Investors looking for high-yield dividend-paying stocks have likely come across British American Tobacco (NYSE: BTI) and its 9.5% yield. However, a high yield does not necessarily mean the stock is a good investment.
Let's take a closer look at the tobacco company, the safety of its dividend, and whether the stock is a buy, sell, or hold.
Shifting away from cigarettes
Cigarette smoking has been on the decline, especially in the U.S., for many years. Last year, the Centers for Disease Control released data that only 1-in-9 adults (11%) in the U.S. now smoke, an all-time low, down from 42% of adults in the mid-1960s.
That's good news from a public health standpoint but not good news for tobacco companies that still get most of their revenue from traditional cigarettes. For British American Tobacco, or BAT for short, over 80% of its revenue last year came from traditional combustible products.
The maker of Camel and American Spirit cigarettes saw combustible volumes fall 8.3% last year, or 5.3% on an organic basis (excludes acquisitions and divestitures). However, with price increases, it was able to increase its combustible revenue by 0.6%. The U.S. market was particularly weak, with combustible volumes falling 11.3% and combustible revenue down 6.4%.
Given the declining combustible market, BAT is looking to shift to non-combustible products such as vapor pods, heating sticks, and oral pouches. Its non-combustible revenue grew a solid 13.6% last year.
The company is looking to generate half its revenue from its non-combustible product portfolio by 2035. These products accounted for 16.5% of its revenue in 2023. This is a similar strategy to Philip Morris International (NYSE: PM), although its rival is much further along, with nearly 39% of its first-quarter revenue coming from smoke-free products.
Image source: Getty Images.
Dividend safety
When looking at the safety of BAT's dividend, the first thing to look at is its cash flow. On that front, it generated an operating cash flow of 10.7 billion British pounds ($13.6 billion) and a free cash flow of nearly 8.4 billion pounds ($10.7 billion). It paid out just over 5.0 billion pounds ($6.4 billion) in dividends, giving it a coverage ratio of 1.7 times based on free cash flow.
This indicates the company's dividend is well covered and that it has room to increase it.
The other aspect to look at is the company's debt load. On that front, it had a net debt of 34.6 billion pounds ($44 billion). Importantly, it was able to reduce its net debt by nearly 12% last year, and it expects to generate 40 billion pounds ($50.8 billion) in free cash flow over the next five years.
The company ended the year with 2.6 times leverage, or net debt divided by its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).
Overall, BAT's dividend looks very safe, given its coverage ratio, free cash flow generation, and leverage.
Buy, hold, or sell?
When looking at BAT's valuation, the stock is not expensive, trading at under 6.5 times forward price-to-earnings (P/E). That is generally below the valuation the stock has traded at in the past.
BTI PE Ratio (Forward) data by YCharts
That said, it is a slow-growth company in a cyclically declining industry, so it is likely not going to receive a robust P/E multiple. The company is smartly looking to shift to new products, although it is trailing behind Philip Morris International in this shift and it will take time.
However, the company is generating a lot of cash, and it is paying a nice dividend, giving the stock a robust yield. The stock price is down nearly 50% over the past 10 years, but the current valuation should help keep a floor on the stock.
Taken all together, I'd consider the stock a hold for income-oriented investors looking for a high yield.
However, I prefer Philip Morris International in the space given the tremendous growth it is seeing with its non-combustible portfolio of products, including Zyn and IQOS. Its combustible segment also isn't facing the same headwinds since it does not sell cigarettes in the U.S.
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Geoffrey Seiler has positions in Philip Morris International. The Motley Fool recommends British American Tobacco PLC and Philip Morris International and recommends the following options: long January 2026 $40 calls on British American Tobacco and short January 2026 $40 puts on British American Tobacco. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
