Jefferies starts coverage on global tobacco sector; BAT top pick

Jefferies has initiated coverage on the global tobacco sector, identifying it as a "sweet spot of Staples" due to modest growth, defensive characteristics, high cash returns, and appealing valuation, noting its P/E re-rating from 12x to 15x "has further to run." British American Tobacco (BAT) is their top pick and "improver," rated Buy with a 4800p/ $66 target, citing Velo success and attractive valuation. Philip Morris is the preferred "growth pick" and Imperial Brands a "value standout," both initiated at Buy. Conversely, Japan Tobacco is Hold due to limited NGP exposure, and Altria is Underperform, facing share losses and demanding valuation. The firm anticipates regulatory headwinds for combustibles have peaked, with tailwinds for Next-Generation Products (NGPs), particularly oral nicotine pouches, driving future growth.

Analysis

Jefferies has initiated coverage on the global tobacco sector with a positive outlook, framing it as a "sweet spot of Staples" due to a combination of modest growth, high cash returns, and appealing valuations. The brokerage notes the sector's price-to-earnings multiple has already expanded from 12x to 15x over the last two years but believes this re-rating has further potential. Growth is projected to be in the low single-digits, driven equally by legacy combustibles and next-generation products (NGPs), with NGPs now accounting for approximately 16% of the global nicotine market value. A key pillar of the thesis is the view that regulatory headwinds for combustibles have likely peaked, while tailwinds are emerging for NGPs, especially for oral nicotine pouches in the U.S. and Europe which face lighter oversight. Within the sector, Jefferies identifies clear differentiation: British American Tobacco (BTI) is the top pick and designated "improver," with a Buy rating and a $66 price target, citing the success of its Velo brand and an attractive valuation. Philip Morris (PM) is the preferred "growth pick" due to its leading IQOS brand and ZYN pouch business, while Imperial Brands (IMBBY) is a "value standout," both also rated Buy. Conversely, the firm is cautious on Japan Tobacco (2914), rated Hold due to limited NGP exposure, and negative on Altria (MO), rated Underperform, citing market share losses for Marlboro and a demanding valuation.

Key Decisions for Investors

• Given the sector's defensive qualities, strong dividend yields, and potential for further P/E re-rating, investors could consider overweighting exposure to tobacco, particularly a selective basket of names with strong next-generation product (NGP) pipelines.
• A clear relative value trade emerges from the analysis: favor long positions in British American Tobacco (BTI), Philip Morris (PM), and Imperial Brands (IMBBY) while considering an underweight or short position in Altria (MO), which is cited for market share losses and a demanding valuation.
• Investors should closely monitor the performance of key NGP brands like Velo, IQOS, and ZYN, as their market penetration and regulatory treatment are the primary catalysts for growth and stock differentiation within the industry.
• With "best-in-class" dividend yields and rising share buybacks highlighted, income-focused investors should evaluate the sector for its robust capital return profiles, which provide a significant component of total return and a potential cushion against market volatility.