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British American Tobacco Faces Long-Term Dividend Sustainability Risk

British American Tobacco's high 7.3% dividend yield attracts investors, but concerns arise about its sustainability due to declining cigarette volumes. Investors should proceed with caution in navigating these market headwinds.

Date: 
AI Rating:   5
Dividend Yield and Sustainability
British American Tobacco (NYSE: BTI) offers an attractive 7.3% dividend yield, significantly higher than the S&P 500 average of 1.2%. This yield is particularly appealing for income-focused investors. However, there are concerns about its long-term sustainability.

**Earnings Overview**
The financials show that revenue from combustible products constitutes around 80% of British American Tobacco's top line, with cigarette sales being the predominant source of income, accounting for 97% of its volume. Recent data indicates a consistent decline in cigarette volumes over the past three years, with a 5% drop noted in 2024. The company has been using price increases to offset these declines, allowing it to sustain its dividend despite weaker fundamentals. Nonetheless, this strategy might not be viable in the long run as consumer preferences shift.

**Dividend Payout Ratio**
For 2024, the dividend payout ratio raised concerns as it exceeded 100% of the earnings, illustrating that the company paid out more in dividends than it earned. Based on adjusted earnings, the payout ratio appears more manageable at 66%. This position raises questions about the company's ability to maintain its dividend as it struggles to adapt its business model amid falling cigarette sales.

**Investment in New Categories**
British American Tobacco is attempting to diversify by investing in non-combustible products such as vaping and heated products, which currently only contribute about 20% of revenue. While this diversification is a progressive strategy, it remains insufficient to fully alleviate the declines in the core cigarette segment.

Overall, British American Tobacco is under pressure due to changing market dynamics. Investors are advised to be cautious while considering the stock, given potential future risks to its dividend sustainability stemming from ongoing declines in its cigarette business.

Stocks:  BTI