Think You Know British American Tobacco? Here's 1 Little-known Fact You Shouldn't Overlook.
The big draw for investors with regard to British American Tobacco (NYSE: BTI) is its huge dividend, which at the current share price yields 9.5%. The big risk for investors is the ongoing decline of the market for cigarettes, which is British American Tobacco's biggest business line. That said, you may have missed a subtle but important change that British American Tobacco made recently in how it looks at its U.S. business.
The biggest problem British American Tobacco faces
The main headwind for British American Tobacco is the ongoing decline of its cigarette business. This is not a small issue. The company produced roughly 700 billion cigarettes in 2018. But the ongoing societal shift away from cigarette use has steadily reduced demand year in and year out, and the company has cut production in response. In 2023, the tobacco giant produced just 555 billion cigarettes. That's a 21% decline in five years.
If any other consumer staples company witnessed a decline like that, shareholders would be worrying themselves sick. That helps explain the more than 50% stock price decline British American Tobacco has experienced since it hit its peak in 2017. Like other cigarette makers, the company has been raising its prices per pack steadily to offset the impact of volume declines. That has allowed it to keep supporting its high dividend, which is, as noted, the most attractive feature of the stock today.
However, the more important factor for long-term investors to watch will be the company's ability to find a replacement for its declining cigarette business. British American Tobacco has achieved some success on this front. Its non-combustibles business now provides around 16.5% of revenue, and it achieved profitability at the division level two years ahead of schedule.
While that's good news, it isn't enough to offset the ongoing contraction in the tobacco business. So the real question here is how much time does British American Tobacco have before cigarettes are gone?
British American Tobacco made a big accounting change
Corporate accounting is a complex matter that requires management teams to make assumptions. And sometimes, those assumptions can have major implications for a company's business. In 2023, British American Tobacco changed the way it accounted for its U.S. tobacco business -- a subtle shift that could easily have slipped under the radar of retail investors because of the arcane nature of the change.
Previously, British American Tobacco based its projections on the premise that its U.S. tobacco brands, which include Camel and Lucky Strike, would always exist. But now, it forecasts that the U.S. tobacco business will slowly become worthless over the next 30 years. In the company's own words:
Following a review of the U.S. market reflecting continuing macro-economic headwinds, growth of illicit single-use Vapour products and uncertainty regarding menthol regulation, from 1 January 2024 the Group will commence amortising certain U.S. brands (Newport, Camel, Natural American Spirit and Pall Mall) over a period not exceeding 30 years.
That resulted in a one-time charge and will lead to higher ongoing depreciation and amortization expenses, which will create an ongoing headwind to earnings. But the fact that's most notable is that British American Tobacco has basically put an end date on one of its most important businesses. That makes it all the more important for it to hit its 2035 goal of generating 50% of revenue from non-cigarette products. Further, given the expected demise of the U.S. cigarette business, that must be viewed as just an intermediate goal. The company will need to keep growing its non-cigarette business lines from there.
Go in with your eyes wide open
British American Tobacco is a high-risk dividend stock, which is one of the reasons why its yield is so large. But the big takeaway here is that the company is telling investors that there will be a point in the not-too-distant future when the operations that are most important to it today will, effectively, be going away. That's a countdown timer that you shouldn't ignore if you step into this stock, and it's set at 30 years.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends British American Tobacco P.l.c. 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.
