British American Tobacco (BTI -0.33%) is a consumer staples stock, but it is probably one of the riskiest consumer staples stocks you can buy. That's highlighted by its dividend yield, which at around 8.2% is more than three times larger than the yield of the average consumer staples stock. There's a very high probability that the dividend will be paid just as it has in the past over the next year. But that doesn't mean that British American Tobacco's business isn't becoming increasingly risky.
The trend is not British American Tobacco's friend
The first thing that investors need to recognize is that cigarettes are the core of British American Tobacco's business. A little math with the company's first half 2024 results will prove this out (as a foreign company it only reports semi-annually). Its combustibles division makes up roughly 80% of revenues. Within combustibles, cigarettes account for nearly 98% of the company's volume. So something very close to 80% of the company's business is driven by cigarettes.
Image source: Getty Images.
That's a big problem from a business perspective because cigarette volumes have been steadily declining. Through the first six months of 2024, the company's cigarette volume fell 6.8% versus the same six months of 2023. In 2023, British American Tobacco's cigarette volumes dropped 5.3%. In 2022, the decline was 5.1%. The trend goes further back, but those three data points are enough to highlight what's going on at this consumer staples company -- and the fact that the downtrend appears to be accelerating.
If the 6.8% decline in the first half of 2024 is applied to the entire year, the company's cigarette volume will have fallen from roughly 555 billion cigarettes in 2023 to around 517 million this year. Extend that out another year and you come up with roughly 482 billion cigarettes sold. And that's assuming that the rate of decline stays the same and doesn't increase as it has been for the past few years.
British American Tobacco knows there's a problem
So far British American Tobacco has been able to offset the impact of volume declines with price increases. But price increases can only go on for so long before they start to exacerbate the volume decline. The company is keenly aware of the problem it faces, too, because in 2023 it changed the way it accounted for its U.S. brands. Although it's a somewhat arcane GAAP accounting issue, the company basically went from assuming the brands would always have value to assuming that they will be worthless in 30 years.
By the end of 2024, the brands will have 29 years of "value" left. And by the end of 2025, the remaining life will be 28 years. You get the idea -- each year that passes is another year of life gone. That's why the company is working so hard to build up new businesses, which account for around 20% of the top line on the income statement. That's good and some progress is being made in the effort to offset the ongoing declines in the cigarette business. However, British American Tobacco is still a long way away from the point at which its new businesses, such as nicotine pouches, can offset the business decline taking shape within its most important business.
A year is fine, but how much more is a big question mark
Dividend investors looking at British American Tobacco's huge 8.2% dividend yield can be pretty confident that the quarterly payments will get paid as usual in 2025. But most income investors don't buy a stock with the goal of owning it for just one year. If you buy British American Tobacco thinking you've secured a lifetime of reliable income, think again. There are very big risks as the business attempts to adjust to the negative trends in its most important business. If you buy British American Tobacco, you'll need to watch it like a hawk.
