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British American Tobacco (LSE:BATS) is an income share that last cut its dividend in 1999. And over the past 26 years, its share price has increased more than tenfold. Talk about a win-win.
However, there’s some evidence to suggest that the British American Tobacco (or BAT as it’s known) stock market valuation is running out of puff. And no matter how good a company’s payout might appear to be, this is a warning sign that — in my opinion — needs to be taken seriously.
Today (28 September), the group’s share price remains around 30% lower than it was in the middle of 2017, when its stock was changing hands for around £55 a share. It’s now possible to buy one for close to £39. This is back to where it was in January 2016.
The group knows that the writing’s on the wall for traditional nicotine-based products. That’s why it’s transitioning to a new range of smokeless offerings — known as New Categories — that the group claims are less harmful. It remains to be seen whether vapes and assorted heated products will be able to generate the same level of cash as cigarettes. I have my doubts.
Other risks
But this is not the only threat to its earnings that it faces. The group identifies the illicit trade in cigarettes, geopolitical tensions, further anti-growth regulations, supply chain disruption, litigation, additional taxes, adverse foreign exchange movements and extreme weather events as other potential challenges. That’s quite a list.
It’s also carrying a significant amount of debt on its balance sheet. At 31 December 2024, it was £36.95bn — just under half of the group’s market cap. However, as a reminder of how cash generative the business can be, its net debt has fallen by £8bn over the past two financial years.
Generous returns
Despite all these challenges, it’s impossible to deny that the stock presently offers a healthy dividend. Based on amounts paid over the past 12 months (237.88p), it’s currently yielding 6.1%. Analysts are expecting this to increase over the next three years to 243.61p (2025), 248.87p (2026) and 257.41p (2027). If these predictions are right — no guarantees, of course — the stock’s forward yield rises to 6.6%.
This is more than twice the current average for the FTSE 100. And as the table below illustrates, over the past three years, that the group’s spent nearly 59% of its operating cash flows on dividends and share buybacks.
| Category | £m |
|---|---|
| Cash at 1 January 2022 | 2,463 |
| Net cash inflows from operating activities | 31,233 |
| Net cash inflows from investing activities | 374 |
| Repayment (net) of borrowings (capital and interest) | (10,277) |
| Purchase of own shares | (2,994) |
| Dividends paid | (15,567) |
| Other movements | (128) |
| Cash at 31 December 2024 | 5,104 |
My view
But I suspect the present level of its dividend is unsustainable over the longer term. New Category products cost more to make and are likely to require constant refreshing and reinvention.
Smokeless products are banned (or restricted) in many countries and are an easy target for higher taxes as cash-strapped governments look for additional sources of revenue.
Looking ahead, I suspect the group’s profit is likely to be harmed by a combination of falling revenue and rising costs.
While I acknowledge that BAT’s earnings are unlikely to fall off a cliff any time soon, I suspect a slow, gradual decline will become evident over the next few years or so. For this reason, I’m not interested in investing despite the generous dividend currently on offer.
