With interest rates at record lows, the stock market is one of the few places left where shareholders can find attractive levels of income. The FTSE 100 dividend stock I’m looking at today offers a remarkable 8% yield.
As I’ll explain, I think this payout should be sustainable, even though it’s more than twice the FTSE 100 average of 3.7%. Indeed, I think 2021 could be the year when this company’s shares start to trade at a more normal valuation. That could push up the share price.
Cheap as chips?
The FTSE 100 dividend stock I’m talking about is British American Tobacco (LSE: BATS). This ‘big tobacco’ share obviously carries some ethical concerns, but it also offers a cash-backed dividend yield of 8%.
BATS’ high dividend yield is partly down to its low share price. Although the group’s sales and profits are stable, the shares trade on just eight times forecast earnings for 2020. High profit margins mean the business generates plenty of cash, supporting the generous dividend.
Why is BATS so cheap?
In fairness, I can see a couple of reasons why this unloved FTSE 100 dividend stock might deserve to be cheap.
One is that global demand for tobacco seems likely to continue falling. The number of cigarettes sold by British American fell by 4.7% last year, for example. This isn’t a new trend — volumes have been falling for years. BATS and other big tobacco companies have been fighting this trend by raising prices and cutting costs.
I don’t think this is critical just yet. BATS sold 677bn cigarettes last year. But it could become an issue at some point in the future.
The second reason for caution is that the group still has a little too much debt for my liking. This is a legacy of the 2017 acquisition of rival Reynolds American. I’d normally be wary about high debt levels, but BATS’ gearing is gradually coming down. In my view, the group’s debt should be manageable. I don’t think it will cause problems for shareholders.
Why I’d buy this FTSE 100 dividend stock
This year has seen the market focus on growth stocks and tech stocks, some of which now have rather high valuations.
British American Tobacco isn’t growth and it definitely isn’t tech. But the company’s financial performance suggests to me it should be a good income investment.
The stock’s valuation is low, relative to its earnings. Profit margins are high, and the firm’s profits are reliably converted into cash. Although the firm is investing a limited amount in newer, alternative products, the core tobacco business doesn’t require much investment. This means that BATS can afford to pay generous dividends from its surplus cash each year.
This kind of old-fashioned value isn’t popular at the moment. Ethical concerns relating to tobacco stocks are also a headwind. But I think BATS shares are probably cheap enough to reflect the risks facing the firm.
In my view, this 8% dividend yield looks quite safe. I’d be happy to keep buying the BATS shares for my portfolio at current levels.
