There is one very specific feature of it British-American tobacco‘S (NYSE:BTI) stocks that keep investors interested: the dividend yield. At a time when the S&P500 index offers a small interest rate of 1.2% and the average consumer goods stock 2.6%, while British American Tobacco’s interest rate is a lofty 8.1%.
“Wow” is a fair response to hearing that return, but that huge return comes with risks and long-term investors need to think about what the future might look like here. Will this company offer such enviable returns in five years?
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British American Tobacco’s name is quite descriptive, as it is one of the largest cigarette manufacturers in the world. Combustible products accounted for approximately 80% of sales in the first half of 2024. That total includes cigarettes as well as other things that essentially burn tobacco. Cigarettes accounted for approximately 98% of the volume. So while the company does other things, British American Tobacco is essentially a cigarette company.
Image source: Getty Images.
What makes British American Tobacco unique among its competitors is that it has a truly global cigarette business. Its main competitors Altria And Philip Morris International not. Altria only operates in North America. Philip Morris International was spun off from Altria to exploit Altria’s brands in foreign markets. However, being global is good and bad, because cigarette sales are a tough business, especially in North America, where volumes have been declining for years. Essentially, consumers are turning away from smoking.
The numbers are quite discouraging. In the case of British American Tobacco, the number of cigarettes fell by 5.1% in 2022, by 5.3% in 2023 and by 6.8% in the first six months of 2024. It appears that the declines are starting to accelerate.
Like its peers, British American Tobacco has been able to offset volume declines with price increases. Given the nature of tobacco, consumers are usually quite loyal to the product. The frequent purchases are the reason why cigarettes are classified as a consumer product. However, the declines continue largely due to health concerns. That said, price increases can only be taken so far before they too begin to have a negative impact on volume. Given the current volume trajectory, the future does not look bright.
To be generous, and to make the math easy, we’ll assume that British American Tobacco manages to keep its volume decline at 5% per year for the next five years. In the first half of 2024, the company sold approximately 250 billion units.
Estimates of British American Tobacco cigarette volume down 5%
Six months
Volume (in billions)
2024 (actual)
250
2025
238
2026
226
2027
214
2028
204
2029
193
Data source: British American Tobacco and author estimates.
In five years, British American Tobacco’s core business could see volume drop from 250 billion cigarettes sold to less than 200 billion. That’s a huge problem, and those estimates are based on a volume decline that is lower than the last three years. This is what investors may be investing in when they add British American Tobacco to their portfolio. If this were just any other consumer goods company, investors would probably run for the hills.
To be honest, given the high dividend yield, most investors choose to avoid British American Tobacco. Still, that return is clearly attracting some aggressive investors to take a risk on the stock. Furthering the story for these income seekers is the fact that British American Tobacco is investing in what it calls new categories, including things like vaping and smokeless tobacco pouches.
There are problems here too. Only the company’s modern pouches division managed to see a volume increase in the first half of 2024. However, the huge volume increase of over 50% is unlikely to be a sustainable figure in the long term. And even with that increase, modern pouches still make a small contribution compared to cigarettes, with modern pouches accounting for less than 3% of total sales. At this rate, it will be a long time before British American Tobacco has a big enough business to offset its cigarette problems.
If you’re trying to live off the income your portfolio generates, British American Tobacco’s high yield will likely look very attractive. But it carries very large and very real risks, given the continued decline of the company’s core businesses. This isn’t a “set it and forget it” dividend stock. Only the most aggressive investors should own British American Tobacco. That list probably shouldn’t include conservative dividend investors looking to fund their retirement over the long term.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends British American Tobacco Plc and Philip Morris International and recommends 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 has a disclosure policy.
Where will ultra-high yield British American Tobacco be in five years? was originally published by The Motley Fool
