Discount fast-fashion chain Primark dominates discussions around Associated British Foods (ABF).

But as well as being the company behind the budget retail brand, now the UK’s largest clothing, footwear and accessories seller by volume, the Weston family-controlled conglomerate also encompasses leading food and ingredients businesses.

These bits of the group are often neglected in the wider analysis of the FTSE 100 company despite offering diversification away from the often-fickle retail sector. Notably the £15.4 billion cap continues to invest in these areas for future growth.

FOUR OUT OF FIVE

Thriving in the UK, where its cut-price clothing is drawing in price-sensitive shoppers during this cost-of-living crisis, Primark is also expanding across Europe and pushing into America, making it an irresistible growth story for market watchers to comment on.

Though Primark hogs the headlines, Associated British Foods is in fact split into five divisions. Yes, the retail brand accounts for 50% of group earnings before interest and tax or operating profit, but that means the four other divisions also contribute a combined 50% and therefore merit more attention from investors as a result. 

The grocery business accounts for 26% of earnings, sugar represents 11%, the ingredients operation accounts for a further 10%, and there is an interesting agriculture business which chips in 3% of earnings.

In the third quarter to 27 May 2023, Primark delivered a 13% sales rise to the best part of £2 billion, but sales from the four divisions which make up ‘total food’ increased by an even more impressive 18% to almost £2.73 billion.

Associated British Foods reported strong constant currency sales growth in grocery and ingredients at 13% and 10% respectively. This was driven by price hikes implemented earlier in the year to offset input cost increases, demonstrating decent pricing power.

WHY DOESN’T ASSOCIATED BRITISH FOODS SPIN OFF PRIMARK?

It is frequently suggested that Associated British Foods should spin off Primark, the jewel in the conglomerate’s crown churning out growth most retail rivals would kill for. The argument goes there are no obvious synergies between Primark and the food businesses, that a demerger would enable Primark to shine under a separate management team while unlocking value for investors.

On a sum of the parts basis, Liberum points out Primark is underappreciated by the market with an implied price-to-earnings valuation discount of around 30% to global retail peers including Swedish fast-fashion seller H&M (HM-B:STO), Zara-owner Inditex (ITX:BME), Uniqlo-parent Fast Retailing (9983:TYO), as well as GAP (GPS:NYSE) and Pepco (PCO:WSE).

The broker regards this discount as ‘excessive given Primark’s margin profile and significant future growth prospects’, which would seem to add weight to the case for a break-up of the group.

Yet Associated British Foods’ management has always resisted any clamour for a demerger. They see the conglomerate’s diversity as a strength, with the cash flows generated across the group’s portfolio of businesses underpinning its long-run record of earnings growth and capital returns through dividends and buybacks.

One good example of this is the shuttering of non-essential retail during, as the grocery, ingredients, agriculture and sugar divisions were able to pick up the slack.

GROCERIES OFFER ADDITIONAL GROWTH LEG

The two biggest food units by revenue – grocery and sugar – provide extra legs to growth beyond Primark. Generating more than £3.7 billion in revenue in the year ended 17 September 2022, the grocery division makes and markets a range of international and local food brands ranging from Twinings tea and Ovaltine malted drinks to Kingsmill and Allinson’s breads, Jordans cereals, Patak’s Indian food and Mazola cooking oils.

It also spans the Silver Spoon and Billington’s retail sugar brands in the UK, and sports nutrition sector labels HIGH5 and Reflex Nutrition.

Odds are you consume some of these products, since nine out of 10 UK households use Associated British Foods’ grocery brands. And this part of the business has potential for overseas growth too.

Headwinds for the grocery business include cheaper private label competition, which is taking share from brands as shoppers grapple with cost-of-living pressures, as well as the margin erosion from cost inflation, though Associated British Foods has successfully passed through most of the latter to customers through price increases and Liberum sees grocery operating margins expanding to double digits in full year 2024.

SWEET POTENTIAL

While health-conscious consumers are trying to reduce their sugar intake, the reality is billions of us have a sweet tooth, which underpins the prospects for the world-leading-yet-lumpy global sugar production business. With operations in the EU, Africa and China and over £2 billion of sales last year, this division has the capacity to produce 4.5 million tonnes of sugar annually.

However, there are risks for investors to weigh, among them weather, which can impact the quantity and quality of beet sugar and sugarcane crops, as well as European and world sugar prices, which are currently high but prone to volatility which can lead to a bumpy earnings profile.

Readers may be unaware that Associated British Foods’ sugar-making plants are also highly efficient ‘bio-refineries’ that enable it to produce products maximising the value from every root of sugar beet and every stick of sugar cane; these include animal feed, biofuels and speciality products sold into industry sectors including food and drink, fuels, pharmaceuticals, industrials, agriculture, horticulture, power and energy.

INGREDIENTS FOR GROWTH

Further diversifying the business are Associated British Foods’ ingredients operations, which are leaders in yeast and bakery ingredients as well as in ingredients for animal nutrition, pharmaceutical and various other industries. With annual sales approaching £1.83 billion at last count, the ingredients arm has also done well in this high inflation environment by successfully recovering elevated costs.

Finally, there is the agriculture arm, which manufactures animal feed, nutrition and technology-based products and offers data services for the agri-food industry. This part of the business supplies everything from compound animal feed, feed enzymes and specialised feed ingredients to a range of value-added services to farmers, feed and food manufacturers, processors and retailers.

This is a fragmented market with opportunities for consolidation and Associated British Foods is playing its part, having recently announced (6 June) the acquisition of milk recording and data specialist National Milk Records. While this was a modest-sized deal at £48 million, broker Shore Capital believes National Milk Records will ‘bolster ABF’s presence in the UK dairy scene’.

Thanks to its conglomerate structure Liberum believes the most appropriate way to value Associated British Foods is through a discounted cash flow and sum of the parts analysis. This underpins the broker’s £24 valuation. This compares with a share price at the time of writing of £19.93.

‹ Previous2023-07-06Next ›