Tobacco giants British American Tobacco (LSE: BATS) and Imperial Brands (LSE: IMB) are some of the biggest dividend payers in the FTSE 100.
Together these two income champions distributed a total of £6bn in dividends to investors during 2019. At the time of writing, both support dividend yields of between 7.5% and 10%, compared to the FTSE 100 average of 4.5%.
However, both of these companies are trying to deal with a threat to their business models. Smoking is in terminal decline and regulators around the world are stepping up their efforts to stamp out the deadly habit.
Growing risks
Regulators have been pursuing Big Tobacco since the 1960s and, so far, companies like British American and Imperial to have managed not just to survive, but prosper as well.
Indeed, shareholders in these businesses have seen an annual return of around 10% over the past few decades. But things are changing fast. In the past few years, a handful of countries around the world have introduced plain packaging to try and reduce the appeal of buying cigarettes.
At the same time, the launch of electronic cigarettes and so-called reduced-risk products have accelerated the move away from traditional cigarettes.
These products will provide some cushion for Imperial and British American, but they are still only a relatively small part of the overall groups’ operations. British American reported total revenues of £24.5bn in 2018, but reduced risk products made up just £883m of that.
Growing market
That said, demand for these products are growing relatively quickly. Sales of next-generation products at Imperial tripled during the six months to the end of March. However, with a full-year target of just over £400m, sales of these products will only account for just over 1% of total revenues.
Managers have stated that reduced-risk products such as e-cigarettes and heat not burn tobacco, can actually be more profitable than traditional cigarettes over the long term. The cartridges in these products are cheaper to produce in large quantities.
Nevertheless, in the meantime, these companies are going to have to continue to spend big to attract new customers. Neither Imperial’s nor British American’s reduced-risk products are, as yet, contributing to the bottom line.
Steer clear
Only time will tell if these new devices can come to the rescue of Big Tobacco, but they are already in the crosshairs of regulators. A spate of deaths in the US linked to vaping have only increased the chances that regulators will clampdown on this juvenile market.
Still, it looks as if British American and Imperial’s dividends are sustainable for the next few years, but what happens after that is difficult to tell.
Regulators wouldn’t need to do much to pull the rug out from underneath these companies. With debts of £60bn across the two businesses, if regulators do decide to act, the only way British American and Imperial’s shares will go is down.
With this being the case, I think if you’re looking for blue-chip income, it might better to look elsewhere.