Executive Summary / Key Takeaways

• British American Tobacco (BTAFF) is undergoing a profound transformation, committing to "Building a Smokeless World" with an ambitious target of 50% of revenue from non-combustibles by 2035, driven by its multi-category strategy and innovative product pipeline.
• The company achieved new category profitability two years ahead of schedule in 2023, with smokeless products now accounting for 17.5% of group revenue and contributing significantly to overall growth, demonstrating the efficacy of targeted investments and scale benefits.
• BAT's technological differentiation across Vapor (Vuse), Heated Products (Glo), and Modern Oral (Velo) is critical, with new innovations like Glo Hilo, Vuse Ultra, and Velo Plus designed to capture premium segments and drive future growth, supported by strategic R&D and patent settlements.
• Despite facing significant headwinds in traditional combustibles (U.S. macroeconomic pressures, illicit vapor, new regulations in Australia and Bangladesh), BAT projects a return to its medium-term growth algorithm of 3-5% revenue and 4-6% APFO by 2026, underpinned by an improving U.S. performance and new category momentum.
• The company maintains strong financial resilience, characterized by over 100% operating cash conversion, a progressive dividend policy, and a commitment to sustainable share buybacks, supported by deleveraging efforts and potential divestment of non-core assets like its ITC (ITC) hotel stake.

Industry Transformation and BAT's Strategic Pivot

The global nicotine industry is undergoing a fundamental transformation, driven by an accelerating consumer shift towards reduced-risk alternatives. British American Tobacco p.l.c. (BTAFF) stands at the forefront of this evolution, strategically pivoting from its century-old foundation in traditional tobacco to "Building a Smokeless World." This ambitious vision, aiming for 50% of its revenue from non-combustibles by 2035, underscores a profound commitment to public health and long-term sustainable growth. BAT's multi-category strategy, encompassing Vapor, Heated Products, and Modern Oral, is designed to cater to diverse consumer preferences and navigate complex regulatory landscapes globally.

The company's history, marked by its founding in 1902 and the significant 2017 acquisition of Reynolds American Inc., has provided a robust global footprint and a strong portfolio of brands. This foundation is now being leveraged to drive its strategic shift, with a refined focus on Quality Growth, a Sustainable Future, and a Dynamic Business. This strategic direction positions BAT to capitalize on the vast opportunity presented by the fact that only about 10% of the world's one billion smokers currently use new category products.

In the competitive landscape, BAT operates alongside major global players such as Philip Morris International (PM), Altria Group (MO), and Imperial Brands (IMB). BAT's strength lies in its extensive geographic diversification and a broad portfolio of brands, which provides resilience against regional market volatility. While PM has been aggressive in its smoke-free innovation, and MO dominates the U.S. market, BAT's balanced approach across categories and its global distribution network offer a distinct advantage in adapting to evolving consumer demands and regulatory environments worldwide. The company's strategic emphasis on emerging markets also provides unique growth opportunities, potentially differentiating it from competitors with more concentrated market exposures.

Technological Edge and Innovation Engine

BAT's core technological differentiation lies in its multi-category portfolio of new generation products, which are central to its "Smokeless World" ambition. The company has transformed its innovation ecosystem, developing an exciting pipeline across Vapor, Heated Products, and Modern Oral, with significant deployments planned through 2025.

In the Vapor segment, Vuse remains the global and U.S. value share leader, demonstrating strong financial resilience. The Vuse Alto device and tobacco flavors received a marketing granted order in the U.S., reinforcing its market position. New product developments, such as Vuse Go 2.0, offer improved sensorials with superior heating technology, a removable battery, and a device lock, directly addressing key sustainability and safety concerns. Furthermore, BAT is introducing Vuse Ultra, a premium vapor product, with targeted rollouts commencing in Canada in Q1 2025, aiming to tap into an underserved segment that currently represents just 3% of the vapor category value. This strategic move is designed to enhance profitability and market share in a rapidly evolving category.

