FTSE 100 dividend stock British American Tobacco continues transformation

In a trading update ahead of its year end, the tobacco giant confirms millions more are switching to vaping products. Our head of markets dives into the detail.

British American Tobacco (LSE:BATS) sits within a sector in the midst of transformation and is driving its own charge towards the new world.

As the industry recognises the longer term need to lessen the reliance on traditional tobacco, switching towards the fast-growing “New Category” products area, the signs for BAT are encouraging.

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In a trading update ahead of its December year end, BAT said consumers in the so-called New Category - things like vaping and tobacco heating products - rose by 3.2 million and now stands at 21.5 million, against a target of 50 million by 2030. At the same time, the group is confident of reaching its 2025 milestone of £5 billion revenue and at the same time turning the unit into profitability.

With increasingly established markets, such as the Vuse product in the US which has maintained its leading position and has a value share of 39% in that market, the group’s established scale and cash generation pulls the target closer.

For the traditional products which still prop up the business overall, there also remain signs of ongoing resilience. The nature of the products allows for strong pricing power without destabilising demand, and this largely offsets some of the issues the group is facing. Economic pressure generally and a post-Covid normalisation of habits has led to some downtrading, while finance costs have risen due to higher interest rates and the strength of the US dollar.

Even so, the dollar strength also boosts BAT’s earnings on repatriation, and an FX tailwind of around 7% will drive higher profits for the year. At constant currency the group expects revenue growth of between 2% and 4% for the year, with overall metrics improved due to predicted annualised cost savings of £1.5 billion by the end of 2022. This is in addition to the likelihood of a strong improvement in the adjusted operating profit margin, despite the inflationary pressures being experienced in the supply chain.

In the meantime, the company’s extraordinary cash generation has enabled the prolonged growth of the dividend payment, where the current yield of 6.4% is an added attraction to holders of the stock. Nor does the largesse of shareholder returns end there, with a previously announced share buyback programme of £2 billion leading to hopes that something similar could follow this year.

Of course, there are also concerns which have tended to overhang the industry. Litigation has been a sporadic issue over the last decade, while regulation remains on the minds of governments worldwide with health benefits in mind. From an investment perspective, the sector has more recently been overlooked by some investors who are simply unable to enter the fray on ethical grounds.

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Of late, however, there may be some winds of change. Recent market volatility and the rotation away from growth stocks into value has refocussed attention on the likes of the oil and tobacco stocks.

However unfashionable they may be, propelled by strong cash generation, inelastic demand and generous dividend yields, the likes of British American Tobacco are having their own day in the sun at present.

Indeed, the share price has spiked by 29% over the last year, as compared to a rise of 2% for the wider FTSE100, with the market consensus of the shares as a strong buy likely to remain intact.