Evaluating the Investment Potential of British American Tobacco: A 7.9% Dividend Yield

Investors may find compelling reasons to consider British American Tobacco (NYSE: BTI) for long-term income generation. With an impressive yield of 7.9%, compared to the S&P 500 index’s yield of approximately 1.2%, it’s worth looking closely at this stock. The key question remains: Is investing in British American Tobacco worth the risk?

Understanding British American Tobacco’s Business Model

British American Tobacco operates as a European company and provides financial data only twice a year. Despite this limited reporting, the data reveals critical insights. Notably, the company’s combustibles division contributes about 80% of total revenue, with cigarettes representing nearly 98% of the volume in that category. In essence, British American Tobacco primarily functions as a cigarette manufacturer.

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While approximately 20% of revenue does arise from other categories such as vapes and nicotine pouches, these fall under the company’s new categories division. This expansion indicates management’s effort to diversify beyond traditional cigarette sales, an essential move for the company’s sustainability and growth.

Challenges Facing British American Tobacco’s Cigarette Sales

Customers of cigarette products display remarkable loyalty, often purchasing regardless of economic climate. This attribute places tobacco companies in the consumer staples sector. However, despite the addictive nature of nicotine, volumes have been declining steadily over time.

In the first half of 2024, British American Tobacco experienced a 6.8% drop in cigarette sales compared to the same period in 2023. In full year 2023, the decline reached 5.3%, following a 5.1% decrease in 2022. The downward trend has persisted, highlighting ongoing issues in the core business segment.

To counteract volume losses, British American Tobacco has implemented price increases, a strategy common in the industry. This approach has successfully supported its high dividend and has allowed for potential increases. However, continual price hikes can eventually lead to adverse effects, making it crucial for the company to discover alternative growth avenues to supplement its shrinking cigarette market.

Despite the new categories division showing efforts in expansion, only one aspect of that business exhibited growth in the first half of 2024. Overall revenue for the division fell by 1% year-over-year, with an adjusted increase of only 2.3%. This growth is inadequate to compensate for the weaknesses observed in the cigarette sector.

The Dilemma of Long-term Income from British American Tobacco

The principal concern revolves around British American Tobacco’s significant yield, which seems attractive for income-focused investors. However, this yield’s longevity is questionable due to underlying business trends. If the company does not successfully transition away from its declining cigarette segment, the highly praised dividend could be at risk. Consequently, potential investors should evaluate whether they believe British American Tobacco can adapt effectively before making any commitments.

Should You Invest $1,000 in British American Tobacco Today?

Before making any investments in British American Tobacco, consider this:

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends British American Tobacco P.l.c. and suggests the following options: long January 2026 $40 calls on British American Tobacco and short January 2026 $40 puts on British American Tobacco. The Motley Fool follows a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.