British American Tobacco: From Cigarettes to Nicotine Portfolios
Updated: Aug 22
British American Tobacco is one of the world’s largest tobacco and nicotine companies, with a portfolio of leading cigarette brands and a growing presence in smokeless products such as vaping, heated tobacco, and nicotine pouches. Through brands such as Lucky Strike, Newport, Camel, Vuse, glo, and Velo, the company serves millions of consumers across more than 140 markets worldwide. Supported by strong cash generation, significant pricing power, and a strategy focused on building a predominantly smokeless business by 2035, British American Tobacco aims to balance the resilience of its traditional tobacco portfolio with the growth potential of its New Categories segment. The question remains: Does this tobacco giant deserve a spot in your portfolio?
This is not financial advice. I am not a financial advisor, and I publish these analyses to document my own research and share my thoughts with readers and followers. If you are considering investing in any of the companies or ideas discussed, you should always do your own research and, if necessary, consult a qualified financial professional. All investing involves risk, and you may lose some or all of the money you invest.
For full disclosure, I do not own shares in British American Tobacco at the time of writing this analysis. I publicly share my investment portfolio, including all of my current holdings and changes I make over time. If you are interested in seeing what I currently invest in and learning how you can follow or copy my portfolio, you can read more here.
The Business
British American Tobacco is one of the world’s largest tobacco and nicotine companies, with a history that dates back to 1902 and a global presence across more than 140 markets. The company operates a multi-category business model built around combustible tobacco products, traditional oral tobacco, and a growing portfolio of smokeless nicotine products. Its core business is still cigarettes, which generated the majority of revenue in 2025, but BAT is gradually transforming itself from a traditional tobacco company into a broader nicotine and consumer products business. Its combustible portfolio includes well-known international, regional, and local brands across premium, mainstream, and value price points, allowing the company to serve different consumer groups across both developed and emerging markets. This legacy tobacco business remains highly profitable and cash generative, even though cigarette volumes are structurally declining in many markets. The reason is that tobacco companies like BAT have historically been able to offset lower volumes through pricing, brand strength, and disciplined cost control. This gives BAT a strong financial foundation that can fund dividends, share buybacks, debt reduction, and investment in new categories. BAT’s newer growth area is its smokeless portfolio, which includes Vapour, Heated Products, Modern Oral, and Traditional Oral products. The company’s main global brands in these categories are Vuse, glo, and Velo. Vuse is BAT’s global Vapour brand and one of the leading brands in tracked legal vaping channels, offering adult smokers an alternative to cigarettes through rechargeable closed systems, consumables, and selected disposable formats. glo is BAT’s Heated Product brand, where tobacco or plant-based consumables are heated rather than burned, creating a nicotine aerosol without combustion. Velo is BAT’s Modern Oral brand and has become the fastest-growing part of its New Categories portfolio. These nicotine pouches are placed under the lip and do not contain tobacco leaf, making them a convenient smokeless alternative for adult nicotine consumers. BAT is organized across three main regions: the United States, Americas and Europe, and Asia-Pacific, Middle East and Africa. This gives the company a balanced geographic footprint, combining highly profitable developed markets with exposure to emerging markets where tobacco consumption patterns may differ from Western countries. The U.S. is especially important because it is BAT’s largest region and includes Reynolds American, which BAT fully acquired in 2017. That acquisition gave BAT full ownership of major U.S. brands such as Newport, Camel, and Natural American Spirit, while also strengthening its position in one of the world’s most profitable nicotine markets. Outside the U.S., BAT has built its position through a long history of acquisitions, including Rothmans, Imperial Tobacco Canada, Souza Cruz, Tekel, Protabaco, and several vaping and nicotine pouch assets. The company has also partially monetized its investment in ITC in India, which has given it additional financial flexibility while still retaining a meaningful stake. BAT’s competitive moat is primarily built on brand strength, scale, distribution, regulation, and cash flow. Its brand portfolio is one of its most important advantages. Tobacco and nicotine products are habit-driven categories where trusted brands, familiarity, taste, product experience, and availability matter. BAT owns brands with decades of consumer recognition across both cigarettes and smokeless nicotine, including Lucky Strike, Dunhill, Kent, Pall Mall, Rothmans, Newport, Camel, Natural American Spirit, Vuse, glo, and Velo. This broad portfolio allows the company to compete across different price points, product categories, and geographies. It also gives BAT pricing power, especially in combustibles, where strong brands and consumer loyalty help the company raise prices even as industry volumes decline. Another important advantage is BAT’s global scale. The company sells combustible products in more than 140 markets, operates a large manufacturing network, and manages a globally integrated supply chain. This scale creates cost efficiencies, supports strong retail availability, and gives BAT the ability to invest in marketing, innovation, compliance, and product development at a level smaller competitors cannot easily match. In nicotine, distribution is particularly important because products must be consistently available across convenience stores, gas stations, supermarkets, specialist retailers, and digital channels where permitted. BAT’s long-standing relationships with retailers and distributors make it difficult for new entrants to replicate its market access. Regulation is also a major part of BAT’s moat. Tobacco and nicotine are among the most heavily regulated consumer categories in the world. Advertising restrictions, packaging rules, excise taxes, product approvals, age restrictions, and health regulations create a difficult operating environment. However, these same barriers also protect established companies. New competitors face significant hurdles when trying to build brands, gain distribution, comply with regulation, and achieve scale. BAT has decades of experience navigating complex regulatory systems across many countries, which gives it an advantage in both traditional tobacco and newer nicotine categories. This is especially important as Vapour, Heated Products, and Modern Oral products face increasing scrutiny from regulators. BAT’s scientific and product development capabilities also support its competitive position. As the company shifts toward smokeless products, it needs to prove product quality, safety standards, and reduced-risk potential compared with cigarettes, while recognizing that these products are not risk free and remain addictive. BAT invests in research, clinical studies, product testing, digital hubs, innovation centers, and external partnerships to strengthen its New Categories portfolio. This matters because the future of the nicotine industry will likely depend not only on brand and distribution, but also on product performance, consumer satisfaction, regulatory acceptance, and scientific credibility. The company’s cash generation is another key advantage. BAT’s legacy cigarette business continues to produce substantial cash flow, which gives the company the resources to invest in Vuse, glo, Velo, manufacturing capabilities, technology, acquisitions, and shareholder returns. This creates a self-funding transition model where the declining but highly profitable combustible business finances the growth of smokeless products. If BAT can successfully shift more of its revenue and profit toward New Categories while maintaining pricing power in combustibles, the company could remain highly cash generative for many years.
