British American Tobacco: A Bullish Turnaround Driven by New Categories and Margin Power

British American Tobacco (BAT) has long been synonymous with combustible cigarettes, but its FY25 guidance upgrade signals a decisive pivot toward a future dominated by high-margin, innovative nicotine products. The company's strategic focus on Modern Oral (Velo Plus) and premium Vapour (Vuse Ultra) is unlocking growth amid a declining combustible market, while its deleveraging trajectory and shareholder-friendly capital allocation are setting the stage for a valuation recovery by 2026. Here's why investors should take notice now.

The New Categories Revolution: Growth Catalysts in Focus
BAT's New Categories—Modern Oral, Vapour, and Heated Products—are the engine of its future. The Modern Oral segment, led by Velo Plus, is surging. In the U.S., Velo Plus has driven a triple-digit revenue growth, capturing an 11.9% volume share of Modern Oral—a category BAT is dominating with a 29.7% global share in key markets. This product's success is no fluke: it combines strong trial rates with superior retention, positioning BAT to capitalize on the $15 billion U.S. Modern Oral opportunity.

Meanwhile, Vuse Ultra, the premium Vapour product launching in H2 2025, is a game-changer. Illicit single-use vapes have battered Vuse's performance, but Ultra's premium positioning and targeted marketing are designed to counter this. By focusing on high-profit segments, BAT aims to reverse Vapour's mid-teens revenue decline in the U.S. and Canada by year-end. The company's Quality Growth strategy—prioritizing profitability over volume—ensures that every dollar invested here counts.

Margin Expansion: The Silent Profit Machine
BAT's margin story is underappreciated. The company is aggressively cutting costs, with £1.2 billion in cumulative savings by 2025 and an additional £2 billion through 2030. This, combined with the shift to higher-margin New Categories, is already paying off. In 2024, Modern Oral's contribution margin improved by 7.1 percentage points, and the trend is accelerating.

The math is straightforward: every 1% increase in New Categories' revenue mix boosts EBITDA margins by 0.5-1.0 percentage points. With New Categories now accounting for 28% of revenue and growing at mid-single-digit rates, BAT's adjusted EBITDA margin is primed to expand from 42% in 2024 to 45%+ by 2026. This margin power is the unsung hero of BAT's valuation turnaround.

Deleveraging and Shareholder Returns: A Strong Balance Sheet Ahead
BAT's financial discipline is another pillar of its comeback. The company aims to slash its net debt/EBITDA ratio to 2.0-2.5x by 2026, down from 2.44x in 2024. This deleveraging isn't just about safety—it's about fueling shareholder returns.

BAT has already announced a £1.1 billion share buyback for 2025, up from £900 million, and plans to grow its dividend in sterling terms. With £8 billion+ in average annual free cash flow (excluding one-off items), the company has the firepower to reward investors while maintaining a fortress balance sheet.

Risks? Yes. Mitigated? Absolutely.
Critics will point to headwinds: Bangladesh's excise hikes, Australia's regulations, and U.S. illicit competition. But BAT isn't just enduring these—it's outmaneuvering them. The Vuse Ultra rollout is a direct counter to illicit vapes, while Modern Oral's global expansion (e.g., EU Snus market access) opens new doors. Cost savings offset inflation, and the second-half weighted performance (due to delayed innovations) means FY25's results are set to accelerate.

The Bullish Case: Valuation Recovery in 2026
BAT trades at a 2025 EV/EBITDA multiple of 10.5x, near historic lows. But as margins expand and leverage declines, the multiple should rebound. By 2026, with 4-6% EBITDA growth and a deleveraged balance sheet, BAT's valuation could rise to 12-13x EV/EBITDA, implying a 20-30% upside from current levels.

This isn't just a recovery—it's a reset. BAT is transforming from a combustible relic to a modern nicotine innovator, with a capital return policy that rewards long-term holders.

Invest Now, Reap in 2026
The catalysts are clear: Velo Plus and Vuse Ultra are driving top-line growth, margins are expanding, and the balance sheet is strengthening. With a shareholder-friendly capital allocation strategy and a path to mid-term targets, BAT is primed for a valuation re-rating.

For income-focused investors, the dividend yield of 5.5% is a compelling entry point. For growth investors, the 2026 margin and EBITDA targets offer asymmetric upside. Either way, BAT's FY25 guidance upgrade isn't just a bump in the road—it's a turning point.

Final Call: Buy BAT for 2026's Margin Power and Multiple Expansion
The writing is on the wall: BAT's New Categories are winning, its costs are under control, and its balance sheet is getting leaner. The stock is priced for pessimism. With 2026's targets in sight, now is the time to position for the turnaround.

This analysis is for informational purposes only. Consult a financial advisor before making investment decisions.