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ABF - weather impacting Primark, but outlook unchanged

George Salmon | 17 April 2018 | A A A
ABF - weather impacting Primark, but outlook unchanged

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Associated British Foods Ord 5,15/22p

Sell: 1,884.50 | Buy: 1,885.50 | Change 3.00 (0.16%)
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After stripping out a slight currency headwind, revenues at ABF in the 24 weeks ending 3 March 2018 rose 3% to £7.4bn, with adjusted operating profit 1% ahead at £648m.

The shares rose 2.8% on the morning of results.

The interim dividend was set at 11.7p per share, up 3% on last year.

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Our View

It's no surprise that the majority of ABF's divisions are in some way tied to the food supply chain. However, what the name doesn't tell you is it also owns Primark, and it's fashion rather than food driving the group.

Primark's expansion across the Atlantic is of particular importance. The American market offers huge growth potential, which is a big part of the reason why the shares trade at a premium to other retail names, at 18.4 times expected earnings.

A successful US roll-out has the potential for huge rewards, but the risk is the brand fails to gain traction in the notoriously competitive US fashion sector. Plans to downsize three of its eight US stores will have no doubt raised an eyebrow or two.

However, we're not panicking just yet. The odd bump on the road to finding its niche stateside is to be expected, and trading has consistently been described as good.

Growth in Primark's established UK and European markets is more about new store openings than higher like-for-like sales. This may not be anything to write home about, but the group is still seizing market share from rivals, and we can expect a total of 1.2m sq. ft. of sales space to open this year.

Weaker sterling raised input costs, but this has unwound slightly recently. Together with operational efficiencies, increased buying power and a firmer stance on markdowns, the group is confident margins will rebound.

Of the rest of ABF's divisions Sugar is probably the most interesting. It recovered nicely last year, but is now feeling the effect of weaker market prices in the EU. Investors could do without this headwind, but really only Primark has the potential to meaningfully move the dial.

The prospective yield is just 1.7%, but analysts anticipate shareholder returns rising from here as growth continues. How successful the group is at replicating its popularity in the UK and Europe in the US will play a big part in determining the pace and duration of this upwards trend.

It'll undoubtedly be a challenge, but Primark's excellent track record shows it has the ability to rise to it.

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Half year results details - at constant currency

Sales at ABF's largest division, Retail, rose 7% to £3.5bn. However, this was driven by the addition of new space. Like-for-like sales fell 1.5% as unseasonal weather in Autumn 2017 and Spring 2018 weighed on trading.

Operating profit in the division rose just 4%, to £341m as operating margins fell to 9.8% from 10% last year. This came as the impact of a stronger US dollar more than offset improved buying. Favourable currency moves mean profitability looks to be improving in the second half of the year.

In Grocery, a strong showing from Ovaltine and Twinings and improved margins at George Weston foods helped divisional revenues rise 4% to £1.7bn, with profits up 9% to £159m. The integration of the Modena balsamic vinegar business acquired last October is progressing well, although a poor grape harvest is set to impact second half profitability.

As expected, AB Sugar delivered a weaker performance. This was primarily due to the removal of EU quotas, which led to significantly lower prices for the UK and Spanish businesses. Production is higher in both the Chinese and African businesses.

The successful integration of Specialty Blending in Ingredients, helped sales rise 5% to £720m, with profits up 11% to £63m. Similarly, in Agriculture the roll-out of new ventures and higher feed volumes helped revenues jump 13% to £615m, with profits up 9% to £24m.

The group's full year outlook is unchanged, with progress expected in both adjusted operating profit and adjusted earnings per share.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.