The British American Tobacco dividend is up 6%. Time to buy?

There is good news today for shareholders British American Tobacco (LSE: BATS). The dividend for the year has been raised by 6%. That continues the pattern over the past few decades of an annual increase in pay. It takes the payout per share to 57.7p per quarter, for a total of £2.31 per year.

But cigarettes accounted for more than 80% of the company’s profits last year. And with long-term demand, there is a risk that the company will cut its dividend in the future. So should I add to the existing ones?

Dividend growth

A 6% increase is positive. Last year, the increase was equal to more than 1%.

Some companies have a dividend policy and British American is one of them. It aims to pay out 65% of its annual earnings per share as dividends. But there is flexibility for the purpose, because the company also has a progressive policy (meaning that the goal is to increase the payment every year).

Those two goals could collide if earnings per share decline too much. Last year, diluted earnings per share fell 1.3%, although on an adjusted basis they rose 5.8%.
Using the adjusted diluted numbers, the payout ratio was 62.2%. That is close to the target and I am comfortable that the dividend remains affordable Lucky Strike brand owner.

This business increases profits and free cash flow. Profit from operations increased by 2.8% compared to the previous year, while net cash generated from operating activities increased by 7%. If the company can continue to perform strongly like this, then British American Tobacco’s dividend will grow again in the years to come.

Mixed reactions

But City reacted to the negative results. The stock was down about 5% in morning trade. They have lost 9.9% of their value over the past year.

While profits are up and profits are 7.7% higher than last year (mostly due to exchange rate fluctuations), there are several aspects to the results. Adjusted net debt rose 7.3% to £38bn. That’s a lot of debt, especially when interest rates are rising.

The company expects global cigarette volumes to decline by around 2% this year. While the firm has done a good job continuing to increase revenue, that is driven by price increases. The volume of these cigarettes decreased by 5.1% year-on-year. In the long run, it can become more difficult to try and offset declining volumes by increasing prices.

My movement

The long-term decline in tobacco remains a risk to sales and profits for manufacturers. While non-tobacco revenues grew by 41% last year, nowhere near that for tobacco. Cigarettes are very profitable for the company, while non-tobacco businesses remain loss-making. However, it is now expected to turn a profit next year – 12 months ahead of schedule.

I think the fundamentals of the business remain strong. The demand for cigarettes is structurally declining but remains high. The company can leverage its portfolio of well-known brands that provide pricing power. That translates into huge profits – and yet another year of growth in British American Tobacco’s dividend.

If I had money to invest today, I would increase my shares in the company.