Could Buying British American Tobacco Stock Today Set You Up for Life?

British American Tobacco (BTI) has caught the eye of many dividend investors with its enticing 8.6% yield. However, before you rush to add this stock to your portfolio, it's crucial to consider the underlying challenges facing the company and the sustainability of its dividend.

The allure of a high dividend yield is undeniable, especially when compared to the 1.2% yield of the S&P 500 or the 2.5% average yield of consumer staples stocks. But the 4% rule of thumb for retirement withdrawals suggests that a high yield alone may not be enough to set you up for life. The key question is whether BTI can maintain its dividend in the face of declining cigarette volumes and regulatory pressures.

BTI's cigarette volumes have been declining for years, with a 6.9% drop in the first half of 2024, following a 5.5% decline in 2023 and a 5.2% drop in 2022. The company has been offsetting these declines with price increases, but this strategy may not be sustainable in the long term. As volume declines accelerate, price increases could potentially hasten the decline rather than offset it.

Moreover, BTI admitted in 2023 that its U.S. business could be worthless in as little as 30 years, raising concerns about the long-term viability of its dividend. While the company is investing in new businesses like vaping and pouches, its combustibles division still generates four times the revenue of its noncombustibles business. This suggests that relying on BTI's dividend for life may be risky, as the company's core cigarette operations face significant headwinds.

To assess the sustainability of BTI's dividend, it's essential to consider the potential impact of regulatory changes on its cigarette sales. Higher taxes and stricter warnings have contributed to declining cigarette volumes, and these trends are likely to continue. As a result, BTI's dividend may face increasing pressure, making it less reliable as a source of long-term income.

BTI's investment in non-combustible products like vaping and pouches is crucial for long-term dividend sustainability. As cigarette volumes decline, these products help offset the negative impact. In 2023, BTI's non-combustibles division generated 25% of revenue, up from 18% in 2022. However, the combustibles division still accounts for 75% of revenue, indicating that BTI's success in transitioning to non-combustibles will determine the sustainability of its high dividend yield.

In conclusion, while BTI's high dividend yield may seem enticing, the sustainability of its dividend is questionable given the company's declining cigarette volumes and regulatory pressures. Investors should carefully consider the risks and potential long-term implications before adding BTI to their portfolios. Diversifying your income sources and maintaining a balanced investment strategy can help mitigate the risks associated with relying on a single high-yield stock for retirement income.