British American Tobacco (BTI 1.07%) reached a key goal in 2023 and it did it two years ahead of schedule. That's a good outcome for a company that is facing an existential crisis. As you watch this global cigarette maker, you need to keep in mind both the progress it is making in other areas of the company and the goals it has set for itself.
British American Tobacco's big problem
There's no question that British American Tobacco is facing tough times. This consumer staples maker's core business, selling cigarettes, is in decline. In 2018, it produced roughly 700 billion cigarettes. But over the following five years, or so, that fell to just 555 billion, a huge 21% decline. If that had happened at any other consumer staples, company investors would be running for the hills.
To be fair, British American Tobacco's stock is down more than 50% since its peak levels in 2017. So Wall Street is definitely shunning the shares. However, the stock has a huge 9.5% dividend yield, so there are likely a lot of dividend investors that are examining the company hoping to find a diamond in the rough. The interesting thing is that, despite the volume decline, British American Tobacco has been able to raise prices to offset the damage and, thus, sustain its huge dividend payment.
The company can likely keep the lower-volume/higher-prices trend going for a bit longer. And, thus, the dividend probably isn't at risk over the near term. But at some point, the price increase will likely exacerbate the declines in the cigarette business. If such a tipping point is reached, British American Tobacco will be in for a world of hurt. Management admitted that outcome is in the cards in 2023 when it changed the way it accounted for its U.S. brands, effectively saying that they will become worthless in 30 years (previously the brands were expected to continue existing in perpetuity).
Here's what British American Tobacco is doing about it
Given the accounting change in 2023, it is clear that British American Tobacco isn't trying to pretend that problems it faces aren't real. In fact, it has been working to build up its "new categories" division, which is where it places non-combustible products like vapes, pouches, and heated tobacco. This business is still fairly modest, but it is growing. In 2023 the new categories business made up nearly 17% of the top line.
By 2035, a touch over 10 years from now, the company's goal is for that figure to reach 50%. While the progress to that goal will probably be a bit lumpy, and will depend at least in part on how well the cigarette division does, investors watching British American Tobacco will want to see clear progress toward that goal over the next five years. Given that the figure is 17% today, 25% within five years shouldn't be too outlandish an expectation.
That said, there was a notable bit of good news in 2023 from the new categories division that is incredibly important. According to the company's full-year earnings release, "New Categories achieved profitability in 2023 (at a category contribution level), two years ahead of original target." That's important because it means the up-and-coming division isn't a massive drag on the results of the overall company. It is a huge sign that British American Tobacco is succeeding in its efforts to transition its business in a new direction.
Fewer cigarettes, more new categories
So, over the next five years, investors watching British American Tobacco will want to see two things. First, continued growth in the new categories division. Second, as slow a decline as possible in the cigarette business. The big picture, ultimately, is that this company needs to change, it has set out targets for the change, and Wall Street needs to track the progress of that change. If British American Tobacco can make steady progress on its internal goals, it might actually be able to survive the decline of the cigarette industry while continuing to pay investors an attractive dividend.