For Heated Products (HP), the Glo brand is undergoing a significant rejuvenation. The Glo Hyper Pro, a more premium offering, features new heat technology and longer-lasting sessions, coupled with redesigned consumables that significantly improve taste and flavor delivery. This innovation has already shown promising results, with Glo Pro helping to improve volume share, declining only 40 basis points in 2024 compared to 110 basis points in 2023. A pivotal development is Glo Hilo, a "breakthrough system" launched in Serbia in Q4 2024, designed to reshape Glo's positioning in the premium HP segment, which accounts for over 80% of industry value. The full rollout of Glo Hilo from mid-2025 is expected to substantially increase BAT's competitiveness. Additionally, the company's tobacco-free range, Veo, with its herbal substrate, has gained first-mover advantage in 10 European markets in 2023, expanding to 19 markets by 2024, and is outperforming competing products. A global patent settlement with Philip Morris International has also provided BAT with greater freedom to accelerate its tobacco harm reduction agenda and innovation.

The Modern Oral category, led by the Velo brand, is the fastest-growing new category for BAT, with revenue surging 53% in 2024. Velo Plus, a higher moisture product launched in Q4 2024 in seven flavors and two nicotine strengths, is showing "very encouraging early results," contributing approximately 7% to the total Modern Oral volume share and reaching 18% in New York in December. The U.S. recovery for Modern Oral is also driven by a refreshed Velo expression and the launch of Grizzly Modern Oral. Velo's strong performance is underpinned by high consumer acquisition and conversion scores, coupled with strong brand power, particularly in the AME region where it holds a 65% volume share and captured 70% of category revenue growth. Notably, Velo's gross margin per mil in AME is over two times that of combustibles, highlighting its significant contribution to profitability.

These technological advancements and strategic R&D initiatives are crucial to BAT's competitive moat. By focusing on premiumization, enhanced consumer experience, and addressing sustainability concerns, BAT aims to differentiate its offerings and capture higher-value segments. The continuous innovation pipeline, supported by investments in people, science, IP, and capabilities, along with leveraging centers of excellence and external partnerships, is designed to drive financial performance through higher average selling prices, lower manufacturing costs, and improved margins in new categories, ultimately bolstering its market positioning and long-term growth strategy.

Financial Performance: A Story of Transformation and Resilience

BAT's financial performance in 2024 reflects a year of strategic investment and sharpened execution, yielding results largely in line with expectations. The company delivered group revenue growth of 1.3% and adjusted profit from operations (APFO) growth of 1.4% on an organic constant currency basis, with diluted EPS increasing by 3.6%. This performance underscores the resilience of its multi-category portfolio and global footprint, particularly as new categories continue to gain traction.

Smokeless products emerged as a significant growth driver, with revenue increasing by 8.9% in 2024, accelerating in the second half of the year. This segment now accounts for 17.5% of group revenue, up 1 percentage point from the previous year. The focus on "quality growth" has been instrumental, leading to a £251 million improvement in new category contribution and a 7 percentage point increase in its contribution margin. This achievement is particularly noteworthy as BAT reached new category profitability two years ahead of its original target in 2023, reducing losses by £1.1 billion since 2020. The profitability of Vapor and Modern Oral already offsets losses in Heated Products, with management confident that Heated Products will also turn profitable with new innovations.

In traditional combustibles, volumes declined 5% organically in 2024, primarily due to U.S. market exits and supply chain disruptions in Sudan. Excluding these factors, the decline was 3.5%. Despite volume pressures, pricing remained strong, increasing by nearly 9%. The U.S. market, a cornerstone of BAT's business, saw revenue decline by 3.4% and adjusted operating profit fall by 3.5% in 2024, impacted by commercial actions, macroeconomic pressures, and the proliferation of illicit vapor products. However, management noted an improving financial performance throughout the year, with the U.S. expected to return to growth from 2025. Outside the U.S., the AME region delivered robust performance, with revenue growing nearly 5% and APFO rising 7.5%, driven by strong combustibles and double-digit new category growth. Similarly, APMEA's total revenue grew by 5.4% and APFO increased by 7.5%, supported by pricing gains and new category expansion.