Management
Tadeu Marroco serves as the CEO of British American Tobacco, a role he assumed in May 2023 after more than three decades with the company. He joined BAT in 1992 and has since held a variety of leadership roles across finance, strategy, and regional operations. His educational background includes a degree in electrical engineering from the Universidade Federal do Rio de Janeiro and an MBA from both the COPPEAD Graduate School of Business in Brazil and ESSEC Business School in France. His long tenure within the organization has given him a deep understanding of BAT’s business, its global operations, and the evolving dynamics of the tobacco and nicotine industry. Throughout his career at BAT, Tadeu Marroco held several senior leadership positions across different geographies and functions. Before becoming CEO, he served as Chief Financial Officer, where he was responsible for overseeing the company’s financial strategy, capital allocation, and operational performance. During his tenure as CFO, BAT continued to generate strong cash flows while investing heavily in the development of its New Categories portfolio. His financial discipline and strategic oversight helped support the company’s efforts to strengthen its balance sheet, invest in innovation, and maintain attractive shareholder returns. Prior to serving as CFO, he also held leadership roles in regional operations and finance, giving him broad exposure to BAT’s markets, brands, and commercial activities around the world. Tadeu Marroco played a central role in shaping and executing BAT’s long-term transformation strategy. As one of the key architects behind the company’s “A Better Tomorrow” vision, he helped drive BAT’s transition from a traditional tobacco company toward a broader multi-category nicotine business. This strategy focuses on encouraging adult smokers who would otherwise continue smoking to switch to smokeless alternatives such as Vapour, Heated Products, and Modern Oral products. His involvement in developing this transformation agenda positioned him as a natural successor when he became CEO in 2023. Since assuming the role of CEO, Tadeu Marroco has focused on sharpening BAT’s strategic priorities and strengthening execution across the organization. When he took over leadership, he committed to refining the company’s strategy and accelerating progress toward its ambition of becoming a predominantly smokeless business by 2035. He has highlighted the importance of building a consistent track record of delivery across BAT’s key strategic pillars while ensuring that the company remains disciplined in how it allocates capital and invests for future growth. Under his leadership, BAT continues to expand its portfolio of reduced-risk products while maintaining the strong profitability and cash generation of its traditional tobacco business. A key element of Tadeu Marroco’s leadership philosophy is balancing transformation with financial performance. He has emphasized that BAT’s combustible portfolio remains a valuable source of cash flow that can fund investment in innovation, support debt reduction, and provide returns to shareholders. At the same time, he recognizes that the long-term success of the company depends on growing its smokeless categories and adapting to changing consumer preferences and regulatory environments. This dual focus reflects a pragmatic approach to managing a business that must simultaneously harvest a mature category while building new growth platforms for the future. Beyond strategy and financial performance, Tadeu Marroco has emphasized the importance of creating a more agile, consumer-focused, and accountable organization. He has spoken about the need to modernize BAT’s culture, accelerate decision-making, and strengthen collaboration across the company as it navigates a rapidly changing industry. His leadership style is often described as data-driven and execution-oriented, combining analytical rigor with a long-term perspective on value creation. Having spent more than thirty years inside the company, he possesses a deep understanding of both BAT’s strengths and the challenges facing the global nicotine industry. BAT has continued to make progress in expanding its New Categories business and advancing its transformation agenda under his leadership. His extensive experience across finance, strategy, and operations, combined with his central role in shaping BAT’s long-term vision, provides confidence that he understands both the opportunities and risks facing the company. Given his track record within the organization and his commitment to building a predominantly smokeless business while preserving the company’s strong cash-generating capabilities, Tadeu Marroco appears well positioned to guide British American Tobacco through its next phase of evolution.
