Actions in British American Tobacco (LSE: BATS) currently come with a big dividend yield. This should put them on the radar of investors looking for a second income.

But the big question is sustainability. Tobacco volumes are declining, so the question is whether the company’s next generation of products will be able to pick up the slack.

Dividend coverage

I don’t often consider dividend coverage – the gap between a company’s earnings and its dividends – as a useful metric. Mainly because it’s easy for investors to draw the wrong conclusions.

British American Tobacco is one of the rare cases where I think it’s useful though. The company has returned the vast majority of its earnings to shareholders over the past 10 years. This means there isn’t much wiggle room. If profits start to decline, the company will not be able to maintain its dividend for long.

Cigarette volumes are slowly declining, but I expect this trend to accelerate over time. The company will therefore have to replace this income to continue sending liquidity to investors.

Next generation products

In reality, it appears that it will be British Tobacco’s new category products that will need to be adopted. These include vapes, nicotine pouches and heated tobacco.

There is evidence of strong growth in this part of the business. Since 2020, revenue from new products has grown 33% annually and the division now accounts for nearly 20% of total sales.

The division has also become profitable recently. So, if this strong momentum continues, investors could find themselves earning a second income for a long time.

There is also another important point to consider. If the company’s new products seem capable of maintaining the dividend, I wouldn’t expect the yield to stay at 8%.

Consumer Products

Right away, the marketclearly views British American Tobacco as a tobacco company in decline. Which is fair enough: that’s where about 85% of revenue comes from.

If the company starts to resemble a more stable consumer products company, I expect that to change. The tastes of Unilever And Haleon do not have an 8% dividend yield.

Their dividend yields are less than half because long-term demand for their core products is more robust. And expect British American Tobacco to be similar if its business moves in that direction.

This implies that the stock price could double from now if smoke-free products could ultimately fully support the current dividend. It’s a big ask, but a huge potential reward if it’s possible.

Safety margin

The argument for British American Tobacco stock boils down to whether smokeless products can replace lost tobacco revenue enough to justify the stock price. I think it’s just too close to follow.

From there, it wouldn’t take much for me to cross the finish line. So I will be watching the December update very carefully for news regarding the growth of the new categories.