British American Tobacco: Riding the Nicotine Shift to Outperform Philip Morris

The global nicotine landscape is undergoing a seismic shift, driven by regulatory pressure, health awareness, and the rise of reduced-risk alternatives. British American Tobacco (BAT) has positioned itself at the forefront of this transformation, recently raising its 2025 sales targets and signaling confidence in its U.S. growth engine. Meanwhile, Philip Morris International (PM) remains a formidable competitor but trades at a premium that may not fully reflect BAT's upside potential. For investors seeking exposure to this structural shift, BAT presents a compelling valuation arbitrage opportunity.

The Structural Shift in Nicotine Consumption

The decline of traditional combustible cigarettes—projected to fall by 2% globally this year—has accelerated the race for reduced-risk alternatives. BAT and PM are leading this charge, but their approaches differ in execution and valuation. BAT's New Categories, which include nicotine pouches (Velo Plus), heated tobacco (glo Hilo), and premium vapor (Vuse Ultra), now account for 17.5% of its revenue. These segments are growing at mid-single-digit rates, outpacing PM's smoke-free business, which contributed 42% of PM's Q1 2025 revenue but trades at a P/E ratio nearly double BAT's.

BAT's U.S. Play: A Growth Engine Ignites

The U.S. is BAT's crown jewel. Velo Plus, its nicotine pouch star, achieved triple-digit revenue growth in early 2025, capturing 11.9% of the Modern Oral segment—a 550-basis-point surge. This product's success, paired with stable premium cigarette brands like Natural American Spirit, has enabled BAT to reaffirm its 1%-2% full-year revenue growth target, despite industry headwinds.

In contrast, PM's U.S. strategy leans heavily on ZYN nicotine pouches, which face rising competition and a saturated premium market. While ZYN's 53.8% shipment growth in Q1 2025 is robust, BAT's holistic U.S. approach—combining combustibles stabilization with Modern Oral dominance—creates a compound growth catalyst.

Valuation Arbitrage: BAT vs. PM

BAT trades at a discounted valuation compared to PM, despite its accelerating growth trajectory. As of June 2025:
- BAT's P/E ratio: ~15.5 (vs. PM's 20.86).
- Leverage: BAT aims to reduce its net debt/EBITDA ratio to 2.0–2.5x by end-2026, while PM's leverage remains moderate but its growth is already priced in.
- Dividend yield: BAT offers 4.8% (vs. PM's 4.0%), with a progressive payout history and a £1.1 billion share buyback in 2025.

Why Now is the Time to Invest

BAT's June 3, 2025, trading update will act as a catalyst. Analysts expect it to confirm:
1. Strong U.S. Modern Oral momentum (Velo Plus).
2. The successful rollout of glo Hilo (doubling trial-to-conversion rates in Serbia).
3. Vuse Ultra's potential to counter illicit vapor competition in H2.

Meanwhile, PM's valuation risks include regulatory headwinds (e.g., EU flavor bans) and reliance on IQOS, which faces slowing growth in saturated markets like Japan. BAT's diversified portfolio and lower valuation create a margin of safety, especially as its New Categories expand into Europe and Asia.

Risks to Consider

• Regulatory uncertainty: Stricter nicotine rules could delay product launches.
• Illicit market competition: BAT's vapor segment faces headwinds in the U.S. and Canada.
• Execution risks: Global rollouts (e.g., glo Hilo) require flawless execution.

Final Analysis: A Buy at Current Levels

BAT's valuation gap versus PM offers a rare opportunity. With a 12–18 month horizon, investors can capitalize on:
- Structural growth: New Categories' mid-single-digit expansion.
- U.S. dominance: Velo Plus's market share gains and premium cigarette stability.
- Financial discipline: Deleveraging and shareholder returns.

The data is clear: BAT's fundamentals align with its valuation, while PM's premium may overstate its growth potential. For investors seeking to profit from the nicotine shift, BAT is the better leveraged play.

Action Item: Buy BAT shares ahead of its June 3 update, targeting a 12–18 month holding period.

In a sector undergoing profound transformation, BAT's blend of innovation, geographic diversification, and undervaluation makes it a standout investment. The nicotine revolution isn't just a trend—it's a seismic shift, and BAT is leading the charge.