The Numbers
The first number we will look into is the return on invested capital, also known as ROIC. We want to see a 10-year history, with all numbers exceeding 10% in each year. British American Tobacco’s ROIC has remained relatively modest for much of the past decade and has generally stayed below the level that I would ideally like to see. The most important reason is the acquisition of Reynolds American in 2017. The transaction gave BAT full ownership of one of the most attractive tobacco businesses in the world and significantly strengthened its position in the U.S. market, but it came at a very high price. BAT paid a substantial amount for the acquisition, which means the company has needed to generate much higher profits in order to achieve attractive returns. While the acquisition strengthened BAT strategically, it has weighed on ROIC ever since. Another factor has been the performance of the U.S. cigarette market. Some of the acquired cigarette brands have faced pressure from declining smoking rates, consumers trading down to cheaper alternatives, and the growth of illicit nicotine products. These challenges ultimately led BAT to significantly reduce the value it assigned to certain U.S. cigarette brands in 2023. While this did not affect cash flow, it reflected lower expectations for future earnings from parts of the acquired business and highlighted that BAT has not achieved the level of profitability originally anticipated when Reynolds American was acquired. BAT has also spent heavily on building its New Categories business, which includes Vuse, glo, and Velo. These investments have required substantial spending on research and development, manufacturing, regulatory approvals, marketing, and distribution. Such investments reduce returns in the short term because the costs come before the full benefits. This is particularly true for nicotine pouches, vaping products, and heated tobacco products, where BAT has been competing aggressively against established rivals while simultaneously navigating evolving regulatory requirements across multiple markets. Looking at the trend, there are some encouraging signs. ROIC has gradually improved from the low levels seen immediately after the Reynolds acquisition, rising from around 7% to 8% in the years following the deal to roughly 9% in recent years. This suggests that the company is slowly becoming more efficient while benefiting from debt reduction, cost savings, and improving profitability in its smokeless portfolio. Management has repeatedly emphasized stronger execution, capital discipline, and a sharper focus on profitable growth rather than growth at any cost. Looking ahead, I believe ROIC should gradually improve, although I do not expect it to reach the exceptionally high levels achieved by some of the best consumer companies. The key drivers will be continued debt reduction, growth in higher-margin smokeless products, and further scaling of BAT’s New Categories business. Modern Oral products such as Velo are already generating strong growth, and as these businesses mature, they should become increasingly profitable. At the same time, BAT’s traditional tobacco business continues to generate significant cash flow that can be used to reduce debt and return capital to shareholders. If management successfully executes its strategy of becoming a predominantly smokeless business by 2035 while maintaining the profitability of its cigarette portfolio, ROIC should continue its gradual upward trajectory over the coming years.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. To put it simply, equity is the part of the company that belongs to its shareholders – like the portion of a house you truly own after paying off part of the mortgage. Growing equity over time means the company is becoming more valuable for its owners. So, when we track book value plus dividends, we’re essentially looking at how much value is being built for shareholders year after year. British American Tobacco’s equity development has been unusual over the past decade. The most significant change occurred in 2017, when equity increased dramatically following the acquisition of Reynolds American. The acquisition transformed BAT into a much larger company and gave it full ownership of some of the most valuable tobacco brands in the United States. As a result, the company’s reported equity increased substantially. This explains the extraordinary growth seen in 2017 and why equity remained at a much higher level in the years that followed. Following the acquisition, equity remained relatively stable for several years. Although the tobacco industry continued to face volume declines in many markets, BAT generated strong profits and substantial cash flow, which helped support shareholder value. However, equity growth was limited because a large portion of the company’s cash flow was used to pay dividends and reduce debt rather than build equity on the balance sheet. This is not unusual for mature consumer businesses that generate more cash than they need to reinvest in their operations. The most notable decline occurred between 2022 and 2024. The primary reason was that BAT reduced the value assigned to several U.S. cigarette brands acquired through Reynolds American after concluding that their long-term prospects were weaker than previously expected. This reduced reported equity significantly and explains most of the decline seen during those years. While the reduction was substantial, it did not affect the company’s day-to-day operations or its ability to generate cash flow. Instead, it reflected a more cautious view of the future earnings potential of parts of the U.S. cigarette business. It is also important to remember that equity is often less informative for tobacco companies than for many other industries. BAT's value is largely derived from its brands, customer relationships, distribution network, regulatory expertise, and ability to generate cash flow. These strengths are not always fully reflected in the equity figure. As a result, changes in equity can sometimes paint a more negative picture than the underlying economics of the business would suggest. The small increase in 2025 is encouraging because it suggests that the period of large downward adjustments may be behind the company. At the same time, BAT continues to grow its smokeless portfolio through brands such as Vuse, glo, and Velo, while maintaining strong profitability in its traditional tobacco business. If these newer categories continue to grow and become a larger contributor to earnings, they should gradually help support shareholder value over time. Looking ahead, I do not expect equity to grow at a particularly fast rate. BAT generates significant cash flow and returns a large portion of it to shareholders through dividends, which naturally limits the amount retained within the business. However, I do expect equity to become more stable and gradually increase over time if management continues reducing debt, growing its smokeless products profitably, and avoiding further large downward revisions to the value of its acquired brands. For BAT, I believe cash flow generation, debt reduction, and earnings growth are more important indicators to monitor than equity growth alone, but the recent stabilization is nevertheless a positive sign.