Like all cigarette makers, British American Tobacco(NYSE: BTI) has one really big problem: Its core product is cigarettes. It is working to reduce its reliance on this declining product category, but there's no easy fix. Here's what the company has done so far, and why it still has miles to go before cigarettes aren't the most important product it sells.
Just how bad is British American Tobacco's cigarette problem?
When British American Tobacco reported first-half 2024 earnings, CEO Tadeu Marroco led off with this comment: "We are building a smokeless world. We added 1.4 million consumers (to 26.4 million) of our smokeless brands, now accounting for 17.9% of Group revenue, an increase of 1.4 ppts vs FY23."
Image source: Getty Images.
However, if roughly 18% of revenue comes from smokeless products, then the remaining 82% comes from traditional tobacco. In that category, cigarettes are the driving force. So, when it comes to the top and bottom lines, cigarettes are clearly still calling the shots.
With that in mind, cigarette volumes fell 6.8% year over year in the first half of 2024. Other combustible products did worse with volumes down 12.6%. Luckily, other combustibles -- such as cigars -- only make up 2% of volume. Still, these trends are concerning, and the company recognized the challenge in a big way last year with a major accounting change.
In 2023, British American Tobacco took a massive impairment charge, writing down the value of its U.S. operations. Management also announced its decision to amortize the value of its U.S. cigarette brands over a period of no more than 30 years, a tacit acknowledgment that the long-term viability of this business is unknown.
New categories are where the future is for British American Tobacco
Management clearly isn't sticking its head in the sand with about 18% of revenue coming from smokeless products, but even here, the news isn't all good.
For example, the company's growth engine on the non-cigarette side falls into a division called New Categories. That group accounts for 13.3% of revenue. This is where British American Tobacco is putting the bulk of its effort, or so you would expect. Revenue in the New Categories group fell 0.4% year over year during the first half of 2024. However, revenue was up 7.4% on an "adjusted organic" basis, which excludes:
[T]he performance of businesses sold (including the Group's Russian and Belarusian businesses) or acquired, or that have an enduring structural change impacting performance that may significantly affect the users' understanding of the Group's performance in the current and comparator periods to ensure like-for-like assessment across all periods.
The first half of that note makes sense. The second half (enduring structural change) is pretty open-ended. Eliminating some businesses from comparable results can make sense, given that this is, essentially, a division filled with start-up businesses -- some of which are products that simply didn't exist before. It's reasonable that progress might be slow and some investments may fall by the wayside along the path forward.
But when you dig in a little, oral pouches was the only New Categories product that saw volume increase year over year during the period. That increase was a huge 50%, but with volume declines in the four other major products in the New Categories group, that doesn't seem like quite as resounding a strategic success.
British American Tobacco is doing well, but there's tons of work to do
This isn't meant to suggest that British American Tobacco is doomed or that the company isn't succeeding in its effort to shift away from cigarettes. It's meant to temper the excitement that investors may have after bidding the stock up about 25% in the past three months. Also, note the massive 7.6% dividend yield may not work out to be quite as reliable as some investors believe over the long term.
With a lot of work to do on the non-cigarette side of the business, British American Tobacco is still a fairly risky dividend investment. Investors should tread with caution.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends British American Tobacco P.l.c. and recommends the following options: long January 2026 $40 calls on British American Tobacco and short January 2026 $40 puts on British American Tobacco. The Motley Fool has a disclosure policy.
