British American Tobacco: Lighting Up the Future with Reduced-Risk Innovation Amid Regulatory Challenges

British American Tobacco (BATS:NYSE) is undergoing a strategic metamorphosis, shifting from its historic reliance on combustible cigarettes to a future dominated by reduced-risk products (RRPs). The company's FY2024 results, released in late June 2025, reveal a dual-engine strategy: leveraging pricing power and operational discipline in its core cigarette business while aggressively scaling its “New Categories” of smokeless alternatives. This pivot positions BAT to capitalize on global trends toward harm reduction, even as it navigates headwinds like litigation risks, illicit competition, and regulatory uncertainty. For investors, the question is whether BAT's execution can translate into a compelling long-term return. Here's why the answer is a resounding YES, with a BUY rating and a 3-year upside target of 41%.

The Near-Term: Cigarette Resilience and Pricing Power

BAT's combustibles business remains a cash cow, even as global volumes decline. In FY2024, organic combustibles revenue grew 0.1% (at constant rates), with pricing/mix gains of 5.3% offsetting a 5.2% volume drop. This pricing power is critical: in the U.S., where combustibles volume fell 10.1%, BAT stabilized share in the latter half of the year through aggressive promotions and inventory management. Meanwhile, emerging markets like Africa, Middle East, and Eastern Europe (AME) and Asia-Pacific, Middle East, and Africa (APMEA) posted volume and value share gains, demonstrating BAT's ability to navigate regional differences.

The company's cost discipline is equally impressive. Despite £387 million in cost inflation (driven by leaf prices and manufacturing), £402 million in savings helped deliver a 1.4% rise in adjusted organic profit. With plans to hit £1.2 billion in cumulative savings by 2025 and £2 billion by 2030, BAT is proving it can manage costs even as it invests in growth.

The Long-Term: New Categories Are the Growth Engine

BAT's ambition to become a “predominantly smokeless business by 2035” is gaining traction. In FY2024, New Categories (including heated tobacco, vapour, and Modern Oral products) contributed 17.5% of total revenue, up from 14.5% in FY2023. More importantly, their contribution margin improved by 7.1 percentage points to 7.1%, signaling maturation.

• Vapour (Vuse): Maintained a 40.3% value share in key markets, though U.S. sales were dented by illicit single-use vapes. BAT's response? Innovation. In Louisiana, post-regulatory enforcement, Vuse sales rebounded, proving the power of product differentiation.
• Heated Products (glo): New products like glo Hyper Pro and non-tobacco veo consumables drove volume share gains in Italy and Japan. Poland and the Czech Republic also saw strong adoption.
• Modern Oral (Velo): The star performer. Velo's global volume share rose to 11.2%, with a 28.2% share in the Modern Oral category. The U.S. alone gained 180 basis points after launching Velo Plus, a high-nicotine variant with expanded flavors.

Crucially, APMEA is a growth hotspot. New Category revenue in the region surged nearly 9% (organic constant currency), driven by South Korea, New Zealand, and Japan. Modern Oral's expansion here is particularly promising, as APMEA's emerging markets lack the regulatory overhang seen in Western markets.

Risks: Litigation, Illicit Markets, and Regulatory Headwinds

BAT isn't without risks. The Canadian CCAA settlement, which could cost up to £6.2 billion, remains unresolved. While BAT is optimistic about a favorable outcome, the uncertainty drags on. Meanwhile, illicit products—especially in the U.S. and Canada—are eroding margins. BAT's response? Pushing for stricter enforcement and doubling down on innovation to outcompete counterfeiters.

Regulatory hurdles also loom. Bangladesh's excise hikes and Australia's new tobacco regulations threaten combustibles sales. BAT's plan? Focus on high-margin alternatives. In Australia, for instance, Modern Oral sales grew despite regulatory shifts.

The Investment Case: 7% Dividend Yield + 41% Upside Over Three Years

BAT's 7.2% dividend yield (as of July 2025) is a standout in a low-yield world. The company has returned £28 billion to shareholders via dividends and buybacks over five years, and a £900 million buyback is planned for 2025. With a free cash flow of £7.9 billion and a debt-to-EBITDA ratio of 2.44x (well within its 2.0–2.5x target), BAT has the balance sheet to sustain payouts and invest in growth.

Looking ahead, BAT's mid-term targets—3–5% revenue growth and 4–6% profit growth by 2026—are achievable. With New Categories hitting 17.5% of revenue already, the path to 50% by 2035 is clear. Our 3-year price target of £45 (vs. £31.90 as of July 2025) assumes:
1. 15% CAGR for New Categories through 2027.
2. Stable combustibles margins via pricing power.
3. Debt reduction to 2.0x by 2026.

Conclusion: BAT is a Buy for Income and Growth Investors

BAT is a rare blend of high yield and transformative growth. Its 7% dividend is a safety net for investors, while its RRP innovation—driven by products like Velo and glo—positions it to dominate a $200 billion+ reduced-risk market. Yes, risks like litigation and illicit competition exist, but BAT's disciplined capital allocation and regional execution in APMEA mitigate these.

For a 3-year horizon, we see 41% upside, making BAT a compelling buy at current levels. Investors seeking a mix of income and secular growth should consider adding this tobacco titan to their portfolios.

Final Note: Monitor regulatory outcomes in Canada and the U.S., as well as APMEA's Modern Oral adoption rates. Both could accelerate BAT's trajectory.