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. British American Tobacco has historically generated very strong free cash flow and high free cash flow margins. This is one of the most attractive characteristics of the business. Tobacco is a highly profitable industry with strong pricing power, relatively predictable demand, and limited investment requirements compared to many other consumer businesses. As a result, a large portion of the revenue generated by BAT ultimately turns into cash. Even though cigarette volumes have gradually declined in many markets, the company has generally been able to offset much of this decline through price increases, cost efficiencies, and a favorable product mix. This has allowed BAT to maintain strong profitability and cash generation over time. Another reason BAT generates substantial free cash flow is that the business does not require particularly large ongoing investments to operate. Cigarette manufacturing is a mature industry with an established production network that has been built over many decades. While BAT continues to invest in factories, technology, and product development, these investments are relatively modest compared to the cash generated by the business. In recent years, most of the company’s investment spending has been directed toward growing its New Categories portfolio, particularly nicotine pouches, vaping products, and heated tobacco products. Even with these investments, BAT has consistently converted a large share of its profits into free cash flow. The decline in free cash flow during 2025 was primarily driven by temporary factors rather than a deterioration in the underlying business. Management highlighted that cash generation was affected by a large upfront payment related to the Canadian litigation settlement as well as the fact that the prior year benefited from delayed tax payments in the United States. These factors created a difficult comparison with 2024 and reduced reported free cash flow during the year. In addition, BAT continued investing in its transformation strategy and increased spending to support the growth of its New Categories business, particularly within Modern Oral products. While these investments reduce free cash flow in the short term, they are intended to strengthen the company’s future growth prospects. Despite the decline in 2025, BAT’s free cash flow margin remained very strong by most industry standards. A margin above 20% means that a significant portion of every pound of revenue generated by the company is ultimately converted into cash that can be used for debt reduction, dividends, share repurchases, acquisitions, or reinvestment in the business. Few large consumer companies consistently generate free cash flow margins at this level. Looking ahead, I expect free cash flow to improve. Management has stated that the factors that negatively affected cash generation in 2025 were largely temporary and remains confident in the company’s long-term cash-generating ability. The company expects its traditional tobacco business to remain highly cash generative while its New Categories portfolio becomes an increasingly meaningful contributor to earnings. As products such as Velo, Vuse, and glo continue to scale, they should require less investment relative to the revenue and profits they generate, which could further support cash flow growth. Management also expects investment spending to remain at manageable levels while still providing sufficient resources to support growth in smokeless products. British American Tobacco uses its free cash flow in several ways. First, the company reinvests part of the cash into growing its New Categories business through product development, manufacturing capacity, regulatory approvals, and commercial expansion. Second, reducing debt remains an important priority. Management has repeatedly stated that it wants to continue strengthening the balance sheet and reduce leverage toward its target range. Third, BAT returns substantial amounts of cash to shareholders. The company has increased its dividend for more than 25 consecutive years and continues to view the dividend as a core part of its shareholder return strategy. In addition, BAT launched a sustainable share repurchase program in 2024 and has already increased the planned buyback from £700 million initially to £1.3 billion in 2026. Finally, management has indicated that selective acquisitions may be pursued when they can support the company’s transformation toward a predominantly smokeless business. While the free cash flow yield is lower than it has been in many previous years, this is largely a consequence of the temporary factors that weighed on free cash flow in 2025, including the Canadian litigation payment, the absence of prior-year tax benefits, and continued investment in the company’s transformation. If free cash flow improves as expected, the free cash flow yield should also become more attractive. However, we will revisit valuation later in the analysis.
Debt
Another important aspect to investigate is a company’s debt. We need to determine whether the business carries a manageable level of debt, ideally one that could be repaid within three years using current earnings. This can be assessed by calculating the ratio of long-term debt to earnings. In the case of British American Tobacco, the debt-to-earnings ratio stands at approximately 4,13 years, which is slightly higher than my preferred threshold. The elevated debt level is largely a result of the acquisition of Reynolds American in 2017, which significantly strengthened BAT’s position in the United States but also increased the company’s borrowings. Since then, management has made reducing debt a priority and has used a portion of the company’s substantial free cash flow to strengthen the balance sheet. Given BAT’s strong cash generation and the continued growth of its smokeless products, I do not view the debt as a major concern. Management has also indicated that it expects debt levels to continue declining and believes the company is on track to reach its desired debt range in the near future. If this happens, BAT will have greater financial flexibility to increase shareholder returns, invest in growth opportunities, and pursue selective acquisitions that support its long-term transformation.
