2023-06-25 23:18:16 ET
Summary
- Associated British Foods plc is a global company that operates in the food, ingredients, and retail sectors.
- Primark has scope for further growth through global expansion and increased e-commerce capabilities in core markets.
- ASBFY's non-retail brands are developing their product offering to cater to changing consumer needs, supporting underlying growth.
- The company's margins declined as a result of inflationary pressure and supply chain issues, reducing its attractiveness.
- ASBFY's valuation does not imply sufficient upside to imply a buy rating.
Investment thesis
Our current investment thesis is:
- Primark will drive growth in the coming years through further global expansion and the development of its e-commerce capabilities in core markets.
- Non-retail remains robust, with some scope for improved growth, especially if supplemented by M&A.
- ASBFY's margins have declined due to inflationary pressures, heavily impacting its attractiveness. The company looks undervalued on paper but when factoring this in, we do not see sufficient upside.
Company description
Associated British Foods plc ( OTCPK:ASBFY ) is a global company that operates in the food, ingredients, and retail sectors.
It is divided into five segments: Grocery, Sugar, Agriculture, Ingredients, and Retail (Primark).
Share price
ASBFY's share price has declined across the last decade, driven by softening financial performance and increased competition. Even with dividends included, the share price performance has been poor.
Financial analysis
Presented above is ABF's financial performance for the last decade.
Revenue & Commercial Factors
Revenue has grown at a CAGR of 4% across the last 10 years, with consistent improvement leading up to the Covid-19 pandemic. Although revenue has returned to its pre-Covid level, net income has not.
Retail
The retail industry has been very fruitful for ASBFY. Primark is an Irish multinational fast fashion retailer that operates stores across Europe and the US. This segment has driven improvement for ASBFY, as Primark has rapidly gained popularity and expanded overseas.
Primark operates in the affordable segment of the retail industry. It offers a wide range of products with good quality but with a focus on keeping costs low. The company operates similarly to fast fashion retailers, although with less focus on fashion trends and more on a wide range of products. Primark is essentially the Aldi/Lidl of the retail industry.
Primark was a business caught out by the impact of Covid-19, as the business (remarkably) did not have an e-commerce store. The thought process was that this would drive people in-store, allowing the business to benefit from cross/upselling. This has clearly been rectified and it has further propelled the business. As the following illustrates, the interest in Primark is on an upward trajectory, and we expect much of the benefits to be felt in the coming years as its e-commerce offering matures.
Further, we believe Primark will remain resilient during current market conditions. Inflationary pressures are wreaking havoc, with rates increasing in response. This has contributed to a squeeze on consumers' finances, as living costs rapidly rise and wages struggle to keep up. Our view is that while many retailers struggle with slowing demand, Primark's pricing strategy will win new customers and keep the business on its current trajectory. In H1, Primark achieved 15% LFL growth in the UK, 8% in Europe, and 11% in the US.
The focus on sustainability and ethical practices is gaining prominence in the retail industry, to the extent that it is seen as a potential fast fashion killer. Consumers are increasingly concerned about environmental impact, fair trade, and animal welfare. Primark has launched "Primark Cares", its first circular collection. Further, c.50% of clothing unit sales contained recycled materials, up from 39% the period prior. The company is rapidly developing in this area and responding to one of the key criticisms it faces.
Future growth for Primark will be driven by its e-commerce offering, as touched on prior, as well as the expansion of stores. Primark is currently in the process of building a second distribution center in the US and has 5 stores due to open in the second half of this year.
Food and Groceries
The Food and agriculture industries are highly competitive, with tight margins. The reason for this is the commoditized nature of the products sold. This said, the industry is fundamentally attractive due to the stickiness of demand and lack of volatility. So long as the population grows and consumers eat, the demand for ingredients will remain strong.
This is offset somewhat by Groceries, within which ABF owns several valuable brands such as Twinings, Dorset, Jordans, and Ryvita. These brands are exploiting the shift in consumer preferences toward healthier, natural, and sustainably sourced products. This looks to be driven by increased knowledge of healthier diets and social signaling. Our view is that this is more than just a trend but a fundamental shift in the market. We believe ASBFY's brands are positioned well in this regard, known for their high-quality ingredient.
