There’s no doubt that the tobacco industry is declining. But does that necessarily hold for big tobacco companies too? I was struck by this question when the FTSE 100 tobacco biggie British American Tobacco (LSE: BATS) released its results yesterday. Contrary to the industry trend, there appears to be much going for the company. And indeed for its investors too, including a high dividend yield.
Rising profits and high dividend yield
For the year ending 31 December 2020, BATS reported an increase in profits. This is a positive in itself. But if I were an investor in the share, my confidence in it would have significantly risen by now on another count as well.
It so happens that BATS also has a high dividend yield. A high yield in a slowdown can portend a dividend cut. But BATS has done the opposite, likely driven by its earnings increase.
The company has increased dividends by 2.5%, which amounts to a total dividend of 215.6p payable from May 2021 onwards up to February 2022 in four instalments. At today’s share price, this amounts to a dividend yield of a huge 8.3%.
Revenues can improve for BATS
It’s not like BATS’s earnings report is without flaw, though. Its revenue for the year is down slightly. Yet, there appears to be light at the end of this tunnel. It expects revenues to grow between 3% and 5% in 2021. It chalks up slow revenues in 2020 to the pandemic.
New categories gain ground
There’s more. Its ‘new categories’ business segment, which includes smoking alternatives like e-cigarettes, has grown. In fact, as per a Reuters report, it expects that it will contribute to earnings this year for the first time.
While the increase in both earnings and dividends are a boost to investor confidence, I think for the long-term investor, its developments like those in BATS’s new categories business that are most crucial.
I have argued in the past that many old economy industries like tobacco, oil, and retail are going through a process that has been called “creative destruction” in economic thought. Old business is getting disrupted by changing preferences and developing technologies.
Rising consumer consciousness about the health impacts of tobacco usage and tougher regulations on the sector are leading to declining consumer interest in these products.
In fact, a Financial Times article quotes CEO Jack Bowles as saying that the market for cigarettes is falling at an average of 3% every year.
In this context, the pivot towards new categories appears to be a sound strategy. I think that if the trend of healthy growth in tobacco alternatives continues, there’s hope for the BATS share price. The company’s share price has struggled over the last five years, though it has made gains in the market rally since November.
Risks ahead
There are risks to consider, though. Health concerns about e-cigarettes and vapes have been raised. More evidence about their ill-effects can hamper the nascent market. With the tobacco market already on a downslide, tobacco companies can struggle to grow in this scenario.
I’d keep these risks in mind before buying the BATS share.