The company's operating margin remained flat in 2024, effectively offsetting £390 million in inflationary costs and a 1.1% transactional FX headwind through higher new category profitability and significant cost savings. BAT has a strong track record in efficiency, achieving close to £900 million in savings over the last two years and targeting over £1.2 billion by year-end 2024, with an additional £2 billion in savings targeted by 2030.

From a liquidity and capital allocation perspective, BAT demonstrates strong financial resilience. Operating cash conversion exceeded 100% for the fifth consecutive year, highlighting robust cash generation. The company reduced its leverage to 2.4 times in 2024 (2.75 times adjusted for Canada) and aims to be within its target range of 2 to 2.5 times by 2026, excluding Canada. A £6.2 billion provision was recognized in 2024 for Canada's CCAA proposed plan, which management expects to be tax-deductible. BAT anticipates generating over £50 billion of free cash flow between 2024 and 2030, providing substantial capacity for its capital allocation priorities: reinvesting in transformation, balancing deleveraging, maintaining a progressive dividend (with 2% growth announced), and initiating a sustainable share buyback program. The company completed a £700 million share buyback in 2024 and committed to a £900 million buyback in 2025, partly funded by the partial sale of its ITC investment. Management has also indicated no long-term interest in being a shareholder of ITC's hotel chain, signaling potential future divestment to support deleveraging.

Competitive Positioning and Strategic Responses

BAT's competitive positioning is defined by its global scale, diversified multi-category portfolio, and a strategic focus on innovation to drive its smokeless transformation. In the rapidly evolving nicotine market, BAT actively competes with industry giants like Philip Morris International (PM), Altria Group (MO), and Imperial Brands (IMB), each with distinct strengths and market focuses.

In the Vapor segment, Vuse maintains its global and U.S. value share leadership, outperforming the U.S. industry decline in tracked channels. However, this segment faces intense pressure from illicit single-use vapor products, particularly in the U.S. and Canada, which distort competition and impact legal market sales. BAT's response includes advocating for stronger regulatory enforcement and leveraging its scientific evidence through "Omni" to promote tobacco harm reduction. The success of state-level vapor directories, such as in Louisiana where the legal market grew 33% with a 91% reduction in illicit products, serves as a blueprint for potential broader impact.

For Heated Products, Glo is regaining momentum after a period of underperformance, driven by the rollout of Glo Hyper Pro and the upcoming Glo Hilo. While historically facing competitive pressures in markets like Japan and Italy, the recent global patent settlement with PMI provides BAT greater freedom to innovate and accelerate its product pipeline. This strategic move enhances BAT's ability to compete more effectively in the premium HP segment, a critical area for future growth.

In Modern Oral, Velo is a clear leader, particularly in the AME region where it commands a 65% volume share and captured 70% of category revenue growth. Its strong brand power, high consumer acquisition, and conversion scores position it favorably against rivals. The successful U.S. recovery with a refreshed Velo expression and the launch of Grizzly Modern Oral further solidify its competitive stance in this fast-growing category. Velo's superior gross margin per mil compared to combustibles also provides a significant competitive edge in profitability.

In Combustibles, BAT's U.S. business has shown signs of recovery, with total volume share stabilizing in 2024. The company's investments in expanding contracted distribution to 88% coverage, coupled with strategic brand laddering (e.g., Newport soft pack) and consistent value share gains in premium (Natural American Spirit) and branded value (Lucky Strike), demonstrate its ability to defend and grow share in a declining market. Lucky Strike, notably, remains the fastest-growing cigarette brand in the market. This operational execution in distribution and brand management helps mitigate the impact of macroeconomic pressures and illicit trade.

