Canada remains drag on BAT profitability

A smartphone shows the logo of British American Tobacco. Photo: Cheng Xin/Getty Images.

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.

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

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 to invest in the sector at all on ethical grounds.

For British American Tobacco (LSE:BATS), these issues are in sharp focus. The group previously announced a provision of £6.2 billion to settle legal claims in Canada, which resulted in a sharp share price decline on the day and remains a drag on overall profitability. 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. BATS’ leverage is also uncomfortably high, where the group plans to restore its preferred lower range next year.

Despite these hurdles, BATS has reaffirmed its guidance for the year, with revenue and adjusted operating profit expected to grow by 2%, and in the medium term in a range of 3% to 5% for revenue and 4% to 6% for adjusted operating profit. The group previously advised that the most meaningful growth this year would likely to be weighted towards this second half, as the group planned new category innovation in key markets, in what would be something of an echo to last year’s performance. Indeed, New Category revenue is expected to have grown by double digits in the second half, taking growth for the full year to a mid-single digit number.

• 10 hottest ISA shares, funds and trusts: week ended 5 December 2025
• City of London: the stocks powering our dividend growth
• A cheap way to play Elon Musk’s big idea

These are promising signs. The need for a long-term replacement for traditional combustible products has left the tobacco majors needing to move from a standing start, and even after some years of development the unit this has yet to make a meaningful contribution to profits. There has undoubtedly been some progress and at the latest count smokeless products accounted for 17.5% of overall revenues last year, with an ultimate target of 50% as the group aims to become a predominantly “smokeless” business by 2035.

The successful launch of Velo Plus in the US should also be large contributor to the region returning to revenue and profit growth for the year. Indeed, the US market as a whole has regained positive momentum which is a major driver, and overall this comes against global tobacco industry volumes being expected to fall by 2% this year.

The group remains a cash-generation machine and the announcement of a £1.3 billion share buyback programme will both please investors and, all things being equal, underpin the share price. This is in addition to the group’s progressive dividend policy, where the current yield of 5.6% is punchy by any standards and is adequately covered.

• Insider: heavy director share buying at these four companies
• Fund Focus: the overlooked trap some investors fall into
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

Set against these tides of turbulence, investors have been handsomely rewarded of late for their patience, notwithstanding that the price remains some 20% shy of the record 2017 levels. The shares have risen by 45% over the last year, as compared to an increase of 15.5% for the wider FTSE100, and by 86% over the last two years.

The group is continuing to record high cash generation, which enables a generous shareholder return focus, reduction of debt and investment in transitioning the company. A slightly stretched valuation and an element of profit taking may have taken some of the shine from the update, but the market consensus of the shares as a buy reflects ongoing optimism that the group can continue to flourish.