As 2024 comes to a close, British American Tobacco's (BTI -0.33%) stock is sitting on a roughly 25% year-to-date price gain. That's a pretty rapid advance, particularly for a company that is largely viewed as an income investment, with most of the rally happening over a six-month period, between April and September.
Is this cigarette maker worth buying after the price advance, or is there now even more reason to avoid the stock? Here's a look at four key issues you need to consider when making your call.
One big reason to like British American Tobacco
The one thing that has likely drawn most investors to British American Tobacco is still the biggest reason to like the stock: its dividend yield. Even after this year's price advance, the yield is still 8%, which is far better than the S&P 500 index's (^GSPC -1.11%) 1.2% or the average consumer staples stock's yield of about 2.5% (based on the Consumer Staples Select Sector SPDR ETF (XLP -0.49%) as a proxy for the industry).
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Clearly, if you are looking to generate as much income as possible from your investments, British American Tobacco is a consumer staples business worth looking at. Also notable on this front, the British company shifted to paying dividends quarterly in 2018 and has, since that point, increased its annual payment each and every year (in British pounds). With this stock, it would be difficult to find anything to complain about when it comes to the income stream it produces.
One big reason to dislike British American Tobacco
The dividend, however, must be juxtaposed against the company's business, which is largely selling cigarettes. Its core tobacco business has not been performing well. To be fair, no cigarette maker has been doing all that well lately. But it is important to understand what is going on. In the first half of 2024, British American Tobacco sold 6.8% fewer cigarettes than it did in the same period of 2023. In 2023, cigarette volumes declined by 5.3%. And in 2022, they witnessed a 5.1% volume drop. So it's no surprise that the stock had taken a beating in in 2022 and 2023 with the market cap decline more than 40% at one point. This is not the type of trend you see from a healthy business.
British American Tobacco, like its peers, has offset its volume declines with price increases, resulting in increased profits this year and a corresponding stock rally. Given the addictive nature of nicotine, smokers are a fairly loyal and reliable customer group.
But at some point, it seems likely that those price increases will exacerbate the volume declines. The big question for investors is whether or not a high yield today is worth the risk of buying into a business that is facing a steady decline in demand for its core products.
A second reason to be worried about British American Tobacco
Before dismissing this issue, it is worth taking a step back in time to the end of 2023. That was when British American Tobacco changed the way it accounted for its U.S. business. It's a bit arcane, but, historically, the company had based part of its accounting on the premise that its U.S. brands would have value forever. At the end of 2023, management came to the conclusion that those brands would end up worthless in 25 to 30 years. It took a large write-off, to the tune of 23.0 billion GBP ($29.4 billion), based on that decision.
That one-time charge made its 2023 earnings look terrible, but the bigger takeaway was that British American Tobacco basically admitted that its U.S. cigarette operations are in terminal decline. Although it operates a global portfolio, it doesn't bode well for the company that one of its most important markets looks like it is slowly going away.
A second reason to like British American Tobacco
That said, British American Tobacco clearly isn't ignoring the problem. The fact that it changed its accounting method for the U.S. business clearly indicates that it sees it. So, too, do the company's efforts to build up what it calls its "new categories" business division. This group sells things like vapes and pouches. The division's performance has been a bit of a mixed bag. However, the modern oral pouches product line witnessed volume growth of 50% in the first half of 2024.
The new categories business only accounted for around 16.5% of revenues in the first half of 2024. But the company's efforts in it, notably in its growing modern pouches line, show that it could have a long-term opportunity. That might provide some hope for investors that British American Tobacco can find a way to offset the ongoing declines in its core cigarette operations.
Big trade-offs to consider with British American Tobacco
Every investment decision requires considering both the positive and negative attributes of the potential purchase. However, the risks are particularly large when it comes to British American Tobacco, which is facing a long downtrend in its most important business. While its high-yielding dividend is attractive, this is not a stock you can buy and ignore. In fact, most conservative income investors would probably be better off avoiding it. And if you are brave enough to own British American Tobacco, you'll want to pay close attention to the progress it makes in dealing with the ongoing volume declines in cigarettes. If it can't offset those declines, it likely won't be able to keep supporting its dividend at current levels over the long term.
