Where Will Ultra-High Yield British American Tobacco Be in 5 Years?

There’s one very specific feature of British American Tobacco‘s (NYSE: BTI) stock that keeps investors interested: the dividend yield. At a time when the S&P 500 index is offering a tiny 1.2% yield and the average consumer staples stock 2.6%, British American Tobacco’s yield is a lofty 8.1%.

“Wow” is a fair response to hearing about that return, but that huge yield comes with risks and long-term income investors need to think about what the future might look like here. Will this company offer such an enviable return in five years?

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British American Tobacco’s name is fairly descriptive, given that it is one of the largest cigarette makers on the planet. Combustible products accounted for around 80% of revenue in the first half of 2024. That total includes both cigarettes and other things that, effectively, burn tobacco. Cigarettes accounted for roughly 98% of volume. So, while the company does other things, British American Tobacco is at its core a cigarette company.

A finger flipping dice that spell out long term and short term. — Image source: Getty Images.

What makes British American Tobacco unique among its peers is that it has a truly global cigarette business. Its prime competitors Altria and Philip Morris International don’t. Altria operates only in North America. Philip Morris International was spun out of Altria to operate Altria’s brands in foreign markets. Being global is good and bad, however, because selling cigarettes is a tough business, particularly in North America where volumes have been falling for years. Essentially, consumers are turning away from smoking.

The numbers are pretty daunting. In the case of British American Tobacco, cigarette volume fell 5.1% in 2022, 5.3% in 2023, and 6.8% through the first six months of 2024. If anything it looks like the declines are starting to pick up speed.

Like its peers, British American Tobacco has been able to offset volume declines with price increases. Given the nature of tobacco, consumers tend to be fairly loyal to the product. The frequent purchases are why cigarettes are classified as a consumer staple. However, the declines continue largely thanks to health concerns. That said, price increases can only be pushed so far before they, too, start to negatively impact volume. The future is not bright here given the current volume trajectory.

To be generous, and to make the math easy, assume that British American Tobacco manages to keep volume declines at 5% a year for the next five years. In the first half of 2024, the company sold roughly 250 billion units.

British American Tobacco Cigarette Volume Estimates with a 5% Decline Rate
Half Year	Volume (in billions)
2024 (actual)	250
2025	238
2026	226
2027	214
2028	204
2029	193

Data source: British American Tobacco and author estimates.

In five years’ time, British American Tobacco’s most important business could see volume decline from 250 billion cigarettes sold to less than 200 billion. That’s a huge problem, and those estimates are based on a volume decline rate that is lower than the one experienced over the past three years. This is what investors are potentially buying into when they add British American Tobacco to their portfolio. If this were any other consumer staples company investors would likely be running for the hills.

To be fair, given the lofty dividend yield, most investors are choosing to avoid British American Tobacco. Still, that yield is clearly attracting some aggressive investors to take a risk on the stock. Helping the story along for these income seekers is the fact that British American Tobacco is investing in what it calls new categories, which include things like vaping and smokeless tobacco pouches.

There are problems here, too. Only the company’s modern pouches business managed to see a volume increase in the first half of 2024. The huge 50%-plus volume jump, however, probably isn’t a sustainable figure over the long term. And even with that increase, modern pouches are still a small contributor relative to cigarettes, with modern pouches accounting for less than 3% of total revenue. At this rate, it will be a long time before British American Tobacco has a business large enough to offset the troubles it is seeing in cigarettes.

If you are trying to live off of the income your portfolio generates, then British American Tobacco’s high yield will probably seem very attractive. But it comes with very large and very real risks, given the ongoing declines the company’s most important business is experiencing. This is not a “set it and forget it” dividend stock. Only the most aggressive investors should own British American Tobacco. That list probably shouldn’t include conservative dividend investors hoping to fund their retirement 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 P.l.c. and Philip Morris International 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.

Where Will Ultra-High Yield British American Tobacco Be in 5 Years? was originally published by The Motley Fool

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