There are not that many dividend shares that offer a yield close to 7%. Among large FTSE 100 companies, there are a few. In fact, I have one of them in my portfolio – and I think the yield might be about to get even more attractive for me. Here is why.
Tobacco giant
The company in question is British American Tobacco (LSE: BATS), the owner of iconic brands such as Lucky Strike. The tobacco business fails to meet many investors’ ethical criteria. But for those who are willing to invest, it has historically been a lucrative business. Manufacturing costs are low, competition is limited, and the pricing power of premium brands enable the company to maintain attractive profit margins.
That model has come under threat with a decrease in cigarette smoking. That remains a big risk to revenues and profits. But the pricing power does enable a company like British American Tobacco to raise prices, which can help to support profits even if volumes fall. The company is also developing new product lines, although they risk hurting profit margins as, so far, they are less profitable than cigarettes.
Currently, the British American Tobacco yield is a tasty 6.7%. I expect some good news this week that could push that higher.
BATS annual results
This Friday, the company is due to unveil its final results for last year. That will include its decision on what to do next with its dividend. As one of the UK’s leading dividend shares, the announcement will be closely watched in the City.
I expect the company to raise the dividend. That would mean that the company would offer a higher prospective yield at its current share price. The company has increased its dividend annually for over two decades. That does not mean that it is guaranteed to keep doing so. Indeed, the company has emphasised that its dividend payout ratio of around 65% of earnings means that dividends could change in line with earnings.
But I see reasons for optimism. In a pre-close second-half trading update in December, the company said that revenue grew in excess of 5%, excluding currency impact. It also said it had seen strong performance in its key US market. That was driven not only by growth in next generation products such as vaping, but also in pricing for cigarettes. That could help keep profits buoyant.
I would buy this dividend share today
Tobacco shares have been in the doldrums for years but have had more positive momentum lately. The BATS share price has increased 20% over the past year, for example.
That means that the yield available to me if I buy its shares today is less than if I had bought a year ago, due to the share price gain. But if the dividend keeps going up, shares I buy today could still see increasing yield in years to come. Friday’s announcement could be the first step on that journey. Last year saw an increase of 2.5%, which, although welcome, was less than some recent BAT dividend rises had been. With more clarity now on business outlook than a year ago, I am hoping that Friday may see a bigger increase. I continue to hold BATS shares in my portfolio and am hoping for an increasing dividend yield.
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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.
