Dividend Report Card: British American Tobacco

Source from:  The Motley Fool 08/17/2010

Does this tobacco company's dividend pass the test? In the dividend report card series, we analyse financial metrics to begin answering the following questions about a company's dividend: 1.Over time, has this company steadily increased its payouts? 2.How sustainable is the dividend? 3.Does the company have room to further increase the dividend? For a full explanation of each category, click here for a tutorial. Today's pupil is British American Tobacco (LSE: BATS), which has an expected 5.5% yield. Dividend history

British American Tobacco's five-year earnings growth rate is negative over this rolling period because of the huge ￡1.4 billion gain it made in 2004 on the partial disposal of its US businesses. On a "normalised" basis, then, earnings per share have grown about 14.9% annualised. That's more like it. Ideally, you want to see dividends and earnings growing at similar rates, so British American scores a 5 of 5 in this category. Sustainability

British American Tobacco has a strong balance sheet and generates more than enough operating profit (EBIT) to pay interest on its debt. It does pay out a substantial amount of its earnings and free cash flow as dividends, but remember that tobacco companies don't need to spend a lot of cash reinvesting in their businesses each year. For the most part, their processing and distribution infrastructure is already in place and there hasn't been a major innovation in tobacco since cigarette filters were introduced in the early 20th century. This leaves more cash to be distributed as dividends -- a winning scenario for income-minded investors. Growth

The company's stated dividend policy is to pay out at least 65% of its earnings out as dividends and given its sustainable growth rate of 10.6%, I would expect British American Tobacco to raise its dividend between 8-10% annualised over the next five years. Competitors An "ungraded" section of the dividend report card is to see how a stock's current yield stacks up against its direct competitors. If it's too high relative to competitors' yields, the board could be tempted to slow the growth rate, or vice versa, to bring it more in line with the industry average.

With its expected yield at 5.5%, British American Tobacco's dividend fits nicely into its peer average yield around 5%. It therefore shouldn't be under any pressure to either slow down or accelerate its dividend growth relative to its peers. Pencils down! With all the numbers in, here's how British American Tobacco's dividend scored:

A "B" grade for a share yielding 5.5% is quite good. Future dividend growth may not be what it has been, but the trade-off of a high current dividend for less dividend growth is a fair one. British American Tobacco is a solid high-yield name to consider for your portfolio. Enditem