2023-09-21 06:53:23 ET
Summary
- Associated British Foods has faced challenges in its food and clothing divisions due to cost inflation and pandemic-related lockdowns.
- The company's revenue has recovered to pre-pandemic levels, but profitability remains a challenge.
- The outlook for the company is positive, with expected growth in sales and profit, but the valuation of the shares is considered high.
Associated British Foods (ASBFY) has had a challenging few years, between cost inflation in its food division and pandemic-era lockdowns hurting demand in its clothing business due to its heavy reliance on physical stores.
I last wrote about the business in my March 2022 "hold"-rated piece "Associated British Foods: Solid Company But No Bargain". Since then, the shares have moved up 12% according to Seeking Alpha data, although the London share price has moved up 23% in that period. Given a high valuation for what is clearly a less than reliably consistent business based on recent years, but with an eye on expected profitability improvement in the coming year, I maintain my "hold" rating.
Recovery Continues
ABF had a challenging few years. Inflation in the food business took some of the shine off high demand, while prolonged forced closure in many markets hurt Primark.
Things have got back onto a far more even keel, with last year's £17bn revenue comfortably surpassing pre-pandemic levels. Profitability, though, remains more challenging. Last year saw post-tax profits of £720m (a net margin of 4.2%, which is pretty thin in my book) versus £896m in 2019 (5.7%: better, but still not a brilliant margin).
The recovery continued in the first half of the current financial year, as shown in the financial summary below. But note that, again, it's revenue that is roaring ahead. Profits barely moved, although a share buyback programme has boosted earnings per share. At the current valuation, discussed below, I am not persuaded that that is the best of use of funds.
The Path Forward
Business looks buoyant and I expect revenue growth to continue at the full-year level. In a trading update last week, the company said that its food division continues to see strong sales growth, while retail division sales are expected to come in around 15% ahead of last year, with 9% like-for-like sales growth. That is decent, although in an inflationary environment does not necessarily equate to strong underlying sales volume growth.
When it comes to profit, the statement said that, "outlook for this financial year is slightly better than previous expectations of Group adjusted operating profit to be moderately ahead of last year". Beating expectations is positive. But the upgrade sounds modest - slightly better than moderately ahead of last year. Given the strong revenue growth, it sounds like profit growth may be doing little more than keeping even with it, suggesting that a return to historical margins continues to be elusive.
For the coming year, the company provided the following outlook:
The Group continues to trade well, managing inflation, recovering cash margin and continuing to drive sales in a challenging macro-economic environment.
The last part is a nod to what could turn out to be a bigger risk than it sounds: a tough economy pushing shoppers away from ABF's premium food brands like Twinings (albeit that could help Primark given its wallet-friendly pricing). But I take the reference to recovering cash margin as encouraging. Nonetheless, it feels as if ABF continues not to forge a new future in profitability terms so much as regain ground lost over a rough few years.
Specifically, the company expects profitability in its sugar business to improve, in part due to an Improved sugar beet crop in the U.K., and Primark gross margins to improve thanks to lower material and freight costs as well as better exchange rates. Still, this points to the dilemma of ABF's mixed business model. In theory the food and clothing businesses can offset one another. But while that means a weak performance in one can be counterweighed by a strong performance in the other, the reverse is also true. Thus, sadly, it feels like many years since the company's whole business has blown the lights out. In a nutshell, although I would not necessarily categorise ABF as a conglomerate, it's the old conglomerate problem.
Dividend Prospects
Last year's dividend for the full year came in at 43.7p per share, meaning it is not yet back to pre-pandemic levels.
The interim dividend this year was 14.2p, a 3% year-on-year increase. The company did not explicitly set out expectations for the full year but said the interim declaration "reflect(s) our confidence in our forecast for the out-turn for the year."
That suggests to me that we can expect a similar increase in the final dividend, which would make for full-year total of 45p, equivalent to the 2018 payout.
Valuation Remains Somewhat Optimistic
I previously said that I did not think that Associated British Foods was a bargain.
At some level it looks like a great business. It has powerful brands and limited competition in some categories. Primark has the potential to be a global retail phenomenon in my view.
However, over five years the shares are down 8%. Meanwhile, the dividend yield of 2.1% is fine but hardly anything to get too excited about.
Currently the shares trade on a P/E ratio of 22. I continue to see that as pricey.
Yes, the business has attractions. But it also has risks such as its exposure to sudden downturns in consumer demand or market shifts, as seen during the pandemic and the consequent 2020 dividend cancellation.
I would not buy the shares for my portfolio at this valuation. In anticipation of improved earnings, though, one may characterise it as optimistic. If the coming year (and beyond) delivers on that optimism, I think today's share price may be fair. I therefore feel comfortable maintaining my "hold" rating.
For further details see:
Associated British Foods: The Long Road Back