BAT, vaping and an 8% dividend yield

The yield is one of the biggest around, but some investors are shunning the tobacco sector. Our head of markets talks us through the latest trading update from this FTSE 100 giant.

British American Tobacco's (LSE:BATS) move away from traditional tobacco products is continuing apace, as significant investment into its “New Category” segment begins to take shape.

At the same time, and perhaps counterintuitively, the group is keen to stress its ESG, or green credentials, such as the aim of net zero deforestation in its supply chain and a net positive impact on forests within its tobacco leaf chain by 2025. Indeed, BATs is the only tobacco company in the Dow Jones Sustainability Indices World Index.

In an update ahead of annual results in February, BAT said the New Category revenue target of £5 billion by 2025 is well on track, and should contribute to profitability for the first time after a period of strong investment. Its Vuse vapour product is a global leader, while the tobacco heating product glo Hyper is enjoying strong volume share gains across all of its key markets. In the year to date it has added another 3.6 million customers in non-combustible products, more than 2020 as a whole.

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Cost savings also remain a focus as the company looks to shore up its financial position. It expects to report savings of £1 billion in this period, with the target remaining at £1.5 billion by the end of 2022. Meanwhile, the group’s extraordinary cash generation should enable a focus on reducing debt, with the possibility of a share buyback programme being another show of financial strength.

In the meantime, the exceptional dividend yield of 8.2% is an almost irresistible attraction for income-seeking investors, particularly set against the current interest rate backdrop and, indeed, the average FTSE100 yield of 3.5%.

For the time being, the bulk of BAT’s sales still come from traditional tobacco products, where strong pricing power and the sheer scale of its operations leave the company well placed for future investment in alternatives. As such, overall revenue growth for the period is expected to be 5%, despite the headwinds of lower margin Emerging Markets and lower US volumes muddying the water within the set of combustible products.

For BATs, the strategy is clear and the progress is measurable. However, the share price has been held back by the fact that there are many investors who will simply not touch the sector given the ethical issues, let alone the ever present threat of increased regulation. This is unlikely to change in the immediate future and is reflected by a price which has declined by 3.5% over the last year, as compared to a gain of 10% for the wider FTSE100.

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A gap has therefore emerged between the positive prospects for the company, set against some unwillingness from potential new investors. The market consensus, however, remains rooted as a "strong buy" as a reflection of the company’s strong cash generative ability, a punchy dividend yield and a discounted valuation. 

While this conflict is likely to continue, there are also clear signs that BATs may be a rather different looking entity in the years to come.