British American Tobacco BTI will develop at its newly created Nicoventures tobacco-free nicotine products unit in an attempt to retain revenue from smokers who wish to quit on health grounds. We regard the move as a hedge against declining rates of Marshal smoking in developed markets, and we expect the new unit to remain a very small piece of British American’s top line for several years.

Although we think British American is a solid business, we think the stock’s recent rally has overshot the intrinsic value of the firm, and we recommend value investors look to Imperial Tobacco ITYBY for value in the tobacco industry.

British American’s new business will negotiate with global regulators with a view to launching cigarette-replacement products. Regulators could prove to be a significant hurdle, in our opinion, because in recent years their efforts have been focused on the reduction or even abolition of the use of nicotine and tobacco.

Smokeless tobacco is increasingly being used in the United States as an alternative to smoking, but such products are banned in the European Union (except Sweden), and we think the EU may provide the most lucrative market for British American’s new venture. Reynolds American RAI acquired a smoking-cessation product manufacturer in 2009 in a similar hedge against declining rates of smoking.

However, these products remain a tiny piece of Reynolds’ business, and even smokeless is small. We estimate that revenue from smokeless tobacco will represent just 12% of Altria’s MO total revenue by 2021. Similarly, we expect Nicoventures to remain insignificant for the foreseeable future.

Given that we do not expect any impact on the stock as a result of this venture, we think British American is slightly overvalued at 15 times forward earnings. We recommend investors look at Imperial Tobacco for value in the tobacco industry. The firm is the best placed of its competitors to exploit growth at both ends of the pricing scale in tobacco, but the stock is trading at just 11 times 2018 earnings and offers around 10% upside, in our opinion.