There have been news reports in recent weeks about a Zyn shortage across the United States. Phillip Morris International has been unable to keep up with demand for the popular nicotine pouches as consumers increasingly look for alternatives to smoking cigarettes. The Zyn brand holds a dominant position in the nascent nicotine pouch category, with an estimated 75% volume share in the United States.
Now, with many customers unable to get their nicotine fixes from Zyn, some may switch to other nicotine pouch brands. British American Tobacco (BTI 0.04%) -- and its high-yielding stock -- should benefit.
British American Tobacco: Betting on the future of nicotine
Cigarette giant British American Tobacco owns the Camel and Newport brands (among others), and the vast majority of its profits still come from these legacy operations. However, it is increasingly investing in new nicotine products for consumers.
Among these products are Velo nicotine pouches, which compete head-to-head with Zyn. Velo is a tobacco-free pouch made from nicotine powder that serves as a replacement for chewing tobacco, but with what the company says are reduced health risks compared to smoking. U.S. sales of these pouches have been surging, and are expected to grow at 30% a year through 2030.
Given the Zyn shortages around the country, many consumers might switch to the British American Tobacco brand instead. Velo sales grew by 39% in 2023, and those gains could accelerate in 2024 if Zyn pouches remain hard to find. Over the long term, there is still a huge market for both companies to go after in this niche.
Crackdown on illegal vaping products
British American Tobacco should also benefit from a federal crackdown on illegal electronic vaping products. Earlier this month, U.S. regulators and law enforcement agencies announced increased scrutiny on convenience stores selling unapproved vaping products that have taken the nation by storm.
British American Tobacco owns Vuse, one of the few approved vaping brands. If illegal vapes largely go away, a lot of their users could switch to Vuse as their new nicotine supplier. Despite the major headwinds caused by illegal competition, British American Tobacco's "vapour" category sales grew by 27% in 2023.
Overall, British American Tobacco's new categories are approaching $5 billion in annual sales, and those segments just became profitable on a consolidated basis. This should help boost the company's earnings over the next five to 10 years and counteract the sales volume declines in traditional cigarettes.
BTI Dividend Yield data by YCharts.
The stock is cheap, but should you buy it?
Today, British American Tobacco trades at a price-to-earnings ratio of just 6 and offers a sky-high dividend yield of 9.2%. Investors are pessimistic about the ongoing sales volume declines for traditional tobacco. For example, in 2023, cigarette sales volumes were 8% lower than in 2020. This trend is likely to continue in the coming years.
However, tobacco companies have consistently compensated for those volume declines by hiking their prices, which is why British American Tobacco's combustibles revenue barely declined on a constant-currency basis last year. There are still many years left of cash flow to be had from the cigarette business, especially in international markets.
Wall Street also seems to be underestimating the potential of these non-tobacco nicotine products. $5 billion in annual sales is sizable, and these products could drive a ton of profit growth over the next five years and beyond. In a few years, I think it is likely that investors will look back at a P/E of 6 as having been much too cheap for this company. The narrative about it on Wall Street today does not match its actual financial data.
In that light, British American Tobacco looks like a safe stock for value-focused and income investors at current prices.
