British American Tobacco on track as next-gen forecasts upgraded

This half-year update confirms both the perils and yet the robust profitability of the tobacco industry, as British American Tobacco (LSE:BATS) continues to weave between the hurdles which it faces.

• Our Services: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

On the one hand, the pressure on traditional tobacco products has been in evidence for some considerable time, driven both by changing lifestyle habits as well as increasing regulation. There have been several instances of governments toughening their stance on tobacco sales, especially to youngsters, which adds to the burden of regulatory censure which has plagued the sector over recent years. In addition, and quite apart from this general decline in traditional tobacco products sales as health issues come to the fore, there is a reluctance among some investors to invest in the sector at all on ethical grounds.

For BATS, these issues are in sharp focus. The group previously announced a provision of £6.2 billion to settle legal claims in Canada, some of which has now been released, positively distorting the profit number. The agreement will remain a drag on profitability since it is ongoing, with the balance of the settlement to be paid from future tobacco profits in Canada.

• 10 hottest ISA shares, funds and trusts
• Insider: bosses buy low at this City top pick

Even so, whether this is the thin end of the wedge remains to be seen, and the ruling is in addition to the likes of Australia and Bangladesh, where regulatory headwinds and significant excise increases have hampered performance. Elsewhere, the sale of illicit vapour products in the US has already crimped profits in this major market, although BATS is hopeful that the early signs of Federal and State enforcement will mitigate this issue in due course.

More positively, BATS remains a cash generating machine, and adjusted pre-tax profit for the half-year is expected to be £4.76 billion. In terms of tobacco broadly, there is inelastic demand whereby consumption persists despite price rises, economic burdens and associated health risks. For the year as a whole, the group’s significant revenues should enable the completion of a £1.3 billion share buyback programme, a progressive dividend policy where the current yield of 5.4% is punchy by any standards and a reduction of the net debt to a range with which the group is comfortable.

• Aviva shares tipped to boom and dividend grow
• Stockwatch: should Taylor Wimpey shares be in your portfolio?

Nonetheless, the likely need for a long-term replacement for traditional combustible products has left the tobacco majors needing to move from a standing start, and after some years of development the New Categories business is showing some meaningful progress. It may take some time until these units are sustainably profitable, but the group is quick to highlight the strength of Modern Oral and Vapour, for example, where revenue growth is expected to be in the mid-teens percentage range, for both the half and full year, which is a slight upgrade to its previous forecast.

At the last count, such products accounted for 18.2% of overall revenues, with an ultimate target of 50% as the group aims to become a predominantly “smokeless” business by 2035. In the meantime, the group’s largest market in the US has grown strongly in traditional tobacco products as well as Vapour and Modern Oral, skewed to the first half after which strong second-half comparatives will come into view.  

BATS has also maintained its forecast for the year as a whole, for which it is firmly on track. Revenues are expected to grow within a range of 3% to 5%, leading to a jump in adjusted profit of between 4% and 6%. This comes against global tobacco industry volumes being expected to fall by 2.5% this year.

• FTSE 100 ex-dividend dates: June 2026
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

The tides of turbulence show no signs of abating but nor, for the moment at least, does the group’s prodigious cash generation. The level of competition is increasing which has led to some disappointment at the open, but investors have been handsomely rewarded of late for their patience, notwithstanding that the price remains some 17% shy of the record 2017 levels.

Shares have risen by 37% over the last year, as compared to an increase of 17.8% for the wider FTSE100, and by 90% over the last two years. The group is recording profits which enable a generous shareholder return focus, reduction of debt and investment in transitioning the company. A slightly stretched valuation does little to upset prospects, with the market consensus of the shares as a buy reflecting ongoing optimism that the group can continue to flourish in a new world.