Buy British American Tobacco stock at significant discount

A “compelling entry point” for British American Tobacco (LSE:BATS) shares has been flagged by a City bank after it said the door appeared open to significant shareholder cash returns.

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Jefferies sees upside to 5,500p, which compares with today's level of 4,198p after a sharp fall for shares since they set an eight-year high of 4,962p in May this year.

The bank highlights a positive inflection point where investment in next generation products such as vapes and heated tobacco translates into a multi-year revenue and profit tailwind.

Scale benefits, continued cost discipline and a steadier combustibles business also support the investment case, alongside BAT's much improved balance sheet.

A long road of deleveraging has cut the debt ratio from five times earnings at the time of 2017's transformative Reynolds acquisition to the top of BAT's target corridor of 2.0-2.5 times in 2026.

Jefferies said this opened the door to a potential increase in shareholder cash returns that would further boost earnings per share growth towards the top-end of the 5-8% growth range.

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BAT is due to update investors on its strategy on 29 September, when the company behind the brands Dunhill, Lucky Strike and Vuse hosts a capital markets day in California.

The 5.9% yielding income stock boasts a record of dividend growth going back to 2000.

Based on a long-running policy of targeting 65% of long-term sustainable earnings, this record included growth of 2% in the most recent financial year to a total of 245.04p.

It has returned £34 billion to shareholders over the last six years, including £1.8 billion of share buybacks since 2024 and with a further £1.3 billion of repurchases committed for 2026.

However, the shares and those of Imperial Brands (LSE:IMB) have come under pressure after the recent spike in government bond yields diminished the appeal of higher-yielding defensive stocks such as those in the tobacco sector.

In its note published on Friday, Jefferies said BAT appears attractively valued at a significant discount relative to peer Philip Morris.

The bank said BAT's next generation products were well-invested propositions with ample scale in the key US market, with the potential to drive about 50% of top-line growth medium-term.

It backs Velo to become the US nicotine pouch value share leader by 2030, which could unlock £1.3 billion of incremental profits.

Meanwhile, the US combustibles business appears to be on a steadier footing after growing revenues by 2.1% in July's half-year results.

Jefferies expects US combustibles top-line growth of between 0.5% and 1% from next year, reflecting 18-24 months of portfolio investment and the robust market shares of American Spirit and more affordable brand Pall Mall.

The City firm concluded: “Our sum-of-the-parts model suggests the next generation business is attractively valued, and we see this as a compelling entry point for the shares.”

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Deutsche Bank, meanwhile, sees upside for shares to a target price of 5,100p.

Having faced a number of external and internal challenges in the past three years, the bank said the business now looks better positioned to drive an acceleration in growth.

It added last week: “Externally the major litigations are in the rear view mirror, and there is a more supportive regulatory framework emerging across major markets.

“Internally, there has been a focus on transitioning to a more consumer centric, data driven business which leverages technological developments to accelerate growth.”