BAT's competitive advantages, or "moats," include its extensive global distribution network, a diverse portfolio of established brands, and a robust innovation ecosystem for new categories. These assets enable strong customer loyalty and recurring revenue streams. However, the company remains vulnerable to stringent regulatory changes, such as flavor bans in Europe and new tobacco regulations in Australia, which can accelerate legal industry decline and fuel illicit trade. The proliferation of illicit vapor products, estimated to represent over 60% of the U.S. vapor market, also poses a significant challenge, impacting both legal vapor sales and combustible volumes. BAT's strategic responses, including proactive engagement with regulators and continuous investment in differentiated, compliant products, are crucial for navigating these complex competitive dynamics and securing long-term market share.

Outlook and Key Risks

BAT's outlook is anchored in its commitment to accelerating its smokeless transformation, with a clear pathway to achieving its medium-term growth algorithm. For 2025, the company anticipates revenue growth of around 1% and APFO growth of 1.5% to 2.5% (adjusted for Canada, including a 1.5% transactional FX headwind). This guidance incorporates significant headwinds from Bangladesh and Australia, which are expected to collectively impact group revenue by 1% and APFO by close to 2%. Despite these challenges, key drivers for 2025 include an improving U.S. financial performance, continued strong growth from Velo globally, and a solid performance in the AME region. The deployment of new category innovations throughout the year is expected to make group performance second-half weighted.

Looking further ahead to 2026, BAT projects a return to its medium-term algorithm of 3% to 5% revenue growth and 4% to 6% APFO growth (adjusted for Canada at constant rates). This progressive improvement is expected to be fueled by a less negative backdrop in the U.S. (including a more supportive macroeconomic environment and more meaningful enforcement against illicit vapor), the full-year benefit of new category innovations launched in 2025, the lapping of 2025 combustible headwinds, and a step-up in efficiencies from the company's ambitious £2 billion savings program by 2030. Management expresses confidence that the U.S. business will "turn the corner" in 2025, becoming a more significant contributor to overall group performance.

However, several key risks could impact this outlook. The continued weak enforcement against illicit single-use vapor products in the U.S. and Canada remains a significant concern, as it distorts competition and erodes legal market share. Macroeconomic pressures, particularly impacting lower-income consumers in the U.S., could persist longer than anticipated, affecting affordability and combustible volumes. Regulatory changes, including potential flavor bans and excise increases in various markets, also pose ongoing threats. The uncertainty surrounding the timing and final impact of the Canadian CCAA settlement, despite the £6.2 billion provision, represents a financial overhang. Furthermore, transactional FX headwinds, though expected to ease, could still impact reported results. BAT's ability to mitigate these risks through proactive regulatory engagement, continuous innovation, and disciplined capital allocation will be crucial for realizing its long-term growth ambitions.

Conclusion

British American Tobacco is in the midst of a profound and deliberate transformation, strategically pivoting towards a smokeless future while fortifying its core business. The company's commitment to "Building a Smokeless World" is not merely aspirational but is underpinned by tangible progress, evidenced by achieving new category profitability ahead of schedule and a robust pipeline of innovative products across Vapor, Heated Products, and Modern Oral. These technological advancements, from the premium positioning of Glo Hilo to the high-moisture Velo Plus and the responsible Vuse Go 2.0, are designed to capture growing consumer demand for reduced-risk alternatives and establish clear competitive advantages.

While facing persistent headwinds in traditional combustibles and the pervasive challenge of illicit vapor markets, BAT's diversified global footprint and sharpened execution are demonstrating resilience. The company's financial discipline, marked by strong cash flow generation, a progressive dividend, and a commitment to sustainable share buybacks, provides a solid foundation for funding its strategic transition. As BAT moves towards its 2026 growth targets, the successful execution of its innovation roadmap, coupled with an anticipated improvement in the U.S. market and more effective regulatory enforcement, will be paramount. Investors should recognize BAT's strategic foresight and operational agility in navigating a complex industry, positioning it for long-term value creation as it leads the charge towards a predominantly smokeless future.