BTI stock is at the top of my buy list. I might put 5-10% of my total portfolio into the company.
This investment isn’t for everyone. British American Tobacco falls into the sin stock category. Although, I’ve found it to be one of the better value stocks today.
Investor have beaten down its share price and as a result, its dividend yield has climbed. It’s an impressive yield that looks fairly safe.
If the price keeps dropping, the risk-to-reward will be too good to pass up. And to start out this article, let’s look at the major risks first. This investment might not work out. Too often investors get caught up thinking mostly about the reward potential. But that’s a big mistake.
Managing risk isn’t as sexy… but that’s what sets apart experienced investors from the amateurs. So, we’ll look at the big risks first and then the reward potential (or what I really like about BTI stock as an investor).
British American Tobacco Stock Analysis
BTI Stock 5 Risks for Investors
1. Cigarette Users Dropping
BTI’s core business is seeing a decrease in users. This should not come as a surprise and let’s put some numbers to it…
According to the World Health Organization, there were 1.32 billion tobacco users in 2015. Today, it comes in at 1.3 billion and by 2025, it’s expected to drop to 1.27 billion users.
That’s global tobacco users and the U.S. is seeing a faster drop, along with some other developed countries. That’s important to consider because the U.S. is one of the largest segments of BTI’s revenue.
This decrease in tobacco users goes way back and will continue going forward. Although, investors have factored it well into the company’s valuation. But if it picks up speed, that could further lower the value of British American Tobacco.
When it comes to risk, one of the biggest question marks is regulation. But also keep in mind that regulation can be a double-edged sword. There are some long-standing rules and precedent in place that protect big tobacco companies. We see this with utility companies, etc. Governments get some nice tax revenue from these companies that they don’t want to lose.
Nonetheless, there’s always the risk of more restrictive regulation. For example, the Biden administration is considering cutting nicotine in cigarettes to non-addictive levels. This would be a huge hit to BTI stock. And this ties into the third major risk to consider…
3. Diversification (Product/Geo)
British American Tobacco is in over 180 markets. This global scale provides some diversification benefit. Although, when looking at revenue, the bulk of it is derived from a few key areas that are seeing similar regulatory concerns.
When it comes to products, in the first half of 2021, BTI’s combustible revenue segment made up 86% of total revenue. This segment is seeing some of the most downward pressure. It’s a big risk but as you’ll soon see, the company is shifting away from combustibles to non-combustible products.
4. Investor Sentiment
For the next risk to consider, it’s investor sentiment. There’s been a shift towards green and socially responsible investing. More funds are excluding tobacco, oil and other sin stocks from their portfolios. This lower demand puts downward pressure on the share price. BTI shares have been trading at a discount and that will likely persist.
5. Input cost/inflation
For the last significant risk, commodity costs are climbing. Inflation is picking up and this can put pressure on operating and profit margins. It’s a risk but thanks to pricing power with its addictive products, British American Tobacco should be able to continue passing costs along to customers.
Now that we’ve coved the major risks, let’s look at why BTI is on the top of my buy list…
Why Buy BTI Stock?
1. Stable Revenue, Operating Profits and Financial Health
From a revenue standpoint, British American Tobacco’s annual revenue has leveled out recently…
You might see slightly different numbers depending on where you get your financial info. For my data, I’ve gone straight to the source. Since BTI is a British company, it reports a 20-F annual report instead of a 10-K. I’ve pulled these numbers directly from the SEC website.
Some sources adjust the currency from GBP to USD but for consistency (and to reduce error) I’m keeping it in GBP. As an investor in the U.S., the currency adjustments have an impact but they won’t be a make or break for my overall investment thesis.
Also, the further down the income statement you get, the less reliable the numbers can become. For example, net income and EPS can be heavily manipulated when factoring in all the different accounting rules with GAAP, IFRS, etc.
So, let’s just take a look a little further down from revenue. Here’s profit from operations…
Even though British American Tobacco’s revenue growth has slowed, its operating profit continues to climb. It’s becoming more efficient thanks to cost savings programs like Quantum. By 2022 it aims to achieve a minimum of £1 billion of annualized savings.
This is helping BTI invest in new areas and maintain a better financial position. We’ll look at these growth segments next. But first, a little more insight on the financial health of the company…
Total liabilities are decreasing which is great to see. Cash and cash equivalents have grown a little over this same timeframe. Even with all the negative sentiment and pressure on tobacco companies, BTI is doing well on many fronts.
Thanks to this strong financial position, British American Tobacco’s credit rating is a few steps above the investment grade cutoff. It comes in at BBB+ and if deleveraging continues, it might come in even higher.
2. New Products to Counter Cigarette Trends
Even while the balance sheet is improving, British American Tobacco has been investing heavily into new segments. And already, we’re seeing some solid growth.
In the first half of 2021, new category revenue was up close to 50%. And by 2025, it’s shooting for $5 billion in new category revenue. This is helping to offset the downward pressure from cigarette sales. And eventually, these new segments should surpass the traditional combustible sales.
Some of the new product segments include Vuse and Glo. Here’s the growth in total non-combustible consumers…
Total consumers topped 16 million in the first half of 2021. And by 2030, the company is aiming for 50 million. On the horizon, federal legalization of marijuana should also open up some revenue streams. The company has been making a few big moves to prepare.
BTI is making great strides into growing segments and is financially solid. This is helping the company continue to reward shareholders…
3. Huge Reliable Dividends
Here’s the total annual dividend payout in GBP…
Shares outstanding haven’t changed much so investors continue to see a higher annual dividend per share. And as U.S. investors, we see some additional fluctuations thanks to currency conversions. Nonetheless, the trend is solid.
On the payout safety side, the ratios have climbed a bit but it’s still within a safe range for now. And as you’ve seen, the company is improving its balance sheet while paying higher dividends. So, I’d be surprised to see a dividend cut anytime soon.
Being a foreign company, the U.K. also has favorable taxes for dividends paid to U.S. investors. So, that’s great to see.
BTI Stock Valuation and Final Thoughts
From a valuation standpoint, BTI stock is also the cheapest it’s been in about a decade. Its price-to-sales ratio, price-to-earnings, EV-to-EBITDA and other metrics look attractive when looking at its historical trends. And it trades at an even steeper discount compared to the market as a whole. But as mentioned, the sin stock discount will likely persist.
Overall sin stocks like British American Tobacco have provided excellent long-term returns. And even with the continued negative pressures, that’ll likely continue.
British American Tobacco is beaten down and will hopefully see some capital appreciation in the coming years. But even if it trades sideways, more than an 8% dividend yield is hard to pass up. That alone comes right in line with long-term stock market returns.
Thanks for tuning in today and please let me know if you’re investing in BTI stock in the comments below (or on my YouTube video). Or why are you hesitant to buy?