BAT's big discount to Philip Morris 'should narrow' with ample buyback potential, says broker

Jefferies says British American Tobacco's next‑generation product strategy is on track, citing strong US momentum in Velo nicotine pouches and improving US vaping trends; it nudged 2026 forecasts to organic sales growth of 3.4% and EBIT growth of 4.4%. The broker lifted 2026 'modern oral' volume growth to 34.2%, expects net debt/EBITDA to decline into a 2–2.5x target by end‑2026 (creating scope for higher cash returns), and models annual buybacks of £1.3bn beyond 2026; shares trade at 11.7x 2027 earnings, a 43% discount to Philip Morris which Jefferies expects to narrow.

Analysis

Market structure: BAT (BTI) is positioned to capture share from combustible to next‑gen nicotine products as Velo scales (Jefferies models +34% modern‑oral volume in 2026). If net debt/EBITDA reaches 2.0–2.5x by end‑2026 and buybacks run ~£1.3bn p.a., expect EPS accretion and a re‑rating catalyst vs. PMI; current 43% P/E discount implies >20–30% upside on multiple compression alone if fundamentals hold. Commodities impact is limited; bond spreads should tighten on credit improvement while EM FX/excise moves remain demand risks for volumes.

Risk assessment: Key tail risks are regulatory shocks to pouches/vaping (EU/US/large EM bans or flavour restrictions), sudden excise hikes in top‑10 EM markets, or a vaping safety crisis — any could compress volumes >15–25% within months. Near term (days–weeks) price moves will react to headlines; medium (3–12 months) depends on quarterly volume trends and guidance; long term (12–36 months) hinges on sustainable margin mix shift and deleveraging to ≤2.5x. Hidden dependency: rerating assumes buybacks funded by steady cash flow, not asset sales; a miss forces leverage reacceleration and valuation re‑reset.

Trade implications: Direct long BTI exposure to capture rerating; prefer size scaled to conviction with stops tied to volume/margin deterioration. Relative value: long BTI / short PM pair to isolate re‑rating risk if believing BAT’s buyback/deleveraging story outpaces PMI. Use 12‑month call spreads on BTI to cap cost and sell put spreads selectively post‑earnings. Credit: overweight 3–5y BTI senior bonds or CDS shorts to exploit expected 30–70bp spread tightening as leverage falls.

Contrarian angles: Consensus ignores regulatory clustering risk in EM and potential profit diversion to buybacks over R&D — discount may be appropriate if excise trajectory deteriorates. Alternatively, markets may underprice buyback optionality: if buybacks exceed £1.3bn and modern‑oral growth >30% sustainably, BAT could revalue toward peer multiples in 12–18 months. Historical parallel: re‑rating events at PM when non‑combustible revenue scale crossed mid‑teens % of group sales, suggesting monitoring BAT’s modern‑oral share reaching similar thresholds as a pragmatic trigger. Unintended consequence: aggressive buybacks could limit capex for product innovation and increase vulnerability to new regs.

Key Decisions for Investors

• Establish a 2–3% long position in BTI (British American Tobacco) over the next 4–8 weeks, targeting a 20–30% total return over 12–18 months if the 43% P/E discount compresses toward 20–25%; set a stop‑loss at −15% absolute or if net debt/EBITDA guidance slips above 3.0x.
• Implement a relative‑value pair: long BTI (1% weight) and short PM (1% weight) to isolate re‑rating; rebalance if BTI outperforms by >10% or if BTI’s buyback cadence falls below £1.0bn p.a. or modern‑oral volume growth drops below 20% y/y.
• Buy a 12‑month BTI call spread (e.g., buy 15–25% OTM calls, sell 30–40% OTM calls) sizing premium to 0.5–1.0% of portfolio to capture rerating while capping downside; enter after next quarterly results if volumes confirm Jefferies’ raised forecasts.
• Overweight IG tobacco credit (3–5y senior BTI bonds) by 1–2% of fixed‑income allocation to capture expected 30–70bp spread tightening as leverage falls to 2.0–2.5x; exit or hedge if regulatory proposals in top EM markets materialize within 30–90 days (e.g., proposed excise increases ≥10% or flavour bans).