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Risks
Regulation is a risk for British American Tobacco because the company operates in one of the most heavily regulated industries in the world. Governments and regulatory agencies can influence nearly every aspect of BAT’s business, including which products it can sell, how those products are manufactured, where they can be sold, how they are marketed, how they are packaged, and the amount of tax consumers must pay. Because BAT generates revenue across more than 140 markets, it must navigate a complex regulatory landscape where rules differ significantly from country to country and frequently become more restrictive over time. Changes in regulation can directly affect sales volumes, profitability, product launches, and long-term growth opportunities. In traditional tobacco products, regulation has become increasingly restrictive over the past several decades. Many countries have introduced measures such as graphic health warnings, plain packaging requirements, advertising bans, sponsorship restrictions, smoking bans in public places, and increasingly higher tobacco taxes. While BAT has generally been able to offset declining cigarette volumes through price increases, there is no guarantee this will continue indefinitely. Regulations that reduce the attractiveness of tobacco products or make them less affordable can accelerate volume declines and limit the company’s ability to differentiate its brands. Australia provides a good example of this risk. Years of aggressive tax increases and plain packaging regulations have contributed to a substantial increase in illicit tobacco consumption. Management estimates that a majority of tobacco consumed in Australia now comes from illegal sources, which has negatively affected BAT’s legal sales in what was once an important market. The regulatory environment for BAT’s New Categories business is even more uncertain. Products such as Vuse, glo, and Velo are central to the company’s long-term strategy of becoming a predominantly smokeless business by 2035. However, governments around the world have adopted very different approaches toward vaping products, heated tobacco products, and nicotine pouches. Some countries view these products as potential harm-reduction tools and allow their sale under regulated conditions, while others have introduced severe restrictions or outright bans. Several European countries have already restricted or prohibited nicotine pouches, while others are considering tighter nicotine limits that could make the products less attractive to consumers. As a result, BAT faces the risk that some of its most promising growth categories could be limited by future regulation. The United States represents a particularly important regulatory risk. The U.S. is BAT’s largest and most profitable market, but it is also one of the most heavily regulated. The Food and Drug Administration requires extensive review and approval processes before new nicotine products can be marketed. This creates uncertainty around product launches and future growth opportunities. There is also an ongoing risk that regulators could impose additional restrictions on nicotine levels, flavors, or menthol products. This is especially relevant because menthol products represent an important part of BAT’s U.S. business. Any future restrictions on menthol cigarettes could negatively affect volumes and profitability.
Changing consumer preferences is a risk for British American Tobacco because the company’s long-term success ultimately depends on adults choosing to consume nicotine products. While BAT has successfully navigated declining cigarette volumes for decades through pricing power, product innovation, and expansion into alternative nicotine categories, consumer preferences continue to evolve in ways that could reduce demand for both traditional and smokeless products. Unlike many consumer goods companies that can adapt to changing tastes by launching new products within the same category, BAT faces the challenge that some consumers may choose to avoid nicotine altogether. One of the most significant trends is the continued decline in smoking rates across many developed markets. Public awareness of the health risks associated with smoking has increased substantially over the past several decades, leading many consumers to quit smoking or avoid starting altogether. While BAT has responded by investing heavily in products such as Vuse, glo, and Velo, there is no guarantee that consumers who reject cigarettes will embrace alternative nicotine products. If fewer adults choose to consume nicotine in any form, BAT’s overall addressable market could gradually shrink over time. This challenge may be particularly relevant among younger generations. Many younger adults appear more health-conscious than previous generations and are often less willing to adopt habits that are perceived as harmful or addictive. Public health campaigns, educational programs, and greater access to information have increased awareness of the risks associated with nicotine consumption. At the same time, social attitudes toward smoking have changed considerably. In many countries, smoking is no longer viewed as socially desirable, and similar perceptions could eventually extend to newer nicotine products. If younger consumers continue to avoid nicotine altogether, BAT may find it more difficult to replace older consumers who leave the category. Consumer preferences within nicotine products are also evolving rapidly. BAT’s strategy depends heavily on its ability to attract consumers to smokeless alternatives such as vaping products, heated tobacco devices, and nicotine pouches. However, consumer tastes can change quickly, and there is no certainty that BAT’s products will remain competitive. New technologies, product formats, or brands introduced by competitors may prove more appealing to consumers. For example, nicotine pouches have grown rapidly in popularity in recent years, while some vaping categories have experienced slower growth or regulatory disruption. If BAT fails to anticipate shifts in consumer preferences or bring attractive products to market, it could lose market share in categories that are expected to drive future growth. Another risk is that consumers increasingly prioritize wellness, natural products, and healthier lifestyles. This trend has influenced many consumer industries, including food, beverages, alcohol, and tobacco. As more consumers focus on physical and mental well-being, nicotine products may face additional headwinds regardless of whether they are combustible or smokeless. Even products that are considered reduced-risk alternatives compared to cigarettes still contain nicotine, which may limit their appeal among consumers seeking healthier lifestyles. Finally, changing consumer preferences create uncertainty around BAT’s long-term transformation strategy. The company’s goal is to become a predominantly smokeless business by 2035, and this strategy assumes that a meaningful number of adult consumers will continue to choose nicotine products while switching away from cigarettes. If consumer preferences evolve in a way that reduces overall nicotine consumption rather than simply shifting consumption between product categories, the growth potential of BAT’s New Categories business could be lower than management currently expects.
