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Imperial Brands and British American Tobacco shares: here’s why I believe it’s not game over yet

It’s an interesting time for tobacco giants Imperial Brands (LSE: IMB) and British American Tobacco (LSE: BATS) right now. Smoking rates are declining across the world and governments are making life extremely difficult for tobacco manufacturers by constantly introducing new regulation that impacts the sector. Just a few weeks ago, the UK government pledged to end smoking in England by 2030 as part of a range of measures to tackle the causes of preventable poor health.

That said, I don’t think it’s game over for the FTSE 100 tobacco giants just yet. These companies appear to have tricks up their sleeves that could help them transform their businesses in the years ahead. Let’s take a look at some recent developments in the tobacco sector.

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Imperial Brands

My own personal hunch is that in the future, cannabis could be a key earnings driver for the tobacco companies. I wrote about this idea back in early June. Around the world, attitudes towards the use of cannabis are changing dramatically and the industry appears to have colossal growth potential – by 2025, the legal marijuana market could be worth $150bn+ according to some forecasts.

So, I was interested to see that in late July, Imperial Brands spent $123m to pick up a 20% stake in Auxly Cannabis Group. Headquartered in Vancouver, Canada, Auxly’s vision is “to be a global cannabis leader focused on providing branded cannabis products backed by science and innovation.” Imperial’s investment, which was in the form of a debenture convertible security, gives the FTSE 100 company the right to convert it into Auxly shares at any time during the three-year term of the debenture. If at the end of the term Imperial has not converted, the debenture is repayable in full.

Given that Imperial has a market capitalisation of around £20bn, an investment of $123m is relatively small-scale for the company. However, I think it could be a sign of things to come. The story is definitely worth watching closely, in my view.

British American Tobacco

Meanwhile, shares in British American Tobacco surged recently after the group announced in its half-year report that revenue in its ‘New Categories’ division – which comprises potentially reduced-risk products THP, Vapour, and Modern Oral – grew 27% to £531m with growth in all categories during the six months to the end of June.

Now, given that overall group revenue for the period was £12.1bn, this segment is still a small proportion of the group’s sales. Yet it is encouraging to see such strong growth and it suggests that this segment could potentially help BATS offset the decline in cigarette volumes. CEO Jack Bowles added that “there is much more to be done, with new product launches planned for the second half of the year” and that the company expects revenue growth to “accelerate” in the next six months. Its goal is to grow this division by 30%-50% per year.

So, overall, both FTSE 100 tobacco companies appear to be making progress in diversifying their offerings away from traditional tobacco products. For this reason, I wouldn’t rule out either as potential investments just yet.

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Edward Sheldon owns shares in Imperial Brands. The Motley Fool UK has recommended Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.