, its current dividend yield of 5% puts it higher than the S&P’s average, and is an attractive proposition for me given the current market conditions. Additionally, Morgan Stanley projects the company’s dividend yield to tick up to 5.7% in 2023, which it can comfortably cover with its strong cash flow and dividend cover of 1.1 times.

3. Energy Transfer

Finally, there’s Energy Transfer (NYSE: ET). The Houston-based firm is one of the leading suppliers of natural gas from the US. Given the elevated oil and energy prices this year, it’s no surprise that its stock is up 40%, while being able afford a dividend yield of 8.5%.

This makes Energy Transfer one of the highest dividend yielding stocks out there. In fact, its current dividend yield is more than three times the S&P 500 average. Beyond that, Morgan Stanley is also projecting its dividend yield to grow to 10.3% in 2023. With a robust dividend cover of 1.3 times, this is highly likely. Therefore, this makes it an attractive play for me, especially when natural gas is in high demand given the sanctions imposed on Russia.

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Imperial Tobacco (LSE: IMT) (NASDAQOTH: ITYBY.US) is one of this year’s worst FTSE 100 performers. Indeed, year-to-date the company’s shares have fallen 1%, compared to the FTSE 100 as a whole, which has gained 15%.

This poor performance could be putting some investors off the company. However, I feel that the company is currently undervalued and right now the company could be one of the best opportunities in the FTSE 100.

Valuation is too low

Firstly, Imperial’s current valuation means that the company is currently one of the cheapest tobacco stocks in the world. In particular, if we compare Imperial to its closest London listed peer, British American Tobacco (LSE: BATS) (NYSE: BTI.US) and New York listed peer, Philip Morris (NYSE: PM.US) we can see how undervalued Imperial really is.

Specifically, British American Tobacco currently trades at a historic P/E of 15.9 and Philip Morris trades at a historic P/E of 17.1. However, Imperial currently trades at a lowly historic P/E of only 11.5.

Sales are still robust

What’s more, despite its low valuation Imperial’s tobacco sales are actually stronger than those of peer and international behemoth, Philip Morris.

Indeed, during the first nine months of this year, Imperial’s underlying stick volume of tobacco sold declined 5%. However, during the same period Philip Morris reported that its volume of tobacco sold declined 5.7%.

What’s more, sales of Imperial’s key strategic cigarette brands only declined 1% during the first nine months of this year, while sales of Philip Morris’ infamous Marlboro brand slowed by 5.7%.

That said, Imperial’s sales are still behind those of British American. Still, British American is one of the only tobacco companies in the world that is actually reporting rising cigarette sales. 

Well placed for growth

Having said that, Imperial is still well placed for growth. The company has reviewed its portfolio of 250 cigarette and fine cut tobacco brands and is looking to slim down its offering, focusing on only the most important brands.

Imperial is also driving growth outside of its traditional European market. The company is now focusing on high-growth markets such as Asia and other markets where the company’s market share is less than 15% and there is room for growth.

For example, the company’s most recent growth drive was the acquisition of its Cambodian distributor.

Foolish summary

So overall, investors should not be scared of Imperial’s low valuation and underperformance this year. The company has many opportunities open to it and based on falling sales the company looks more attractive than larger peer Philip Morris.

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