A FTSE 100 dividend stock that yields 8.9%! Should investors buy?

For investors who like dividend stocks, the FTSE 100 index is a great place to look. Some Footsie companies offer mammoth yields.

Take British American Tobacco (LSE:BATS) for example, which currently trades near a 52-week low. The share price slump has pushed the dividend yield up to 8.92%, as I write.

So is this a no-brainer passive income pick? Or is the tobacco giant a stock to avoid?

Here's my take.

First, tobacco companies are highly cash generative. Lucky Strike manufacturer British American Tobacco is no exception. This week, the company maintained its full-year forecast for constant currency organic revenue growth of 3-5%. That's despite a projected 3% fall in global tobacco industry volume. Last year, the firm delivered 2.3% constant currency revenue growth to hit £25.46bn.

Second, British American Tobacco is a Dividend Aristocrat. It has a 23-year history of delivering dividend hikes. Although no dividend stocks are risk-free, long-term shareholders have been rewarded with consistent passive income.

As it operates in a defensive, non-cyclical sector and dividend cover is a reasonable 1.6 times earnings, I’m not expecting any unpleasant surprises in the form of dividend cuts. Plus, tobacco product prices have historically risen at a faster rate than inflation, due to high taxes. In that context, I believe this stock could be a good hedge against inflationary pressures.

Third, I like the firm's plan to future-proof its business model. It's no secret that cigarettes are bad for your health and governments around the world want to reduce smoking. But part of the solution to this problem is a shift towards non-combustible products.

British American Tobacco could benefit from this trend. In the first quarter, it gained 900,000 new consumers in its ‘new categories’ business, which sells non-tobacco alternatives, such as vapes. The company expects the division will become profitable next year and turnover will exceed £5bn by 2025.

Despite progress in diversifying its revenue sources, the company's still highly reliant on traditional tobacco sales. Combustible goods account for around 90% of the group's revenue. Proposals to ban tobacco are gaining traction, which poses a risk to the British American Tobacco share price.

What's more, health campaigners are increasingly calling for stricter regulation on vapour products. So the firm faces twin threats to its core business and its transformation plans.

The company's environmental impact is another challenge in a world where ESG concerns are increasingly important. According to the World Health Organisation, every year the global tobacco industry costs the world 600m trees, 200,000 hectares of land, 22bn tonnes of water, and 84m tonnes of CO2.

Finally, some investors will want to avoid ‘sin’ stocks like British American Tobacco. A company selling addictive nicotine products isn't suitable for all.

The bumper dividend yield is the primary reason I own this stock. Few FTSE 100 shares can rival its passive income record. With a credible plan to reinvent the business model in a way that's better for the environment and consumer health, I think its future could be bright.

If investors are considering buying, the price-to-earnings ratio under nine means the company might be currently undervalued, making today a potentially attractive entry point.

The post A FTSE 100 dividend stock that yields 8.9%! Should investors buy? appeared first on The Motley Fool UK.

More reading

5 Stocks For Trying To Build Wealth After 50

One Top Growth Stock from the Motley Fool

Charlie Carman has positions in British American Tobacco P.l.c. The Motley Fool UK has recommended British American Tobacco P.l.c. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2023