British American Tobacco's Huge Yield: Safe for Now, But Watch This Division

British American Tobacco (BTI) has long been a favorite among income-focused investors, thanks to its lofty dividend yield. As of November 14, 2024, the company boasts an 8.48% yield, making it an attractive option in a market where the average consumer staples stock yields around 2.6%. However, this high yield comes with significant risks, particularly in its U.S. cigarette business. Let's dive into the details to understand why British American Tobacco's dividend is safe for now, but why investors should keep a close eye on its troubled division.

The Allure of British American Tobacco's Dividend

British American Tobacco's current TTM (trailing twelve months) dividend payout is $3.01, which translates to an 8.48% yield. This yield is more than three times the average yield of the broader market and more than double that of the average consumer staples stock. For income-seeking investors, this is a tempting proposition. The company's adjusted earnings payout ratio of roughly 66% in 2024 suggests that the dividend is likely to be safe over the near term. However, the long-term sustainability of this dividend is a different story.

The Risks in the U.S. Cigarette Business

The primary risk to British American Tobacco's dividend sustainability lies in its U.S. cigarette business. In 2024, the company's U.S. cigarette business experienced a volume decline of 10.1%, which is in line with the decline seen by Altria, another major tobacco company. This decline is part of a broader trend, with British American Tobacco's global cigarette volumes dropping by 5% in 2024, 5.3% in 2023, and 5.1% in 2022. The company has been offsetting these volume declines with price increases, but there is a risk that this strategy could eventually backfire and accelerate the decline in cigarette sales.

In addition to these volume declines, British American Tobacco's U.S. business faces regulatory risks. In 2023, the company made a significant accounting change, effectively assuming that its U.S. brands could become worthless in 30 years. This move resulted in a big one-time charge and a statutory loss of £15.8 billion in 2023. The company also faces the risk of regulatory action against its vaping products, such as the FDA's ban on Vuse's menthol-flavoured vapes in October 2023, which represented around three-quarters of Vuse's sales.

The Impact on Dividend Sustainability

These risks could impact British American Tobacco's long-term dividend sustainability in several ways. First, if the volume declines in the U.S. business continue or accelerate, it could put pressure on the company's cash flow and make it more difficult to support the dividend. Second, regulatory action against the company's products could further reduce sales and profits, making it even harder to maintain the dividend. Finally, if the problems in the U.S. business begin to spill over into the company's other markets, it could have a significant impact on the company's overall performance and dividend sustainability.

What Investors Should Watch

Given these risks, investors should keep a close eye on several key metrics:

1. Volume Trends: Monitor the volume trends in the U.S. market. If volumes keep dropping, that's bad. If the decline speeds up, that's worse.
2. Regulatory Actions: Watch for any regulatory actions that could impact the company's products, particularly in the U.S. market.
3. Global Exposure: Keep an eye on how the trends in the U.S. market might impact the company's other markets. The U.S. is a developed market and sometimes ends up leading the world with regard to social issues. Smoking could be just such an issue.

Conclusion

British American Tobacco's dividend looks safe for now, but the long-term trends in the company's most important business suggest that this is not a stock that a conservative investor will probably find attractive. The rapidly declining U.S. business could, in fact, be the canary in the coal mine. If that pain spreads, this high-yield stock could have a hard time supporting its dividend over the long term. Investors should approach this stock with caution and keep a close eye on the trends in the U.S. market.