The big reason to buy British American Tobacco (NYSE: BTI) is its lofty 7.1% dividend yield. That’s an attractive yield, but the broader market is yielding something around 1.2%, and the average consumer staples stock’s yield is 2.6%. That suggests there’s additional risk surrounding an investment in British American Tobacco.
Indeed, there is, and this one division of the company highlights what you need to be watching.
As its name implies, British American Tobacco is a tobacco company. It sells tobacco and other nicotine-related products across various different delivery forms. However, combustible tobacco items make up around 80% of its revenue. Cigarettes account for about 97% of the volume of the combustible products it sells. So, for the most part, British American Tobacco is a cigarette company.
Tobacco is classified as a consumer staple. Consumer staples stocks generally make products that people need to buy on a regular basis, like toothpaste, toilet paper, and food. Given that using nicotine products is a choice, not a necessity, it seems like an odd fit. But the addictive nature of nicotine changes the game a little since consumers tend to keep buying their smokes no matter what is going on in the world.
This is a big positive for British American Tobacco with regard to its dividend. Its cigarette business provides reliable cash flow to support the large payout. In 2024, the company’s adjusted earnings payout ratio was roughly 66%, which is on the high side but not unreasonable. The dividend is likely to be safe over the near term.
The risk that British American Tobacco faces is that it is dealing with a long-term decline in cigarette volumes. In 2024, volume dropped 5%. In 2023, the decline was 5.3%. And in 2022, it was 5.1%. This is an ongoing problem, and it isn’t unique to British American Tobacco.
That said, British American Tobacco’s volume declines are half the level of Altria (NYSE: MO). In 2024, Altria’s volume fell by 10.2%, which was painful. However, there’s a nuance here that’s important when making this comparison. Altria only sells cigarettes in North America. If you dig into British American Tobacco’s fourth-quarter 2024 earnings release, you’ll see that its U.S. cigarette business experienced a volume decline of 10.1%. That’s basically right in line with what Altria is seeing in its business.
Both companies are offsetting their volume declines with price increases. However, that can go on for only just so long before a tipping point is reached, and the price increases end up making the volume declines worse.