Illicit products are a major risk for British American Tobacco because they create unfair competition, reduce legal industry volumes, and undermine the company’s ability to earn attractive returns on the significant investments it makes in compliance, product development, and brand building. BAT operates in highly regulated markets where its products must comply with strict requirements related to ingredients, packaging, health warnings, taxation, product approvals, and marketing. Illegal manufacturers and distributors often ignore these requirements entirely, allowing them to offer products that are cheaper, more accessible, or more appealing to consumers than those sold through legal channels. The problem has become particularly severe in the Vapour category. BAT’s Vuse brand is one of the leading vaping brands in the world and is a key part of the company’s strategy to transition toward a predominantly smokeless business. However, management has repeatedly highlighted that the category continues to be negatively affected by illegal products, particularly in the United States and Canada. Many illicit vaping products enter the market without regulatory approval, often offering flavors, nicotine strengths, or product formats that legal manufacturers cannot provide. Because these products avoid many of the costs associated with compliance and regulation, they can often be sold at lower prices while still generating attractive profits for illegal operators. This makes it more difficult for BAT to compete despite investing heavily in developing legal and compliant alternatives. The issue is especially frustrating for BAT because the company has spent significant resources obtaining regulatory approvals and complying with government requirements. In the United States, for example, the Food and Drug Administration requires extensive product reviews before nicotine products can be legally marketed. BAT must invest heavily in scientific research, product testing, and regulatory submissions, while many illicit competitors simply bypass these requirements. As a result, legal companies bear the costs of regulation while illegal operators often enjoy many of the commercial benefits. Illicit products can also slow the growth of BAT’s New Categories business. Management has noted that weaker-than-expected growth in Vapour was one of the main reasons New Categories did not achieve the level of growth originally targeted in 2025. Since products such as Vuse, Velo, and glo are central to BAT’s long-term transformation strategy, any factor that limits adoption of legal smokeless products represents a meaningful risk. If illegal products continue gaining market share, BAT may struggle to generate the returns it expects from years of investment in these categories. Illicit products also create reputational risks. Counterfeit or unregulated nicotine products may be poorly manufactured, contain unsafe ingredients, or fail to meet quality standards. If consumers have negative experiences with such products, it can damage perceptions of the broader nicotine category. This is particularly important for BAT’s reduced-risk products because the company’s long-term strategy depends on convincing adult consumers, regulators, and policymakers that legal smokeless products can play a role in reducing smoking rates. A market flooded with low-quality or illegal products can undermine this objective and potentially lead to even stricter regulation.
Reasons to invest
The combustible tobacco portfolio is a reason to invest in British American Tobacco because it remains the foundation of the company’s profitability, cash generation, and shareholder returns. While much attention is focused on BAT’s transition toward smokeless products, cigarettes continue to generate the vast majority of the company’s revenue and profits. In 2025, combustible products accounted for almost 80% of revenue and delivered both revenue and profit growth despite ongoing volume declines. This demonstrates the resilience of the business and highlights why the combustible portfolio remains such a valuable asset. The cash generated by cigarettes funds dividends, debt reduction, share buybacks, and investment in BAT’s New Categories portfolio, making the traditional tobacco business a critical enabler of the company’s long-term transformation. One of the most attractive characteristics of the combustible portfolio is its pricing power. Cigarettes are highly profitable products with relatively inelastic demand, meaning that many consumers continue purchasing them even after price increases. BAT has consistently demonstrated its ability to raise prices across markets and offset falling volumes through favorable price and product mix. In 2025, combustible revenue increased despite lower industry volumes, reflecting the strength of this pricing power. Management has also noted that price sensitivity in key markets such as the United States remains relatively benign, allowing the company to continue increasing prices while maintaining profitability. Another reason the combustible portfolio remains attractive is the industry structure. Tobacco is one of the most difficult industries for new competitors to enter. Strict regulations, advertising restrictions, health warnings, product approvals, and taxation create significant barriers to entry. While these regulations can be a challenge, they also protect established companies by making it extremely difficult for new brands to gain scale or build consumer awareness. As a result, the global cigarette market is dominated by a handful of large players, and BAT owns some of the industry's most recognized brands, including Lucky Strike, Dunhill, Kent, Pall Mall, Newport, Camel, and Natural American Spirit. These brands have often been built over decades and continue to enjoy strong consumer loyalty. The United States is particularly important to the investment case. Following the acquisition of Reynolds American, BAT gained full ownership of Newport, one of the strongest cigarette brands in the country. Management highlighted that the U.S. combustible business returned to revenue and profit growth in 2025 for the first time since 2022. Revenue increased by more than 4%, supported by stronger execution, pricing, and an improved brand portfolio. The company also gained market share in value terms, suggesting that its portfolio remains highly competitive despite industry-wide volume declines. Given that the U.S. is BAT’s largest profit pool, continued resilience in this market is especially important for shareholders. Another attractive aspect of the combustible portfolio is its broad geographic footprint. BAT operates across both developed and emerging markets, reducing its dependence on any single country. In addition to strong performance in the United States, management highlighted robust combustible growth in markets such as Brazil, Turkey, and Mexico. This geographic diversification helps offset weakness in individual markets and provides exposure to countries where smoking rates remain relatively stable compared to many Western economies. Perhaps most importantly, the combustible portfolio provides BAT with something many companies undergoing transformation lack: a highly profitable and cash-generative legacy business. While BAT invests heavily in Vuse, Velo, and glo, it does not need to rely on external financing to fund these initiatives. Instead, the company can use the cash generated by cigarettes to support innovation, reduce debt, repurchase shares, and grow its dividend. This self-funding model significantly reduces execution risk compared to businesses that must sacrifice profitability to invest in future growth opportunities.
