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(Sharecast News) - RBC Capital Markets downgraded British American Tobacco on Tuesday to 'underperform' from 'sector perform' but lifted the price target to 3,400p from 3,000 as it said profit expectations for the company's New Categories are "seriously overblown".
"Our view of the trajectory of BAT's profits and cash flow hasn't changed very much, but given the share price's phenomenal performance, we feel that it is incumbent on us to revisit our assumptions about the drag on profitability we expect from a growing but low margin New Category business," the bank said.
"What we haven't done before is try to dig into the Heated Tobacco, Vapour and Modern Oral markets in any depth, nor compare the relative composition and profitability of BAT and PMI's businesses.
"We recognise that in part BAT's outperformance has been a function of sector rotation, not to mention other consumer staples stalwarts failing to perform in the defensive and predictable manner that has long been a large part of the sector's investment case, in our view.
"But we also think that expectations for the transformational nature of BAT's New Category business have lost touch with the reality of a business that lacks scale in the most profitable New Category (Heated Tobacco) and is most heavily exposed to the competitive battlefield that is Vapour."
RBC said that being so, its expectations for the potential of BAT's profits and cash flow are relatively muted, hence the downgrade.
The bank said it was being a little more generous in its sales forecasts over the next couple of years, with organic revenue growth 2.2% in 2026E and 1.9% in 2027E.
"We assume the 50bps EBIT margin decline kicks in in 2027 and every year thereafter for the purposes of our adjusted present value calculation.
"This yields a price target of £34, up from £30 previously as we have lowered our capex/sales forecast from 3.5% to 2.0%; (if we're right about New Categories' limited profitability potential, it follows that BAT is not going to invest in building capacity at the rate we had assumed)."
At 1100 BST, the shares were down 2.2% at 4,064p.
