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Investing.com -- British American Tobacco PLC (LON:BATS) fell more than 2% on Tuesday after RBC Capital Markets downgraded the stock to “underperform” from “sector perform,” citing structural weaknesses in its New Categories business.
Analysts said profit expectations for vapour, heated tobacco and modern oral products were “seriously overblown,” with BAT far behind Philip Morris International in the most profitable areas.
In heated tobacco, BAT is about 10% the size of PMI, whose IQOS device dominates with a 72% market share.
While BAT has built scale in vapour, that market is highly fragmented, with low barriers to entry and limited profitability potential.
RBC estimated BAT’s New Categories unit was not profitable in 2024 once costs were fully apportioned, contrasting with PMI’s estimated 28% operating margin in smoke-free products.
BAT’s margin was put at 17%, or close to 0% excluding its profitable traditional oral business.
The analysts concluded that BAT’s growth algorithm of 3-5% annual organic sales and 4-6% EBIT growth is unfeasible given the adverse margin mix from expanding low-margin categories.
They forecast that BAT’s group EBIT margin will fall by about 50 basis points annually from 2026 to 2040.
RBC set a 12-month price target of £34 per share, up from £30, reflecting lower capital expenditure assumptions.
That compares with a current share price of £41.56. The downside scenario was set at £27 and the upside at £45.
The downgrade followed a strong run for BAT stock in 2025, when its total shareholder return almost doubled that of PMI.
However, RBC said much of the optimism around BAT’s transformation into reduced-risk products had lost touch with the underlying profitability reality.
“Expectations for the transformational nature of BAT’s New Category business have lost touch with reality,” the analysts said, pointing to the company’s lack of scale in heated tobacco and overexposure to the intensely competitive vapour segment.