Tobacco stocks: divisive sector, defensive strategy, deep value

Panmure Liberum highlights British American Tobacco (BAT) and Imperial Brands as compelling UK investments in 2025, citing their defensive characteristics, attractive valuations, and high yields exceeding 9%. Despite regulatory pressures and historical aversion, the tobacco sector is demonstrating resilience, with BAT focusing on new categories like vapor products and Imperial Brands prioritizing shareholder returns. The firm draws parallels to the post-dotcom bubble era, suggesting a rotation towards reliable, cash-generating businesses, forecasting total returns from the sector of more than 10% over the next year.

Analysis

Panmure Liberum presents a compelling case for the tobacco sector in 2025, specifically highlighting British American Tobacco (BATS) and Imperial Brands (IMB) as undervalued UK equities offering a rare combination of value, income, and resilience. Despite a significant share price appreciation of over 40% in the past year for both companies, the broker asserts that they remain undervalued and possess the potential for double-digit total returns, driven by attractive dividend yields and re-rating prospects. The analysis draws a parallel to the market conditions of 2000, following the dotcom bubble, suggesting a contemporary investor rotation away from high-growth names towards reliable cash-generating businesses with robust pricing power, a category where tobacco historically performed well. British American Tobacco, trading at a forward earnings multiple of just 6.2 and yielding over 10%, has notably absorbed £27 billion in impairments related to US regulatory challenges, which Panmure Liberum views as having cleared the path for a more credible forward strategy centered on its "new categories"—vapour, heated tobacco, and nicotine pouches—now contributing over £3 billion in revenue and progressing towards profitability. Imperial Brands is characterized as a "cash machine" with a dividend yield approaching 9%, prioritizing income and capital returns, having distributed over £3 billion to shareholders in the last three years, and pursuing a disciplined approach to next-generation product investment. A key observation is the sector's diminished sensitivity to regulatory news, such as recent US tariffs on Chinese-made vapour products, suggesting that a substantial amount of negative sentiment and risk is already priced into current valuations. Panmure Liberum forecasts total returns from the sector exceeding 10% over the next year, primarily fueled by income, as the market revisits the enduring appeal of tobacco's strong brands, high margins, and pricing power, alongside the growing significance of next-generation products.

Key Decisions for Investors

• Investors seeking defensive positioning and high income in a market characterized by slow rate cuts and geopolitical uncertainty should consider re-evaluating tobacco stocks like British American Tobacco and Imperial Brands, given their yields exceeding 9% and Panmure Liberum's forecast for double-digit total returns.
• Particular attention should be paid to British American Tobacco's progress in its 'new categories', as their successful transition to profitability represents a key growth driver and re-rating catalyst, while Imperial Brands' consistent capital return policy offers a more direct yield-focused investment.
• While the sector's recent resilience to regulatory news suggests much is priced in, ongoing monitoring of the regulatory environment in key markets remains crucial, as this factor has historically been a primary driver of volatility and valuation for tobacco equities.