A 7.7% dividend yield makes shares in British American Tobacco (LSE:BATS) an obvious choice for investors looking for passive income. And it’s been very consistent recently.
Over the last five years, the firm has returned £11.40 per share in dividends, so investors who bought the stock in March 2020 have got around 37% of their cash back. But can it continue?
Business overview
British American Tobacco’s a company of two parts. The first is the combustibles business and the second is the new products category, which includes headed tobacco and nicotine pouches.
At the moment, the traditional business generates strong cash flows. But it’s no secret that the long-term outlook for cigarettes isn’t positive and decline is probably inevitable here.
On the other hand, the new categories division is growing. However, it’s a long way off generating the kind of cash flows that might sustain the dividend over the long term.
Investors need to think about one big question. Can cigarette volumes hold up for long enough to allow the new products to grow into a business that can justify the current market-cap?
Cigarettes
In 2024, things held up okay in the combustibles part of the company. Despite sales volumes falling, organic revenues came in roughly in line with the previous year.
It’s worth noting however, that this was largely the result of substantial declines in the US being offset by growth elsewhere. And there are potential difficulties ahead in the next year.
British American Tobacco is anticipating regulatory challenges in Bangladesh and Australasia to weigh on sales in those areas in 2025. This could be a significant issue for cigarette volumes.
With combustibles generating £21bn in sales, minor declines are almost certainly priced into the stock. But I don’t think investors can afford to ignore the early signs of decline.
New categories
Growth in the new categories division was (unsurprisingly) a lot stronger. Overall, this came in at almost 9%, but there were some much more impressive results beneath the surface.
The product I’ve been keeping an eye on is Velo – the firm’s nicotine pouch. Given the success of Zyn (a similar product from Philip Morris) I think this is where investors should be focusing. Velo volumes increased by 56% in 2024. But the scale of the challenge ahead becomes clear with the fact this resulted in revenues of £790m, in the context of a £67bn company.
The entire new categories division brought in £3.5bn in revenues, representing 9% growth. But investors should also be aware of regulatory risk even for non-combustible products.
It’s complicated
There are two strategies a passive income investor could take with British American Tobacco shares. One is to consider buying the stock early, before cigarette sales fall away by too much. The other is to wait and look for sustained growth from the new products before making a decision. The idea would be to limit the risk by getting a clearer idea of the long-term outlook.
Either might be defensible, but neither is obviously a good idea. Regulatory risks introduce a lot of uncertainty and I think passive income investors have better opportunities to consider elsewhere.
