The Primark budget clothing chain is the key allure for fans of Associated British Foods (ABF). It accounts for just over two-fifths of sales and just under three-fifths of profit, and its attractions are reflected in a return on capital employed of 31.1 per cent last year, albeit down from 33.2 per cent. However, with ongoing currency pressures, potential over-optimism about US expansion and a recent history of earnings expectation downgrades, we question whether ABF's shares' sky-high rating is sustainable.
- Low debt
- Diversified business
- Tough outlook for earnings
- Potential overconfidence about Primark's US rollout
- Sugar prices remain under pressure
- Premium rating could come under pressure
Management has been very clear about faltering margins at Primark and we think this may start to register next year when management predicts the group will experience a second year of "modest decline" in adjusted earnings. ABF buys in dollars and sells products in sterling and euros, which is hitting reported numbers. Finance director John Bason said the Primark buying teams had mitigated more than half the impact, but the trend of a strong dollar is likely to persist. The issues have contributed to the downward trajectory of consensus broker forecasts shown in the chart below, which also shows the ongoing ascent of the share price and PE rating.
ABF valuation and EPS adjustments
Most of Primark's 13 per cent constant-currency sales growth last year was through expansion, with floor space increasing by almost 1m sq ft, taking the total to 11.2m, while like-for-like sales rose just 1 per cent. Analysts at RBC highlight the issue of Primark's floor space growth as a factor that could "put pressure on profitability".
The great hope for Primark now is its US expansion. It has opened its first US store in Boston and has plans to take store numbers to seven, spanning 400,000 sq ft. Regardless of what the share price may suggest, we think success is far from guaranteed in the highly competitive US market. Incursions by other successful international retailers have frequently gone awry. For example, Japanese discount clothing retailer Uniqlo is scaling back its growth intentions in the US after a cool response from consumers.
The rest of ABF's business spans branded grocery products (the second most important division, accounting for a quarter of both revenue and profit), sugar, animal feed and ingredients. Trading has been notably weak at the sugar business. Sugar accounts for 14 per cent of sales but only 4 per cent of profit following a whopping 76 per cent constant-currency fall last year. "Greater stability" is expected from here, although the end of the EU sugar quota system in 2017 presents considerable uncertainty. While trading has been encouraging at the other non-Primark divisions, these businesses can hardly justify premium valuations.
| ASSOCIATED BRITISH FOODS (ABF) | ||||
|---|---|---|---|---|
| ORD PRICE: | 3,578p | MARKET VALUE: | £28.3bn | |
| TOUCH: | 3,578p-3,579p | 12-MONTH HIGH: | 3,606p | LOW: 2,708p |
| FORWARD DIVIDEND YIELD: | 1.1% | FOREARD PE RATIO: | 26 | |
| NET ASSET VALUE: | 800p | NET DEBT: | 3% | |
| Year to 12 Sep | Turnover (£bn) | Pre-tax profit (£bn)* | Earnings per share (p)* | Dividend per share (p) |
|---|---|---|---|---|
| 2013 | 13.32 | 0.84 | 99 | 32.0 |
| 2014 | 12.94 | 1.11 | 103 | 34.0 |
| 2015 | 12.94 | 1.03 | 100 | 35.4 |
| 2016* | 13.57 | 1.02 | 117 | 37.5 |
| 2017* | 14.43 | 1.27 | 135 | 39.7 |
| % change | +6 | +14 | +16 | +6 |
Normal market size: 750 Matched bargain trading Beta: 0.93 *Canaccord Genuity forecasts, adjusted PTP and EPS figures | ||||
