Predicting the Future Position of British American Tobacco Shares Over the Next Five Years
The tides might be shifting in favor of tobacco shares. After a decade of no returns, even considering dividends, British American Tobacco (BTI, 0.03%) has seen a remarkable 28% return this year. Investors are becoming more optimistic about the stock, as the company forecasts an accelerated second-half growth and robust organic revenue growth from 2026 due to enhanced contributions from its less hazardous nicotine products.
Investors who missed out on British American Tobacco's gains this year might be regretting their decision, but the celebration could just be starting. So, what does the future hold for this nicotine heavyweight? Time to delve into the details and decide if this is an investment worth considering.
Managing the decline of combustibles
In recent years, investors have steered clear of tobacco stocks due to significant declines in cigarette sales in the United States. In 2022 and 2023, premium cigarette sales dropped 12% annually, marking the market's worst years since the Great Recession. Even the volume declines observed during the 2008 and 2009 economic downturn were surpassed.
As one of the country's leading tobacco companies with well-known brands like Newport and Camel, British American Tobacco has certainly felt the pressure of weakened consumer demand. There are, however, signs that the market might be leveling off. The company's management assures that they are seeing potential recoveries in the U.S. cigarette market, indicating that the low volumes were likely a result of high inflation during the past few years that is now beginning to ease.
Despite the double-digit annual decline in cigarette sales in the U.S., the company's revenue has essentially remained constant over the past five years. By implementing price hikes on cigarettes, British American Tobacco has been able to and likely will continue to maintain revenue, despite the volume declines.
Second, the company has a more promising outlook in foreign countries with better sales trends than the U.S. This dynamic should help keep the revenue for its combustible segment steady over the next five years, unless the cigarette market in the U.S. takes a drastic turn for the worse.
New products driving growth in earnings
Although the combustibles market might not be as encouraging as some may think, it is not the only aspect of British American Tobacco's business. The company is also active in the nicotine pouch, electronic nicotine vapor, and heat-not-burn tobacco device sectors. Its brands include Velo (nicotine pouches), Vuse (vapor), and Glo (heat-not-burn).
Thanks to the general trend of nicotine users transitioning to these alternatives, this segment has seen rapid growth for British American Tobacco over the past few years. If we convert British Pound revenue into U.S. dollars, revenue from these innovative products has increased from $780 million in the first half of 2020 to $2.2 billion in the first half of 2024. With increased scale, the segment is now generating positive earnings and contributing to bottom-line growth.
These products are available in more than 100 countries, leaving plenty of room for expansion. The segment can even complement the decline in cigarette sales, providing some reassurance for investors worried about the tobacco industry's future. As this segment grows, investor concerns about the demise of tobacco companies should gradually fade away.
Where will the stock be in five years?
Anticipating British American Tobacco's future requires contemplating the future of its cigarette and innovative nicotine product segments. Assuming cigarette revenue remains steady in five years thanks to the interplay of volume declines and price increases, revenue from the innovative nicotine products will be the primary driver of growth. I anticipate these products to grow revenue by almost 10% annually over the next five years, given the favorable sector trends.
Total revenue growth of around 3% to 5% annually should be achievable with this growth in revenue, coinciding with management's long-term expectations. If margins expand as new nicotine brands continue to expand, earnings should also increase by 5% to 7% annually over the next five years. If the stock maintains its current price-to-earnings ratio (P/E) in five years, this would equal a 5% to 7% annual stock price growth.
However, this doesn't take into account dividends. British American Tobacco currently pays a dividend with a yield of 8.5%. When added to the earnings growth, investors can expect a total return of roughly 15% over the next five years, potentially even more if the company manages to boost its dividend per share annually. While the stock price increase may not be rapid, investors can still generate substantial returns by holding British American Tobacco stock over the next five years and reaping its substantial dividend payouts.
Investors considering British American Tobacco as an investment opportunity should keep an eye on its diversified product portfolio, particularly its less hazardous nicotine products that are contributing to robust revenue growth. With the potential for a 10% annual increase in revenue from these innovative nicotine products over the next five years, investing money in this finance sector could yield significant returns, complemented by the company's attractive dividend yield of 8.5%.
