British, American Tobacco: Buy, Sell, or Hold?

Historically, tobacco stocks such as British American Tobacco (BTI -0.24%) have been top-notch dividend payers, but with smoking in secular decline, it’s not fully clear if these stocks are reliable high-yield dividend payers or yield traps.

British American Tobacco is clearly rewarding dividend investors with a dividend yield of 9.8%, but is the stock a buy today? To answer that question, let’s look at the reasons to buy, sell, or hold the stock.

Arguments to buy British American Tobacco stock

For most investors, the best reason to buy the stock is its dividend. The 9.8% yield is hard to beat, but British American Tobacco doesn’t steadily raise its dividend the way most American stocks do. Instead, it has a variable dividend policy, meaning the payout fluctuates with the company’s profitability and the health of the business.

The dividend is well funded at the moment, as the company had a dividend payout ratio of just 60% in 2023 based on paying out 5.1 billion pounds in dividends on 8.4 billion pounds in free cash flow.

However, the juicy dividend yield isn’t the only reason to buy British American Tobacco. The company has also had success at diversifying away from cigarettes, led by Vuse e-cigarettes and Velo nicotine pouches. In 2023, revenue from new products jumped 15.6% to 3.35 billion pounds. That was a major reason the company was able to achieve constant currency growth of 1.6%. Cigarettes still make up the vast majority of the company’s business, representing 22.1 billion pounds of the 27.3 billion pounds in total revenue it made.

Growing new categories is key to the company’s future, and currently, it seems to be on the right track.

Image source: Getty Images.

Arguments to sell British American Tobacco stock

British American Tobacco stunned investors in December, when it said it would take an impairment charge of approximately $31 billion on U.S. cigarette brands, mainly those it had gained when it acquired R.J. Reynolds, including Camel and Newport. The company cited macroeconomic headwinds in the U.S. and its vision of building a smokeless world.

The news essentially makes the R.J. Reynolds acquisition look like a failure and rings the alarm on the decline of cigarettes, especially in the United States. That negative trend is unlikely to change. In fact, it seems more likely to accelerate as regulation grows more strict.

Another reason to sell British American Tobacco is the stock’s performance. Shares are trading at nearly a 10-year low and have fallen 45% over the last decade.

While investors have a positive total return because of the dividend, the business has clearly shrunk in value.

Arguments to hold British American Tobacco stock

There’s still a lot of uncertainty around BAT’s future. Its new products business is still relatively small, but it’s delivering solid growth, and Philip Morris‘ success in next-gen products proves that the transition can be done.

Moreover, its dividend is an incentive to be patient, and cigarette sales aren’t falling as fast as the $31 billion writedown might indicate. While volume sales of cigarettes were down 5.3% to 555 million on an organic basis, which eliminates currency, constant-currency sales fell just 0.8% to 22.8 billion euros.

The verdict: Hold the stock

At this point, British American Tobacco seems cheap enough, trading at six times trailing free cash flow, and roughly 4 times trailing adjusted operating profits, to make it worth sticking around for.

The headwinds from the decline in smoking are clear, but the company’s new products hold promise, and the 9.8% dividend yield can’t be ignored.

I wouldn’t expect BAT to outperform the market by any significant margin at this point, but the risk of a sharp slide in the stock seems minimal, as the business looks stable.

British American Tobacco stock is one worth holding.