In conjunction with this, we have seen a rise in the popularity of plant-based diets and the demand for alternative protein sources. ASBFY's brands have been actively expanding into alternative ingredient foods over the last few years, such as Yumi with its veggie burger.
Similarly to the retail industry, expanding into international markets, particularly emerging economies, presents a significant growth opportunity for ASBFY's non-retail segments. The development of strong brands gives ASBFY deep expertise and a proven recipe for success that it can leverage to expand.
ASBFY's commercial profile is not standout or exciting by any means but is positioned to succeed long term. Primark is its crown jewel and we see sufficient progress ahead in the coming years to support further growth. Non-retail has opportunities, also, but should remain resilient regardless.
Margins
ASBFY currently has a GPM of 20%, EBITDA-M of 10%, and a NIM of 4%. Margins have trended down in the last decade.
A decline in margins is disappointing to see, as one would expect the growth in Primark would be sufficient to generate improvement.
This decline is a reflection of inflationary pressure in the food industry, as well as production costs to Primark, which ASBFY has been unable to wholly pass on. Our expectation is for pressures to ease in the coming year, as inflation declines and supply chain disruptions ease. This said, it does not guarantee ASBFY will be able to win its margins back due to the high level of competition.
Balance sheet
ASBFY is conservatively financed, with an ND/EBITDA ratio of 1.2x. This gives the business a large amount of flexibility to conduct further M&A to acquire brands and expand its global footprint. We believe this will be a key development for the company if it is to materially achieve growth in excess of inflation.
Cash flows have been incredibly consistent across the historical period with little volatility. This is important as it allows the business to consistently fund capex and distributions without risks to either.
Distributions have historically been in the form of dividends, although share buybacks are not being used to supplement dividends.
Industry analysis
Presented above is a comparison of ASBFY's growth and profitability to the average of its industry, as defined by Seeking Alpha ( 35 companies).
On both a 3Y and Y5 revenue basis, ASBFY's growth rate has underperformed the market as a whole. The reason for this is likely the weakness of Primark during the Covid-19 period, as well as the lack of scope for large growth in Agriculture and Foods.
ASBFY performs far better when considering growth, with higher margins in all key criteria. ASBFY's delta to the industry is small and so any further slippage could quickly render the business unattractive on this metric, also.
Given the maturity of the industry, we will always prefer margins to growth. For this reason, we believe ABF is relatively attractive within the industry.
Valuation
ASBFY stock is currently trading at 10.7x LTM EV/EBITDA and 7.7x NTM EV/EBITDA. Across all metrics, ASBFY is currently trading at a discount to its historical average.
The arguments for a discount (and thus risks to a bull thesis) are based on:
- Margin deterioration as a result of Covid-19, alongside the risk that ASBFY will be unable to achieve improvement. EBITDA-M is now 2% below FY19 levels, which will likely take several years to win back.
- Weak growth despite the trajectory of Primark, suggesting the business will continue to generate mild returns.
Although we believe these factors are justified, we see improved opportunities with:
- Primark's expansion globally and its e-commerce development in core markets.
- Further development of its brands in the healthy / plant-based segments.
- Opportunity for M&A activity to expand remains.
Overall, we believe these factors net to a slightly bearish view compared to ASBFY's "average" position in the last decade. The margin weakness offsets any potential (realistic) revenue improvement.
For this reason, we have applied a 10% discount to ASBFY's average multiple. Based on this, we derive an upside of 2-10% (LTM/NTM). Given the NTM multiple implies the larger upside, our view is that this is not sufficient upside to justify a buy rating.
Final thoughts
ASBFY is a quality business that has the potential to grow consistently forever. It is highly entrenched in a critical global industry. Supplementing this is the ownership of several highly valuable groceries brands and its crown jewel, Primark.
We expect growth to continue at its current trajectory, driven by Primark. Margin improvement looks possible but will take several years due to the level of competition.
ASBFY's valuation looks attractive but does not reflect the decreased margins. When doing so, we do not see sufficient upside. We suggest patience until there is evidence of margin improvement or a continued decline in share price.
For further details see:
Associated British Foods: Margin Decline Means Patience