There was good news today for shareholders in British American Tobacco (LSE: BATS). The full-year dividend was raised by 6%. That continues the pattern over the past several decades of an annual increase in the payout. It takes the payment per share to 57.7p each quarter, for a yearly total of £2.31.
But cigarettes accounted for over 80% of the company’s revenues last year. And with demand in long-term decline, there is a risk the company will cut its dividend in future. So should I add to my existing holding?
Dividend growth
The increase of 6% struck me as positive. Last year, the equivalent rise was a more miserly 1%.
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Some companies have a dividend policy and British American is one of them. It aims to pay out 65% of annual earnings per share as dividends. But there is flexibility in that goal, as the company also has a progressive policy (meaning it aims to increase the payout annually).
Those two goals could collide if earnings per share fall sharply. Last year, diluted earnings per share did fall 1.3%, although on an adjusted basis they rose 5.8%.
Using the adjusted diluted number, the payout ratio was 62.2%. That is fairly close to the target and I am comfortable the dividend remains affordable for the Lucky Strike brand owner.
The business is growing profits and free cash flow. Profits from operations rose 2.8% compared to the prior year, while net cash generated from operating activities rose 7%. If the company can continue to perform strongly like this, it bodes well for further growth in the British American Tobacco dividend in years to come.
Mixed reactions
But the City reacted negatively to the results. The shares fell around 5% in early morning trading. They have lost 9.9% of their value over the past year.
While profits rose and revenues were 7.7% higher than last year (mostly due to exchange rate fluctuation), there were some concerning aspects in the results. Adjusted net debt rose 7.3% to £38bn. That is a lot of debt, especially at a time when interest rates are increasing.
The company expects global tobacco volumes to be down around 2% this year. While the firm has done a good job continuing to grow its revenue, that is driven by price increases. Its cigarette volumes fell 5.1% year-on-year. In the long term, it may become more difficult to try and compensate for falling volumes by repeatedly increasing prices.
My move
The long-term decline in cigarettes remains an ongoing risk for sales and profits at the manufacturer. While its non-cigarette revenues jumped 41% last year, they are nowhere near those of cigarettes. Cigarettes are highly profitable for the company, whereas its non-cigarette business remains lossmaking. However, it is now expected to turn a profit next year — 12 months ahead of schedule.
I think the basics of the business remain strong. Cigarette demand is in structural decline but it remains vast. The firm can capitalise on that with its portfolio of well-known brands that give it pricing power. That translates into large profits – and yet another year of growth in the British American Tobacco dividend.
If had spare cash to invest today, I would increase my stake in the company.
