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Associated British Foods - Primark back in business

Nicholas Hyett, Equity Analyst | 2 July 2020 | A A A
Associated British Foods - Primark back in business

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Associated British Foods Ord 5,15/22p

Sell: 1,641.00 | Buy: 1,642.00 | Change -19.00 (-1.15%)
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Sales in the third quarter fell 39%, to £2.6bn, as good results in the Grocery and Ingredients business partially offset a 75% fall in Retail sales.

The group's food related businesses are expected to deliver improved operating profits overall this year. Primark's full year operating profits are now expected to be in the region of £300m-£350m, compared to £913m last year.

With the vast majority of Primark stores now trading again recent sales trends have been "reassuring and encouraging".

ABF shares rose 7.2% in early trading.

View the latest ABF share price and how to deal

Our view

Primark, Associated British Food's (ABF) largest division, seems to be performing well as the lockdown lifts.

Clearly open stores are better than closed ones, but early days have seen shoppers queuing to get in and spending more once inside. We suspect that Primark's lower price point will be serving it well, as cautious consumers venture back onto the high street. Meanwhile the lack of discounting should help margins at a time when many retailers are having to slash prices to move old stock.

However, social distancing rules limit footfall and are likely to prevent Primark's busier stores from reaching pre-coronavirus levels in the short term. There's also the risk that what we're currently seeing is an explosion of pent up demand which has been waiting for stores to reopen - and if that is the case the early success could yet tail off.

Lower sales together with a relatively fixed cost base does not bode well for profits. Which is why it's good to see significant progress in reducing overheads during the lockdown. We also suspect that, as one of the few retailers taking on new space, the group will enjoy the whip hand when it comes to negotiating with struggling retail landlords.

ABF is about more than Primark though, and in the current environment that adds to ABF's resilience. The group's various food businesses accounted for around 41% of group operating profit last year.

The Grocery division in particular has benefitted from increased sales over the lockdown as consumers eat more at home, and that's enhancing both sales and margins. Meanwhile a cyclical upturn in EU sugar prices is expected to improve profits in the sizeable Sugar business.

While the strong operating performance is certainly notable and welcome, it's the balance sheet forecasts that really caught our eye this quarter. ABF expects to finish the quarter with net cash of over £750m, just 6.4% below where things stood at the half year. That implies some very impressive cash conservation over the last couple of months, especially as the group continues to open new stores, but also sets the group up well to weather any further economic disruption.

The combination of a price competitive retail product, diversified business interests and strong balance sheet means we think ABF is one of the better placed names in the retail sector. While that is reflected in the valuation to a large degree, future growth opportunities (particularly in the US) and weaker competitors mean the group could emerge from this crisis in a better position than it started. That's not something we would say of many retailers.

ABF key facts

  • Forward P/E ratio: 18.9
  • 10 year average forward P/E ratio: 16.8
  • Prospective yield: 1.9%

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Third Quarter Trading Update

Third quarter Grocery sales rose 9% to £941m. That reflects increased sales through supermarkets and other retail channels, as Jordans, Ryvita, Silver Spoon and Acetum all benefited from increased home consumption. Allied Bakeries saw Kingsmill volumes increase, although private label bread volumes were lower and the agreement to provide private label bread to Co-op will now come to an end in April 2021.

Sales in the Retail division fell 75% to £582m. The closure cost the group around £650m in lost sales every month, with a monthly cash outflow of £100m.

Since the first Austrian stores reopened on 4 May Primark has reported sales of £322m (up to the 20 June) down 12% on a like-for-like basis. 367 of 375 Primark stores are now back open, and in the week ended 20 June sales in England and Ireland were ahead of the same week last year.

Sugar sales fell 1% to £344m. However, operating profits are ahead of last year as the group benefited from higher EU sugar prices, partially offset by lower Illovo export volumes.

The Ingredients and Agriculture businesses saw sales rise 3% and remain flat year-on-year at £385m and £361m respectively.

The group reported a significant cash outflow in the quarter, with a cash outflow from Primark of £800m between 1 March and 23 May. However, the group expects to return to cash generation in the fourth quarter and finish the year with net cash of £750m (compared to £801m at the half year).

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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. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.

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