Associated British Foods (LON:ABF) A Share for All Seasons?

Having been in search for a consumer defensive share for portfolio balancing for the past month or so, I was surprised that I managed to pass up Associated British Foods (LON:ABF). This hit a 52-week low earlier in the month but has since rebounded back, so I have decided to dive in. The cause of the recent dip I believe was just general market sentiment, as the trading report at the end of February indicated that it would deliver profits in line with expectations. But the market is nervous about most retail firms, punishing even small bits of bad news badly, and they don’t come much bigger than ABF, who own many food brands but more importantly the Primark retail chain.

The share price chart isn’t pretty, but over the last 2 years it seems that c.£23 is the lowest it will go, after which support kicks in. It’s been around this area several times before. 

ABF own many very well known food brands, such as Kingsmill, Jordans, Ryvita, Twinings and Ovaltine. Many of these are correlated in the same way, in that they are premium brands which may be under attack from the discounters. However ABF has morphed away from being a food company to being more of a retail one by it’s jewel in the crown: Primark.

It’s difficult to understate how much of a success Primark has been. It now makes up roughly half of turnover and profit, and its growth is not done there. With more stores scheduled to open, it is likely that Primark will make more for ABF than all the rest of its divisions combined. That is fairly remarkable considering that you cannot buy anything off their website – where many other clothes retailers are heading.

As far as one can be about clothes, I’m excited about Primark. I first shopped there in about 2008 and wasn’t impressed. The clothes were cheap but the quality was bad, and there was a distinct difference between that and the mid-range stores such as Zara, Uniqlo and so forth. In the past, this type of combination was not enough (C&A could not make this strategy pay a decade before). 

But then, something changed within the business. Aided by a slick social media campaign (the company does no other advertising), Primark became fashionable in a sense. Words such as ‘Primani’ paid homage to the acceptability of the young to shop there. Aside an environment where most others were putting prices up, Primark’s remained the same. And a gradual increase in quality and store design has given them an incredibly compelling position in the market. They seem safe from the mid-range competition, who would be loathe to compete on price. And their size is such that few players could, not before they went the same way as C&A.

A typical Primark store underlies these observations: always crowded, with people from most market segments represented from the young to the old. People tend to buy several items because of the price. Their flagship store in London could probably open 24 hours and still be busy, and it is a common sight to see tourists in there, taking advantage of the weak pound to stock up. And this has been driving expansion: with 186 stores in the UK there is probably not much more room to grow, but Europe and the US is relatively untouched.

This has led to an impressive bottom line:

What isn’t written here is that margins are extremely healthy at 10.4%. This is an extremely cash generative business. Even allowing for capital expenditures of almost £900m in the past year, ABF paid off their debts and stand on a cash pile of £673m. Given that Primark was responsible for £735m of the profits in the last year, it is hard not to focus on this as the major part of the investment rationale.

The plans for 2018 are to open another 1.2m sqft of store space – this expands the store portfolio by roughly 10%. Primark are also expanding into other products such as makeup. 2018 should also see Primark overtake Next as the UK’s 2nd biggest clothes retailer, and there is no reason to presume why it should not reach the top, as that place is held by Marks and Spencer.

To my mind the Primark brand could still go a lot further, especially in Europe where are many pan-European mid-range brands (Zara, H&M, Superdry etc), but none for the super-budget market. It slightly resembles Ryanair as in it can muscle its way in with cheap prices that few can match. And in a way, this type of business seems far more suited to an economic downturn than others. People still need to buy clothes after all, and it would be the mid-range stores that would suffer first.

As we can see, the prospects for Primark are good. So what are the weak sides for ABF? I can see them as the following:

Failure in the US: It would have been an expensive decision to decide to enter the US and perhaps a riskier one. European fashion trends seem to be more closely aligned, and some adaptation may need to occur. It also can be said there are several large companies there who could replicate what they are doing.

Emergence of competitors: Many similar cut-price brands in the UK have not developed their brands enough (for instance Pep and Co, from Poundland). But that is not to say they could not.

Rising input costs: Increased wages for workers across Europe puts more pressures on either prices going up, or efficiencies to be found elsewhere in the business.

Reputation Risks: One of the more serious aspects is loss of reputation due to issues in the supply chain; particularly the use of low-cost labour. Primark have a code of conduct for their suppliers, but I believe that contraventions of this might be difficult to police until after they have happened.

Missed Fashion Trend: Much of what is sold in the stores is fairly fashion neutral; however stores can only fit so many things in, and there is a risk the wrong type of mix is used. Rivals such as H&M and Zara could steal a march if they purchase correctly.

Downturn in Food Sales: Which would obviously affect profitability. But many of the brands would be easy to dispose of should it ever get to that stage. Many such as Twinings are showing a decent amount of portability. 

I think these risks are material, but at the moment not enough to not invest. At present, ABF and Primark are on a decent run. Whilst growth at Primark appears be now dependent on opening more stores, they appear well placed to be able to do that at a time where many retailers are finding massive stores too much of a burden.

At 17 times earnings, ABF is not particularly cheap. But the same could be said for many in the Consumer Defensive sector, particularly for a solid big player. Coca Cola is at 22 for instance, and Unilever and Diageo are at 20. On a current yield of 1.9%, this is not a get rich quick share, but hopefully a safe haven for some cash. 

Pure Passive Investor. Always looking for ways to make money (but not myself) work harder.

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