One of my biggest holdings is in British American Tobacco (LSE: BATS). The giant behind cigarette brands such as Pall Mall and Dunhill is a cash generation machine.
That has been good news for the British American Tobacco dividend over the past few years. But do the future prospects make it worthwhile for me to hang onto the shares? After all, cigarette sales are steadily declining annually in many markets.
British American Tobacco continues to grow
Perhaps, surprisingly, the company actually has a growing business. In its interim results released today, British American said that revenues increased 5.7% in the first six months of the year, including some benefit from exchange rates.
That does not mean volumes were up. In fact, the key US market saw volumes of combustible products such as cigarettes decline 13.4% in the period. That is a big drop, even allowing for a strong comparative period last year.
But the addictive nature of tobacco means the company can push prices up and many smokers will still buy their favourite brands. So although the overall combustible business showed 0.6% revenue growth in the period, that was due to the effects of price and the mix of what products were sold. Although revenues increased slightly, volumes fell.
However, the performance illustrates the company’s pricing power. It has the ability to keep raising prices to try and offset declining volumes. On top of that, some growth came from the non-cigarette product range. British American has been focussing on this. Non-cigarette sales jumped 45%.
What about the dividend?
The results were weaker than I would have liked and the sharp fall in US cigarette volumes is a concerning trend. That could hurt revenues and profits if it continues.
But the company maintained its full-year guidance, including a commitment to dividend growth in sterling terms. The British American Tobacco dividend has grown annually for more than two decades. Last year’s growth was 2.5%. The company is also buying back £2bn of its shares. As part of that programme it spent £1.3bn in the first half.
Dividends are never guaranteed. But the company’s strong free cashflows (£2.3bn in the first half) and progressive dividend strategy give me a fair degree of confidence it will grow the dividend again when it announces its final results for the year.
Although net debt of £41bn was a bit lower than at the same point last year, it was higher than six months ago. I see the need to service that debt as a long-term risk to the dividend.
My move
I will continue to hold my shares and happily collect the next quarterly British American Tobacco dividend on 17 August.
Over the past year, the shares are up 25%. That means that the dividend yield has fallen. But the yield is still 6.3%. I regard that as attractive.
The highly cash generative nature of the business, which enables a generous dividend, is appealing. I also think that through a combination of raising prices, growing the non-cigarette business and making acquisitions, the firm can continue to grow even as cigarette volumes in developed markets decline.
I would happily add more of these shares to my portfolio.
