Dividend star British American Tobacco gets cheaper

The well covered payout is an invite to income seekers, but the shares are falling after this update. 

This relatively upbeat first-half trading statement comes against what has been a torrid time of late for British American Tobacco (LSE:BATS).

Last year was an "annus horribilis" for the company, with the shares halving in value amid concerns around possible US regulation on menthol products, an area to which BATS is particularly exposed following its multi-billion-dollar acquisition of Reynolds in 2017. 

This was more recently compounded by a Canadian ruling which could lead to a payment of around £7 billion, which would put further pressure on an already stretched balance sheet where, at the full-year numbers in February, net debt stood at £44 billion.

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The threat of ongoing litigation and regulatory overhang is an inevitable – and usually sizeable - cost of doing business in the tobacco industry, and the likes of BATS have been working hard to pursue "New Category" revenue in areas such as vaping, as tobacco volumes continue to decline. 

To this end, the company is making some strong progress and, while still significantly shy of previous levels, the shares have staged something of a recovery rally in 2019, having added around 22%, although that is from a lower base. 

Source: TradingView Past performance is not a guide to future performance

The update keeps full-year guidance unchanged, while highlighting positive trading in the US, strong growth in 'New' categories and improved operating margin, boosted no doubt by the considerable pricing power which accompanies tobacco. 

Despite the continued investment in new products, the company continues to generate prodigious amounts of cash, enabling a dividend whose current yield of 6.6% is adequately covered and a clear invitation to income seekers.

The more recent improvement in fortunes cannot mask the longer-term challenges, however, and this is likely to prove a drag for some time to come. 

Over the last 12 months, the shares remain down 18%, as compared to a 4% dip for the wider FTSE 100 index, and the initial reaction to the update may be the result of some shorter-term profit taking. 

That said, and despite the considerable hurdles which remain, the market seems sharply focused on the potential of BATS as it transforms its business model, with the general view of the shares as a 'strong buy' remaining intact.