Tobacco companies were once among the stock market darlings, churning out growing cash flows year after year and delivering big profits to long-term shareholders. But in recent years, that's changed.
Over the past 10 years, British American Tobacco (NYSE: BTI) The company, one of the world's largest tobacco and nicotine companies, has a total return of minus 6%. S&P 500 The stock is up 231%, including the generous dividends paid to shareholders each quarter.
Today, the company's dividend yield has risen to just under 10%.With tech stocks hitting new all-time highs, this forgotten tobacco giant is looking increasingly undervalued.Is British American Tobacco an income investor's dream right now?
Smoke-friendly food business is declining, but cash flow remains strong
British American Tobacco owns some of the world's longest-standing cigarette brands, including Dunhill, Newport and Camel. While these brands have maintained market share in the tobacco industry for decades, smoking rates are declining overall around the world, impacting shipment volumes. To offset the financial impact of these declining shipment volumes, British American Tobacco has consistently increased the price of a pack of cigarettes.
The results of this strategy can be seen in the company's consolidated financial statements. Despite a decline in tobacco use around the world, British American Tobacco's revenues have grown 5.7% over the past five years. The company expects to generate more than $50 billion in free cash flow over the next five years. For a company with a market capitalization of just $68 billion, this represents the underlying discounted valuation at which British American Tobacco is currently trading.
But those price hikes won't boost cash flow forever — eventually, most people will stop smoking — and that's where the company's new tech products come in.
Growth will come from new nicotine products
Almost everyone is aware of the health risks of smoking, including British American Tobacco's management. That's why the management is committed to developing and marketing nicotine alternatives to cigarettes for adults. These include nicotine pouches, e-cigarettes and heated tobacco devices. These products may have less adverse health effects than cigarettes.
Shareholders should benefit, too. The company's “New Categories” division is expected to grow revenue 21% on an organic, constant-currency basis in 2023 and soon hit $5 billion in annual revenue. Of course, it's a global company, so it can be affected by foreign exchange rates. The division finally achieved profitability last year, delivering positive contribution margins for British American Tobacco for the first time.
Over the next decade and beyond, these new products are expected to drive volume growth for the company and help offset the eventual profit declines in its tobacco business.
Is the dividend sustainable?
Increasing sales volumes with new products is great. But what income investors care about most is the dividend payment. At the current share price, British American Tobacco's dividend yield is approaching 10%. The company has one of the highest dividend yields in the world, which may make some investors skeptical of the sustainability of the dividend.
Looking at the numbers, it's clear that British American Tobacco has plenty of room to maintain its dividend at its current level and is likely to grow it over the next few years. The company's free cash flow (the money a company uses to cover its dividend) was $5.30 per share over the trailing 12 months. The company's dividend is currently $2.90 per share.
Even if its tobacco business performs worse than expected over the next few years, British American Tobacco has plenty of room to maintain its current dividend payments, so income investors can hold onto this cash-generating nicotine giant with peace of mind.
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Brett Schafer has no position in any of the stocks mentioned.The Motley Fool recommends British American Tobacco Plc and recommends the following options: long British American Tobacco January 2026 $40 calls and short British American Tobacco January 2026 $40 puts.The Motley Fool has a disclosure policy.
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