Hollie Adams
Associated British Foods plc (OTCPK:ASBFY) is a diversified international food, ingredients and retail group with sales of £13.9 billion, 128,000 employees and operations in 53 countries across Europe, Africa, the Americas, Asia and Australia. Its purpose is to provide safe, nutritious, affordable food, and clothing that is great value for money. With the breadth of its business, its brands and global reach, ABF aims to consistently deliver value to its stakeholders. Its business is split into five segments: Grocery; Sugar; Agriculture; Ingredients; and Retail. From a bakery founded in 1935, to grocery stores and a clothing brand, the evolution of ABF is one of considered expansion, growing popular brands and making acquisitions in adjacent businesses and markets for over 85 years.
The outlook for retailers of non-essentials, the next year is going to be another difficult one, about surviving and setting up for future thriving. This year, ABF, whose prime asset is Primark, the budget homewares and clothing chain, has a high chance of slipping into earnings losses. The key question in the short term is if this has been factored in the stock price already, after all the stock is down 23% since the start of the year. Full year results for financial year 2022 were released on the 8th of November and delivered strong revenue and profit growth this year in a clear demonstration of the benefits of the group’s diversification and brand strength.
However, looking ahead, economic conditions are challenging and the outlook for consumer discretionary spending may well prove to be weak in the near term. It’s likely sales can be higher over the next year (financial year to the end of September), given the ability of Primark and its food-related businesses to implement higher prices. Additionally, with an Altman Z-Score of 3.1, ABF is strong enough to fund its declared £500 million share buyback programme.
The risk is going to be margins thanks to cost inflation. Higher energy and wage bills will probably push profits below the £1.435 billion adjusted operating profit of FY 2022. I think adjusted operating profit will likely drop by around 5%.
The market is taking a more pessimistic view. An enterprise value of only 4.6x adjusted EBITDA is towards the very bottom of the ten-year range. Granted this does reflect the uncertainty of just how revenue will perform when consumer spending is squeezed over the coming months. However, this is a short-term view and equity is a long-term investment. We need to account for ABF’s financial strength and the longer-term opportunities that are on the table from expanding Primark in the United States.
Also, it seems to me the market tends to ignore ABF’s non-retail businesses a lot of the time, even though they made up almost half of adjusted operating profits this year. The sugar segment, ABF’s third largest by revenue, is benefitting from higher commodity prices. Along with the quite resilient profits from the agriculture and ingredients segments, adjusted operating profits for non-retail should be up on last year.
ABF’s retail segment Primark is what the market pays attention to, as in the UK it’s the most visible asset, with stores in most big towns and cities. This segment’s adjusted operating margin for FY23 will probably be below 8%, when it is normally about 10%. Freight costs, while still double pre-pandemic levels, are down significantly from the seven times higher they were at their height last year. Also, importantly, the price of cotton, material for Primark, also has come down. Energy costs are still a risk as is a stronger dollar for Primark, which buys a majority of its goods in dollars and sells mostly in pounds and euros.
Primark has recognised difficulties in Germany and took a £206 million impairment last year, thanks to a higher cost base and pressure on revenues. The business is in negotiating with unions on costs.
However, Primark is committed to market share and low costs, as that’s its differentiation for the consumer in the marketplace and what has made it successful and thus won’t put up sales prices next year beyond the raises already planned. I think this is a good strategy, in a bleak economic environment, many consumers will downgrade to most price competitive wares.
This is already playing out with Primark noting in recent weeks lower average basket size is being offset by higher customer numbers. As energy bill rise sharply over the winter and next year, it may be the consumer will purchase more low-cost warm clothes to try to keep energy bills down, so Primark’s low-cost jumpers and coats are bound to do very well during the energy crisis.
Normally, I would be concerned by inventory levels which are about 50% higher than last year, but this is just a base effect – when supply chain disruptions meant inventory levels were artificially low last year. Current inventory levels are 36% higher than in 2019, following a year in which sales were only about 7% lower than those recorded last year. So, there is a slight risk that Primark might have to discount more goods to sell them.
Primark is planning to expand in the US, Italy, Iberia and France, and this would increase the number of stores to 530 from 408.
Traditionally shunning e-commerce to protect margins, a new web strategy last week saw its website crash on far higher than expected demand. Primark’s brand is very strong.
Valuation
ABF is still cash-generative and even with lease liabilities included. Financial leverage is just 0.8x and is expected to rise to 1x, in line with the company’s target.
ABF trades on a forward PE of 13x and EV/EBITDA of just 6.6. The group has a decent Piotroski F-Score of 7 out of 9. All this suggests
ABF is a very well placed relative to other discretionary retailers and food retailers in its ability to weather a recession. The stock is defensive. ABF’s cheap valuation more than compensates for the risks it faces.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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