The New Categories segment is a reason to invest in British American Tobacco because it represents the company’s primary growth engine and provides a pathway for long-term growth beyond traditional cigarettes. While the combustible tobacco business continues to generate the majority of BAT’s profits and cash flow, cigarette volumes are gradually declining in most markets. The New Categories portfolio, which includes Vuse, glo, and Velo, is designed to offset this decline by attracting adult consumers to alternative nicotine products. The success of this strategy is becoming increasingly visible, as BAT added 4,7 million smokeless consumers in 2025, bringing its total smokeless consumer base to more than 34 million. This was the strongest annual increase in the company’s history and demonstrates growing consumer acceptance of BAT’s alternative nicotine products. One of the most attractive aspects of the New Categories business is that it is becoming increasingly profitable. For many years, BAT invested heavily in product development, manufacturing, marketing, and regulatory approvals, which weighed on profitability. However, as the business has scaled, profitability has improved significantly. Management highlighted that New Categories generated over £440 million in category contribution in 2025 and that profitability has improved substantially since 2021. This is important because it demonstrates that BAT is no longer simply investing for growth but is increasingly converting that growth into meaningful profits. As the business continues to scale, additional growth should become more profitable because fixed costs can be spread across a larger consumer base. The strongest growth driver within New Categories is currently Modern Oral products, particularly the Velo brand. Modern Oral products are nicotine pouches that are placed under the lip and do not require smoking, vaping, or heating. This category has been growing rapidly around the world because it offers consumers a discreet, convenient, and potentially lower-risk alternative to cigarettes. BAT’s Velo brand has established itself as a leading player in this category and is now the global volume share leader across the largest Modern Oral markets. In Europe, Velo’s volume is approximately six times larger than its nearest competitor, demonstrating the strength of the brand and BAT’s distribution capabilities. The United States represents an especially compelling opportunity. The launch of Velo Plus has been one of the most successful product introductions in BAT’s recent history. Within a short period, Velo Plus became the second-largest Modern Oral brand in the U.S. market and captured a significant portion of industry growth. Management highlighted that Velo Plus generated more than 300% revenue growth in 2025 and maintained consumer retention rates of around 70%, which suggests that consumers who try the product are highly likely to continue using it. The company also believes that awareness of the brand remains relatively low, creating additional opportunities for future growth as distribution expands and marketing efforts continue. Another reason to be optimistic about Modern Oral products is the overall growth potential of the category. In the United States, the Modern Oral market has already become larger than the legal Vapour market and continues to grow rapidly. At the same time, BAT believes usage rates remain low compared to more mature markets such as Scandinavia, suggesting there is still significant room for expansion. Management also highlighted strong growth in countries without a traditional history of oral nicotine consumption, including the United Kingdom, Pakistan, South Africa, Kenya, and Poland. This suggests that the category may have much broader global appeal than initially expected. Beyond Modern Oral, BAT also has opportunities in Heated Products and Vapour. While Vapour growth has recently been impacted by illicit competition, Vuse remains one of the leading vaping brands globally and returned to revenue growth in the second half of 2025 as enforcement actions against illegal products increased. If regulators continue to improve enforcement, BAT could benefit from a more level playing field that allows legal products such as Vuse to compete more effectively. Heated Products also represent a substantial opportunity. Management estimates that the category generates roughly £9 billion in industry revenue globally, while BAT currently holds only a relatively small share of that market. This creates significant room for future expansion if the company can continue improving its product offering and gaining market share.
Innovation is a reason to invest in British American Tobacco because it is essential to the company’s long-term transformation from a traditional cigarette manufacturer into a broader nicotine business. While the combustible tobacco portfolio continues to generate the majority of BAT’s profits, management recognizes that long-term growth will increasingly come from smokeless alternatives. As a result, the company has spent the past several years building a more focused, consumer-led innovation platform designed to improve product satisfaction, strengthen brand loyalty, and increase profitability across its New Categories portfolio. Rather than simply launching new products for the sake of innovation, BAT is increasingly focused on developing premium products that offer clear advantages to consumers and can generate attractive returns on investment. One of the most exciting areas of innovation is Modern Oral products, where BAT’s Velo brand has established a leadership position in many markets. The company continues to refine the consumer experience through new product launches such as Velo Shift. This product introduces a redesigned pouch, new sensory experiences, and differentiated packaging intended to improve comfort and usability. Early results have been encouraging, with Velo Shift already helping BAT gain additional market share in the channels where it has been introduced. Because Modern Oral remains one of the fastest-growing nicotine categories globally, continued product innovation could help BAT strengthen its leadership position and capture a larger share of future growth. Innovation is equally important in Vapour products. BAT views premium vaping devices as an attractive opportunity because consumers are increasingly seeking higher-quality products that offer a better overall experience. Vuse Ultra, the company’s newest premium Vapour platform, represents its most advanced vaping device to date. Early market results have been encouraging, with meaningful market share gains reported in countries such as Canada, Germany, and France. These gains suggest that BAT’s investments in product development are resonating with consumers. If Vuse Ultra continues to gain traction, it could strengthen BAT’s competitive position in a category that remains one of the largest opportunities within reduced-risk nicotine products. The company is also investing