As 2024 draws to a close, British American Tobaccos (NYSE: BTI) The shares are up about 25% since the beginning of the year. That’s pretty rapid progress, especially for a company that’s largely seen as an income investment, with most of the rally happening over a six-month period between April and September.
After the price hike, is this cigarette maker worth buying, or is there even more reason to avoid the stock now? Here are four important things to keep in mind when you call.
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The one thing that has probably drawn most investors to British American Tobacco is still the biggest reason to love the stock: its dividend yield. Even after this year’s price increase, the return is still 8%, which is much better than the S&P500 index of 1.2% or the average return of consumer goods shares of approximately 2.5% (based on the Consumer Staples Select Sector SPDR ETF as a proxy for the sector).
If you’re looking to maximize income from your investments, British American Tobacco is clearly a consumer goods company worth looking at. What’s also notable on this front is that the British company switched to paying dividends on a quarterly basis in 2018 and has increased its annual payout every year since (in British Pounds). With this stock, you’d be hard-pressed to find anything to complain about when it comes to the revenue stream it generates.
However, the dividend must be weighed against the company’s business, which largely sells cigarettes. The core tobacco activities did not perform well. Frankly, no cigarette company has done this well lately. But it’s important to understand what’s going on.
In the first half of 2024, British American Tobacco sold 6.8% fewer cigarettes than in the same period of 2023. In 2023, the number of cigarettes fell by 5.3%. And in 2022, they witnessed a 5.1% decline in volume. So it’s no surprise that the stock took a hit in 2022 and 2023, with its market cap falling more than 40% at one point. This is not the kind of trend you see in a healthy company.
British American Tobacco, like its peers, has offset volume declines with price increases, resulting in higher profits and a corresponding stock rally this year. Given the addictive nature of nicotine, smokers are a fairly loyal and reliable customer base.
But at some point, it seems likely that those price increases will worsen the volume declines. The big question for investors today is whether high returns today are worth the risk of buying a company that is experiencing a steady decline in demand for its core products.
Before we dismiss this issue, it’s worth taking a step back in time to the end of 2023. That’s when British American Tobacco changed the way it managed its US operations. Historically, the company had based some of its accounting on the assumption that its U.S. brands would have value in perpetuity.
At the end of 2023, management concluded that those brands would be worthless in 25 to 30 years. That decision required a major write-down of GBP 23.0 billion ($29.4 billion).
That one-off charge made 2023 earnings look terrible, but most importantly, British American Tobacco essentially admitted that its US cigarette business is definitely in decline. Although it manages a global portfolio, it does not bode well for the company that one of its key markets appears to be slowly disappearing.
That said, British American Tobacco is clearly not ignoring the problem. The fact that it has changed its accounting methodology for the US operations clearly indicates that it sees this. That includes the company’s efforts to build what it calls its “new categories” business division. This group sells things like vapes and pouches. The division’s performance was a bit mixed. However, the modern oral pouches product line saw 50% volume growth in the first half of 2024.
BTI data by YCharts.
The new category business only accounted for about 16.5% of sales in the first half of 2024. But the company’s efforts in this area, especially in its growing line of modern pouches, show that there could be long-term opportunities for it. That could offer investors some hope that British American Tobacco can find a way to offset continued declines in its core cigarette business.
Every investment decision must take into account both the positive and negative characteristics of the potential purchase. However, the risks are particularly high for British American Tobacco, which faces a long-term downward trend in its key sector. While the high-yield dividend is attractive, this isn’t a stock you can buy and ignore. In fact, most conservative income investors would probably be better off avoiding it. And if you’re brave enough to own British American Tobacco, you’ll want to pay close attention to the progress it’s making in dealing with the ongoing cigarette volume declines. If it can’t offset these declines, it likely won’t be able to sustain its dividend at current levels 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 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.
Two reasons to buy British American Tobacco stock in late 2024 and two reasons to avoid it for now was originally published by The Motley Fool
