British American Tobacco Coughs Up Big Dividend Yields

With stock prices racing to record highs and the Federal Reserve considering cutting interest rates, income investors are in a difficult position. The unimpeded rally of the S&P 500 to record highs has caused the average dividend yield to fall below 2%. Looking outside of equities, the potential for falling interest rates has caused yields to fall. But income investors can still find high dividend yields, particularly among tobacco stocks. For example, British American Tobacco has a 7% dividend yield, and a sustainable dividend payout with room for future growth. BTI's dividend yield has spiked to 7% as the stock price has declined approximately 30% in the past one year. While this has been challenging for existing shareholders, new investors can use the recent decline as a buying opportunity, particularly those investors looking for high yields and sustainable dividends. Business Overview Trading with a market capitalization of $83 billion, British American Tobacco is among the world's largest tobacco companies. It owns many tobacco brands, too, including Kool, Benson & Hedges, Dunhill, Kent and Lucky Strike. The company acquired the remaining 48% stake in Reynolds American Tobacco that it did not already own in July 2017. It's incorporated in the United Kingdom and headquartered in London, but investors can purchase its stock through American Depository Receipts that trade on the New York Stock Exchange. The tobacco industry enjoys very strong economics. Tobacco manufacturers like British American Tobacco benefit from economies of scale, with very low manufacturing and distribution costs as a percentage of revenue. They also are restrained from spending much to market their brands, because they are banned from many forms of advertising in the U.S. Also, tobacco companies enjoy huge brand loyalty, which gives them the ability to raise prices each year. Because of all these qualities, tobacco companies are highly profitable with huge cash flows that allow them to return lots of cash to shareholders. In 2018, British American Tobacco grew revenue by over 25%, thanks in large part to the Reynolds American Tobacco acquisition. On an adjusted basis, revenue still increased 3.5% in constant currency last year, while adjusted diluted earnings per share increased 12%. This year is likely to be another strong year. British American Tobacco reported a so-called first-half, pre-close trading update on June 12. The company did not announce any specific revenue or profit numbers, which is somewhat typical for UK-based companies, which oftentimes only announce less-specific statements during quarterly updates, whereas specific numbers are released at the end of each fiscal year. For 2019, British American Tobacco expects currency-neutral revenue growth of 3% to 5%. Despite the continuing headwind of falling smoking rates, expected to reduce global volumes by 3.5%, the company plans to offset this with price increases. New products will add to the company's revenue growth, as British American Tobacco expects its portfolio of new category products to grow by 30% to 50% in 2019. Cost savings following the integration of Reynolds American will be a driver for British American Tobacco's earnings. Other factors include ongoing organic growth due to rising cigarette prices and the rise of vaping products, and declining interest expenses as long as British American Tobacco is able to lower its debt load over the coming years. Smoking Hot Dividend Stock Since British American Tobacco is located outside the U.S., its dividend payments are translated into U.S. currency each quarter. This results in a variable dividend policy, as the exact payment will fluctuate based on prevailing exchange rates. Still, British American Tobacco has a very high yield, which significantly exceeds that of its U.S.-based peers. The past four-quarterly dividend payments totaled $2.54 per share, which represents a high dividend yield of 7.0% based on the recent ADR share price. British American Tobacco has kept its dividend payout ratio in a range of 55%-75% throughout the last decade. Compared to other tobacco stocks, this is not a high payout ratio. With a dividend ratio below 75% projected for 2019, British American Tobacco's dividend appears safe for the foreseeable future. An added advantage to buying BTI stock is that it is headquartered in the U.K., which means there is no dividend withholding tax for United States investors. Importantly, British American Tobacco also has stated that it is on track to reduce its leverage meaningfully during the current fiscal year, as its adjusted net debt to adjusted EBITDA ratio should decline by 0.4 during the 12 months ending December 2019. This should help further improve the sustainability of the dividend. Investors should also note that BTI stock is significantly undervalued. British American Tobacco's stock price has declined massively over the last year, as shares trade 30% below the levels from June 2018. Share prices of other tobacco companies have declined substantially throughout that time frame as well, which has resulted in big declines in these companies' valuations. British American Tobacco trades for less than 9 times this year's expected net earnings, which is a low valuation vs. how the company's shares were valued in the past.

British American Tobacco Coughs Up Big Dividend Yields

BTI's dividend yield has flared to 7% as the stock price has dipped about 30% recently -- a drag for existing shareholders but a burning opportunity for new investors.

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