heavily in innovation within Heated Products through its glo platform. Historically, BAT has been a smaller player in Heated Products compared to some competitors, which means there is significant room for growth if the company can improve its product offering. The introduction of glo Hilo is particularly important because it marks BAT’s first major attempt to compete more aggressively in the premium segment of the Heated Products market. The device incorporates advanced heating technology, a premium design, and a more sophisticated user experience. Early launches in markets such as Japan, Poland, and Italy have produced encouraging results, including attracting consumers from both premium cigarette brands and competing heated tobacco products. This suggests that BAT may be able to expand its presence in a category that already generates billions of pounds in annual industry revenue. Another attractive aspect of BAT’s innovation strategy is its focus on improving profitability rather than simply pursuing volume growth. Management has repeatedly emphasized a disciplined approach to innovation, concentrating investments in markets where regulatory frameworks are supportive and where the company sees the strongest potential returns. This approach has already contributed to a significant improvement in profitability within New Categories. As products such as Velo, Vuse, and glo become more successful, BAT benefits from greater scale, which allows innovation investments to generate higher returns over time. Importantly, BAT’s innovation efforts are supported by the company’s strong cash generation. The combustible tobacco portfolio provides the financial resources needed to invest in research, product development, manufacturing capacity, regulatory approvals, and commercial launches without sacrificing profitability or shareholder returns. This allows BAT to continuously improve its product portfolio while maintaining dividends, reducing debt, and repurchasing shares. Few companies undergoing such a significant business transformation have the advantage of being able to self-fund their innovation efforts.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 4.71, which is from the year 2025. I have selected a projected future EPS growth rate of 5%. Finbox expects EPS to grow by 5% in the next five years. Additionally, I have selected a projected future P/E ratio of 10, which is double the growth rate. This decision is based on British American Tobacco's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $18,96. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy British American Tobacco at a price of $9,48 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 8.549, and capital expenditures were 743. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 520 in our calculations. The tax provision was 2.823. We have 2.172 outstanding shares. Hence, the calculation will be as follows: (8.549 – 520 + 2.823) / 2.172 x 10 = $49,96 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With British American Tobacco's free cash flow per share at $3,59 and a growth rate of 5%, if you want to recoup your investment in 8 years, the Payback Time price is $36,00.
Conclusion
I believe that British American Tobacco is an intriguing company with great management. The company has built its moat through its brand strength, scale, distribution network, regulatory expertise, and strong cash generation. ROIC has been relatively low over the past nine years, primarily due to the acquisition of Reynolds American, but I expect returns to improve as the company continues reducing debt and growing its higher-return smokeless categories. Free cash flow declined in 2025, but this was largely due to a significant upfront payment related to the Canadian litigation settlement and the fact that the prior year benefited from delayed tax payments in the United States. As these factors are not expected to recur, free cash flow should improve moving forward. Regulation remains a key risk because governments can influence nearly every aspect of the business, including product approvals, marketing, packaging, taxation, and sales. Increasingly restrictive regulations on both cigarettes and smokeless products such as Vuse, glo, and Velo could reduce demand, limit growth opportunities, delay product launches, and negatively affect profitability, particularly in important markets such as the United States. Changing consumer preferences also represent a risk because fewer people, particularly younger generations, may choose to use nicotine products at all, reducing the company's potential customer base over time. In addition, BAT's long-term growth strategy depends on consumers switching from cigarettes to products such as Vuse, glo, and Velo, but there is no guarantee these alternatives will remain attractive as consumer preferences continue to evolve toward healthier lifestyles and new product formats. Illicit products are another risk because illegal manufacturers can bypass regulations, taxes, and product approval requirements, allowing them to sell cheaper and often more attractive products than legal competitors. This is particularly problematic in the Vapour category, where illicit products have slowed the growth of Vuse and BAT's broader New Categories strategy while also creating reputational risks and reducing the effectiveness of investments in innovation and regulatory compliance. The combustible tobacco portfolio remains an important reason to invest because it continues to be the company's largest source of revenue, profits, and cash flow, providing the financial foundation for dividends, share buybacks, debt reduction, and investment in future growth. Despite declining industry volumes, BAT benefits from strong pricing power, globally recognized brands, and high barriers to entry that support profitability and cash generation. The New Categories segment is another compelling reason to invest because it serves as the company's primary growth engine, helping offset declining cigarette volumes through products such as Vuse, glo, and Velo. The business is rapidly growing its smokeless consumer base, improving profitability, and holds leading positions in attractive categories such as nicotine pouches, giving BAT a clear pathway to long-term growth beyond traditional tobacco. Innovation further strengthens the investment case by supporting BAT's transition toward faster-growing smokeless categories while improving its competitive position. Through products such as Velo Shift, Vuse Ultra, and glo Hilo, the company is developing more differentiated and premium offerings that improve consumer satisfaction, drive market share gains, and create new growth opportunities across nicotine pouches, vaping, and heated tobacco. While there are many things to like about British American Tobacco, I believe there are better opportunities available in the market. Therefore, I will not be investing in British American Tobacco at this time.
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