Tobacco companies used to be among the darlings of the stock market. Because the cash flows increased every year, they made the long-term shareholders a lot of money. But that has changed in recent years.
In the past 10 years British-American tobacco (NYSE: BTI) – one of the largest tobacco/nicotine companies in the world – has achieved a total return of negative 6%, while the S&P500 has increased by 231%. This also applies to the robust dividend payments the company pays out to shareholders every quarter.
Today, the dividend yield has risen to just under 10%. As tech stocks soar to new all-time highs, this forgotten tobacco giant appears increasingly undervalued. Is British American Tobacco an income investor’s dream right now?
The tobacco market is declining, but cash flows are strong
British American Tobacco owns some of the longest-running cigarette brands in the world. These include Dunhill, Newport and Camel. While these brands have maintained their market share within the cigarette industry for decades, the overall number of smokers worldwide is declining, impacting shipping volumes. To counter the impact of these volume declines on its financials, British American Tobacco has consistently increased cigarette pack prices.
You can see the results of that strategy in the company’s consolidated financials. British American Tobacco’s sales have actually increased by 5.7% over the past five years, despite declining cigarette use worldwide. The company expects to generate more than $50 billion in free cash flow over the next five years. For a company with a market capitalization of just $68 billion, this shows the potential discounted valuation that British American Tobacco is currently trading at.
But these price increases can’t boost cash flow forever, right? Eventually, most people will stop smoking cigarettes. That’s where the new technology products come in handy.
Growth can come from new nicotine products
Almost everyone is aware of the health damage caused by cigarette smoking. This also applies to the executive team of British American Tobacco. That is why they have made efforts to create and purchase other nicotine products to replace cigarettes among the adult population. These include nicotine pouches, e-vapor and non-burning cigarette devices. These products may have less harmful health effects than cigarettes.
Shareholders should also benefit from this. The company’s new category segment grew 21% on an organic constant currency basis in 2023 and should soon reach $5 billion in annual revenue. Since this is a global company, this can obviously be affected by foreign currency exchange rates. This segment finally became profitable last year and contributed positively to British American Tobacco’s profits for the first time ever.
Over the next decade and beyond, these new products could drive the company’s volume growth and hopefully offset eventual profit declines in the cigarette sector.
Is the dividend sustainable?
The volume growth from new products is large. But income investors are primarily interested in one thing: dividend payments. At current share prices, British American Tobacco has a dividend yield of almost 10%. This makes it one of the highest-yielding stocks in the world, which may make some investors skeptical about the sustainability of the payout.
Looking at the numbers, it’s clear that British American Tobacco actually has plenty of room to maintain its dividend payments at current levels, and will likely be able to grow them in the coming years. Free cash flow – which companies use to cover their dividends – was $5.30 per share over the past twelve months. The dividend is currently only $2.90 per share.
Even if the cigarette sector does worse than expected in the coming years, British American Tobacco has plenty of room to maintain its current dividend payout, so income investors can take comfort in owning this cash-generating nicotine giant.
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Brett Schafer has no position in any of the stocks mentioned. The Motley Fool recommends British American Tobacco Plc 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.
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