Tobacco products have remained a reliable staple because nicotine’s addictiveness keeps demand steady even when prices rise or regulations tighten.

British American Tobacco (BTI) has stayed at the top by expanding into e-vapor devices and nicotine pouches like Velo Plus while maintaining its combustible cigarette business, much of which is produced and sourced in the U.S.

Despite market concerns that its returns will fall, BAT’s strong brands, pricing power, and the rollback of a proposed menthol ban help it offset the declining smoker population.

As a result, tobacco is likely to continue generating stable cash flows and dividends for years to come.

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During economic downturns, investors often shift their capital to more stable assets like cash, gold, and safer parts of the stock market.

When people think about staple products, household essentials like diapers, soap, and paper towels typically come to mind.

However, tobacco products represent one of the largest and most reliable staple markets globally due to their addictive nature.

Tobacco use is highly addictive due to the nicotine found in these products. Once regular use is established, it becomes very difficult for users to quit due to both psychological and physical dependence on nicotine.

As a result, demand for tobacco has proven relatively inelastic.

Customers will continue purchasing tobacco products even with rising prices or increased regulations on marketing and sales.

One of the leading players capitalizing on this captive customer base is British American Tobacco (BTI), one of the largest tobacco companies in the world.

Despite stricter rules and regulations that have made the industry tougher, the company has managed to keep its place at the top.

The market has become less crowded over the years, which means that a few key players now have more room to work and grow.

BAT’s deep-rooted brand and loyal customer base help it thrive even when competitors struggle to keep up with new rules.

Over time, the tobacco industry has had to change how it does business. Traditional cigarettes, while still popular, have been slowly giving way to alternatives like e-vapor products and oral nicotine pouches.

BAT has been quick to adapt. Instead of relying solely on traditional smokeable products, the company has expanded its range through acquisitions to include newer options that appeal to a changing customer base.

For example, Velo Plus, a synthetic nicotine pouch that is gaining traction in the U.S., has been a key driver for growth in the modern oral nicotine segment.

Additionally, BAT is preparing for global launches of Glo Hilo, a heated tobacco device, and Vuse Ultra, a vaping product, which are anticipated to accelerate growth in the coming years.

By embracing new products, the company is not only keeping current customers interested but also reaching out to new ones who may be looking for alternatives to smoking.

Furthermore, BAT is relatively well-insulated from significant adverse effects, especially concerning its traditional combustible cigarette business.

For its U.S. operations, cigarettes are predominantly manufactured domestically.

Additionally, a substantial portion of the tobacco leaf used in these products is sourced from U.S. farmers, with only some specialized premium blended tobaccos being imported.

With a stable customer base reluctant to quit tobacco use, BAT has been able to generate high and reliable returns.

Since 2016, the company’s Uniform return on assets ‘’ROA’’ continued to improve and reached all-time highs above 120% last year, demonstrating the powerful addictive pull of nicotine on regular consumers.

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However, the market still has concerns about the tobacco industry.

We can see what the market thinks through our Embedded Expectations Analysis (“EEA”) framework.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

At the current stock price, the market predicts that the company’s Uniform ROA will fall to around 60%.

The market’s pessimistic view is caused by regulations on the tobacco industry tightening considerably worldwide in recent years and a decrease in the number of smokers.

The regulated nature of the tobacco industry might sound like a hurdle, but it can actually work in favor of companies like BAT.

Fewer players can handle the strict rules, which leaves more room for the big names to do well.

With a strong grip on its market, BAT can push through the challenges that come with tighter controls.

Additionally, the anticipated menthol cigarette ban was pulled back on recently by the new administration, lifting a major headwind from the company’s shoulders.

Lastly, while the smoking population decreases year over year, BAT manages to keep prices high. This offsets revenue lost from fewer people smoking.

Investors have benefited from the company’s steady cash flows and dividends over decades, capitalizing on one of society’s most stubborn habits.

Going forward, tobacco is projected to remain a sizable global market.

For BAT, tobacco’s staple nature will likely continue driving strong financial performance for many years to come.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Officer &
Director of Research
at Valens Research