Tobacco Titans: BAT and Imperial Navigate Regulatory Crosswinds to Fuel Growth

The global tobacco sector is undergoing a seismic shift as legacy combustible products decline and next-generation products (NGPs) like e-vapor devices and oral nicotine pouches capture an increasing share of nicotine consumption. Against this backdrop, Jefferies' mid-2025 Buy ratings on British American Tobacco (BAT) and Imperial Brands highlight their roles as resilient operators navigating regulatory headwinds while capitalizing on growth catalysts. Both companies face distinct challenges, but their strategic agility, valuation appeal, and cash-generating prowess position them as outliers in an evolving industry.

BAT: The “Underappreciated Improver” with Margin Momentum

BAT emerges as Jefferies' top pick in the sector, buoyed by its Velo e-vapor device, which has gained traction in the U.S. and Europe. The firm's Buy rating and price target of £4,800 (as of July 2025) reflect confidence in its ability to drive margin expansion and shareholder returns. Key strengths include:
- Product Leadership: Velo's sleek design and nicotine delivery system have helped BAT carve out a 16% share of global NGP value, a segment growing faster than traditional cigarettes.
- Balance Sheet Strength: With net debt/EBITDA at a conservative 1.5x, BAT can fund R&D and buybacks while maintaining a dividend yield of 6.2%—among the highest in the sector.
- Valuation Discount: At 12.5x 2026E P/E, BAT trades below its five-year average, despite outperforming peers in margin improvements and cash flow generation.

Jefferies argues that BAT has already priced in sector-wide risks, such as rising debt costs and regulatory scrutiny. However, the stock's underperformance relative to peers underscores its undervalued status. The brokerage also highlights BAT's “sweet spot” positioning as a “Staples”-like stock: defensive, cash-rich, and insulated from near-term economic volatility.

Imperial Brands: A Value Play with Regulatory Crosscurrents

Imperial's Buy rating, with a price target of £3,600, hinges on its Zone nicotine pouches and a P/E of 8.5x for 2026—among the lowest in the sector. Yet, the firm's trajectory is clouded by operational risks:
- Zone's Early Wins and Legal Hurdles: Zone captured 5% U.S. market share in its first year, but a preliminary injunction over trademark disputes with 2ONE Labs forced design changes, delaying its full rollout.
- UK Tax Pressures: The UK government's proposed £2.2 billion tax hike on vaping products threatens Imperial's smoke-free margins, while its core combustible business faces rising illicit trade in markets like Australia.
- Leadership Continuity: CEO Lukas Paravicini's October 2025 succession aims to maintain the focus on NGP profitability and 3-5% CAGR in adjusted operating profit through 2027.

Despite these risks, Jefferies emphasizes Imperial's financial discipline: a £1 billion share buyback program and dividend hikes (to £1.53 per share) underscore its commitment to shareholder returns. The brokerage's reduced price target to £1,680 reflects near-term uncertainties but retains faith in its long-term value.

Sector Dynamics: NGPs as the New Growth Engine

Jefferies' bullish stance on both stocks is rooted in the tobacco sector's broader transition:
- NGP Penetration: NGPs now account for 16% of global nicotine value, with the U.S. and EU markets offering regulatory tailwinds. For instance, FDA premarket tobacco applications (PMTAs) for oral pouches are approved faster than heated tobacco devices.
- Valuation Re-rating: The sector's P/E multiple has risen from 12x to 15x over two years, driven by dividend yields of 5-7% and buybacks.
- Competitor Landscape: While Philip Morris (PM) leads in IQOS dominance, BAT and Imperial are catching up with differentiated NGP portfolios. Altria and Japan Tobacco, however, lag due to declining U.S. market share and valuation overhangs.

Investment Thesis: BAT for Stability, Imperial for Value with a Higher Risk Appetite

For investors, BAT offers a low-risk entry into the tobacco sector. Its diversified NGP pipeline, strong balance sheet, and valuation discount make it a defensive play with upside as regulatory fears subside. Meanwhile, Imperial's value orientation appeals to investors willing to bet on execution—specifically, resolving Zone's legal issues and navigating UK tax reforms.

Actionable Insights:
1. BAT: Consider a long position for dividend income and capital appreciation, especially if NGP adoption accelerates in the U.S. (Track Velo's market share growth.)
2. Imperial: Treat as a speculative buy with a stop-loss below £1,600. Monitor U.S. FDA rulings on Zone and UK tax policy developments.
3. Sector Diversification: Pair tobacco stocks with healthcare or consumer staples to hedge against regulatory risks.

Conclusion: Navigating the Nicotine Transition

Jefferies' Buy ratings on BAT and Imperial reflect a sector in flux—one where innovation and regulatory agility are critical. BAT's margin-driven model and Imperial's undervalued profile offer distinct opportunities, but investors must weigh BAT's stability against Imperial's growth-at-risk dynamic. As NGPs redefine nicotine consumption, these companies are bets on which firms can thrive in a post-combustible world.

Final Note: Regulatory risks remain high. Investors should monitor FDA rulings, tax policies, and product adoption metrics closely.