European Tobacco: Prefer BAT over IMB on New Category Upside

Core Conclusion

We prefer British American Tobacco (BAT) over Imperial Brands (IMB) within European tobacco, driven by BAT’s structurally higher exposure to fast-growing new categories (14% of sales vs. IMB’s 4%) and its already-profitable modern oral and e-vapour businesses. IMB’s ~96% reliance on combustibles, combined with softening cigarette trends in both US and Europe, leaves it with limited growth offset. BAT’s valuation (11.8x 2026E P/E) remains cheap relative to EU Staples (16-20x) and its own growth trajectory, while IMB’s larger discount (8.1x) fairly reflects higher terminal value risk.

New Categories Offer Structural Growth; BAT Has the Edge

Global nicotine industry revenue grows 4-5% CAGR through 2030E, with new categories (modern oral, e-vapour, heated tobacco) expanding mid-teens. Modern oral screens favorably across eight factors—younger/higher-income demographics, superior nicotine delivery, ~50% lower retail price vs. cigarettes, zero federal excise tax currently, and high market concentration (top-5 brands hold 99% of US modern oral sales). BAT’s new category revenue posted 59% CAGR over three years vs. IMB’s 23%, and BAT has already reached profitability (12% operating margin), whereas IMB’s new category segment remains loss-making. The US modern oral penetration is only ~7% of nicotine market vs. 15-20% in mature Nordics, and daily consumption (3.6 pouches) is well below Sweden’s 10-12, leaving long runway. BAT commands ~60% of the global modern oral market with Velo, and its US market share surged +12ppts L12W (y/y) to ~24%, still far below its 68% share in top European markets—suggesting further innovation-driven gains.

Competitive Position: BAT Outperforming Across Key Markets

In US cigarettes, BAT holds 32.2% value share (L12W) vs. IMB’s 9.0%. BAT’s ASP premium over IMB is ~25%, sustained over four years, supported by premium brands (Natural American Spirit, Lucky Strike). IMB’s value-oriented portfolio (~10% below market average) is losing share to deep-discount, which gained 260bps in the past 12 months. In US e-vapour, BAT’s Vuse commands 41.2% L4W value share (+982bps y/y) and is growing (+10.4% L12W) while the category declines -14.8%. In modern oral, Velo’s L52W sales growth of +331% far exceeds Zyn’s +5.5%. In Europe, BAT holds a premium but narrower advantage: German ASP premium over IMB is ~4%, and BAT has lost market share in Germany (-126bps L52W) and Italy (-135bps) while IMB gained modestly. However, IMB’s overall combustibles exposure leaves it vulnerable as cigarette value declines in these markets (Germany +0.3% L52W, Italy -0.6%, UK -5.9%). BAT’s new category growth offsets these headwinds; IMB has no such buffer.

Valuation & Risk/Reward: BAT Discount Can Contract

BAT trades at 11.8x 2026E P/E, a 27% discount to EU Staples (16x) vs. a historical 42% average. With EPS CAGR of 9.0% (2026-29E) and FCF yield 8.5%, the discount should narrow as new category growth materializes. Target price 4,900p implies 13.7x NTM P/E, offering ~18% upside. IMB at 8.1x P/E with 9.4% EPS CAGR and 10.3% FCF yield looks cheap, but its 48% discount to EU Staples is justified by limited new category exposure and higher terminal value risk (bear case: -0.8% EPS CAGR). IMB’s superior shareholder returns (~13% of market cap p.a. vs. BAT’s 9%) are a positive, but not sufficient to overcome structural volume decline (-3.9% p.a. for IMB combustibles) without new category diversification.

Key Risks

• Regulatory: US FDA PMTA backlog restricts new product launches; modern oral still lacks federal excise tax but state-level taxation increasing (e.g., Washington State). Illegal e-vapour market (~75% of US) may delay regulatory clarity.
• Competition: Zyn (PMI) retains 63% US modern oral share; Altria’s on! PLUS received MGO; PMI plans Zyn Ultra. Velo’s recent share gains may moderate as competitors innovate.
• Profitability of New Categories: BAT’s new category operating margin is 12% vs. combustibles ~42%. Achieving comparable margins requires scale and premium pricing, which remains unproven.
• Combustibles Downside: US cigarette volumes declined -7.1% L52W; deep-discount share gains pressure pricing. If consumer downtrading intensifies (gas prices rising), BAT’s premium portfolio could face volume risk.
• Execution: BAT must sustain Velo Plus innovation and secure PMTA approvals. IMB’s Malibu deep-discount launch (March 2026) faces uncertain uptake.

Appendix Data Summary