British American Tobacco (BTI) has been a high dividend payer for decades, with the stock averaging a >4% yield over the past 10 years. In a world with prolonged periods of low interest rates, investors should be interested in BTI’s long and stable history of paying outsized dividends to shareholders.
Dividends have been remarkably consistent. While there was one small cut during the financial crisis, the company has been able to raise dividends in almost every other year. The 10-year dividend growth rate is 16.1% annually, with earnings fully covering payments in each one of those years.
Not only has the company been shareholder friendly in terms of dividends, but management has also shown a strong focus on share buybacks (most of which have been very accretive to shareholder value). Over the past decade, shares outstanding have been reduced nearly every year, with the total count being lowered by roughly 13% over that period. For a $100 billion company, this results in a huge amount of money being directed towards dividends and buybacks.
The Business
British American Tobacco, headquartered in London, is the second largest listed tobacco company in the world. BTI operates in around 180 markets with a portfolio of more than 200 brands. Its four best selling brands are Dunhill, Lucky Strike, Kent and Pall Mall. In addition, BTI owns a 42% stake in Reynolds American (RAI), as a result of a merger in 2004. Reynolds American is the second largest tobacco company operating in the United States, with a market share of 26.1%.
Valuation
There are three major tobacco companies in the United States: Altria (MO), Reynolds American (RAI) and Lorillard (LO). Only BTI’s closest international peer, Phillip Morris International (PM), has a bigger dividend yield.
BTI’s valuation has traded very closely to PM’s, with their respective EV/EBITDA ratios moving in lock-step over recent years.
Still, PM looks to have superior cash flow generation. With $4.7 billion in free cash flow, BTI trades at a meager 4.6% free cash flow yield. At $6.6 billion however, PM trades at a slightly more attractive 5.1% free cash flow yield. Plus, investors are receiving a 4.6% dividend yield with PM shares versus only 4.1% for BTI.
Charting free cash flow versus dividend payments shows that unless there is a structural change in their businesses, both dividends look secure.
Risks
The company continues to face increased regulatory risks from packaging restrictions and from elevated excise taxes on tobacco products around the globe. Moreover, weak tobacco sales volumes, due to growing healthcare concerns, might hamper PM's future revenue growth. In addition, a stronger dollar will remain an overhang for the company's future cash flows and earnings base growth.
Still, these risks have been headwinds for over a decade now. Over this time period, BTI’s stock has nearly triples with EPS doubling off its 2006 lows.
Conclusion
One dollar invested in the U.S. stock market in 1900 would have been worth $35,255 at the end of 2014. That equals an average annual return of 9.6%. However, one dollar invested in the tobacco industry in 1900 would have ballooned to $6.28 million at the end of 2014, for an average annual return of 14.6%.
While there are clearly headwinds facing the industry (namely e-cigarettes), the industry has shown an ability to overcome nearly every other obstacle over the past 115 years. With a historically high dividend and ample free cash flow to support payments, BTI looks attractive for income seekers. Phillip Morris International however, looks to be a bit cheaper and comes with an even greater dividend yield.
