One of the commonly cited risks when it comes to tobacco stocks is declining cigarette usage. For example, when considering British American Tobacco (LSE: BATS) as a passive income idea this month, I noted that “There are always risks with tobacco: declining demand could hurt revenues and profits.” That is indeed a risk for the BATS share price. But it emerged this week that last year, for the first time in two decades, cigarette consumption in the US actually increased.
With its large American exposure, could this news help the BATS share price?
Cigarette consumption rose in 2020
The data was revealed in a report by the US Federal Trade Commission. It found that, counter to years of falling cigarette use in the US, cigarette sales were bigger last year than in the prior year. The increase was only 0.4%, but for an industry that has spent decades battling declining customer demand, that is still an unusual turn of affairs.
British American Tobacco derives a substantial part of its income from the US. Last year, the US contributed £11.5bn of BAT’s total £25.8bn revenue. So, the company could be a beneficiary of any uptick in cigarette demand in its biggest market.
Long-term outlook
However, last year was an exceptional year. Many people had more time on their hands than usual and fewer entertainment options. Many were nervous. I think that is the most likely explanation of the increase in cigarette sales last year in the US.
After decades of falling sales, I think the long-term trend is clear. So I don’t think we’re about to see a revival in US cigarette sales. The BATS share price isn’t likely to rise meaningfully on that basis. But what I think could be good news about the numbers from a financial perspective is that they suggest cigarette sales in the US may have started to bottom out. Even if they continue to fall in future years, the rate of decline may fall. That could help support BAT’s US cigarette business over the longer term.
Why the BATS share price could rise
A slower rate of decline in cigarette consumption in its key market could already be good news for the BATS share price, I reckon. But I also see other reasons to be positive about the stock.
In recent years, the company has pushed hard into non-cigarette product formats. First-half revenue from such new categories grew 40% compared to the equivalent period last year. The company added 2.6m non-combustible customers in the period. For now, these new categories are loss-making. But the company expects the full-year new categories loss to shrink. Over time, these could become significant profit centres alongside the cigarette business.
My next move on the BATS share price
BATS has no shortage of risks, even if cigarette consumption stabilises. Regulatory pressure could further limit future demand. Tax increases, as we saw in yesterday’s Budget, may also chip away at demand. That could hurt revenues and profits.
Despite that, I have topped up my BATS position this month. The shares yield over 8% and the company is positioning itself for the future, whatever happens to cigarette demand.
Christopher Ruane owns shares in British American Tobacco. The Motley Fool UK has recommended British American Tobacco. 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.
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