British American Tobacco (LSE:BATS) shares have been a brilliant source of passive income for decades. Even during the pandemic they continued delivering enormous shareholder payouts, solidifying the company’s reputation as a top dividend stock.
But on balance things haven’t been that cheery for the FTSE 100 firm and its shareholders. In the past five years the British American Tobacco (BAT) share price has slumped 7% in value. On a 10-year basis the tobacco titan is down by an even worse 28%.
While shareholders have seen the value of their investment plummet, steady long-term dividend growth has lessened the blow. And City brokers expect cash rewards to continue chugging higher, as the table below shows.
| Year | Dividend per share (f) | Dividend yield |
|---|---|---|
| 2023 | 238.6p | 10.5% |
| 2024 | 246p | 10.8% |
| 2025 | 258.4p | 11.4% |
If those dividends estimates prove accurate — and the British American Tobacco share price recovers — I could make a fantastic return on my cash.
So what are the chances of the company meeting analysts’ payout targets? And should I buy the FTSE business for my UK shares portfolio?
Balance sheet blues
Dividends at the firm have risen by an impressive 62% since 2012. This is thanks to its dependable cash flows, which underpin those bright payout forecasts for the next few years.
Indeed, BAT has said it expects to record £40bn of free cash flow before dividends during the next five years.
But on the downside, the company’s high debt levels mean that its balance sheet isn’t as strong as dividend investors such as me might like. Net debt was £37.3bn as of June. And the firm expects its net-debt-to-EBITDA ratio to come in at 2.7 times at the end of 2023, towards the higher end of its targeted range of 2 to 3 times.
BAT’s growing investment in e-cigarettes and similar products raises even more doubt about future dividends. This strategy may give revenues a big boost over the longer term. But it means debt may remain at elevated levels and erode the companys cash flows.
Should I buy the shares?
I’m also concerned at the weak levels of dividend cover for the next few years. If earnings are blown off course they could make payout forecasts look even more vulnerable.
Those predicted dividends for 2024 and 2025 are covered just 1.5 times by anticipated earnings. Any reading below 2 times means that the chances of estimates missing their mark can be high.
The profits outlook for BAT looks even more grim following early December’s trading update. Then the company said that 2023 revenues growth would be at the lower end of a 3 to 5% target.
In another troubling omen the business also wrote down the value of its US brands (like Camel and Newport) by £25bn. This underlines the steady decline of the cigarette market which threatens the very existence of Big Tobacco firms like this.
On balance I think British American shares are far too risky today. Not only do current dividend forecasts look extremely fragile, but I also expect the company’s share price to continue declining in the years ahead.
I’d rather buy other FTSE 100 shares for passive income.
