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Associated British Foods - trading better than expected

Sophie Lund-Yates, Equity Analyst | 7 September 2020 | A A A
Associated British Foods - trading better than expected

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Associated British Foods Ord 5,15/22p

Sell: 2,357.00 | Buy: 2,360.00 | Change 67.00 (2.92%)
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Fourth quarter trading has been better than expected across ABF's food businesses and Primark. As a result, underlying operating profit across Sugar, Grocery, Agriculture and Ingredients will see a "very strong" increase compared to last year. Primark operating profit will be at the higher end of the £300m-£350m range previously guided.

ABF shares rose 3.1% following the announcement.

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Our view

Primark, Associated British Food's (ABF) largest division, has done exceptionally well as lockdowns lifted. Performance has been better than both management, and we, expected.

We suspect that Primark's lower price point will be serving it well as cautious consumers venture back onto the high street. At the same time, a lack of discounting means margins should also hold up too. We've been particularly impressed at the group's ability to shift such huge quantities of what was considered excess summer stock when shops were first forced to close.

There is an element of pent up demand which is boosting sales, but crucially basket sizes are still higher than this time last year. That suggests a longer-term positive trend to us. But the possibility of a sales slow-down once the novelty of open shops wears off can't be ruled out. While the indicators are good, it's too soon to view these as permanent.

The other positive in Primark's favour is 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. This is an important tool at the group's disposal, especially with the outlook still uncertain. This kind of advantageous position can help support profits in tough times.

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 enhanced 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. ABF expects to finish the year with £1.3bn in net cash. That's good going at any time, let alone when the waters have been choppy. 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: 17.3
  • 10 year average forward P/E ratio: 20
  • Prospective yield: 2.2%

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Full year Trading Update

Grocery benefited from increased retail demand in the US, Europe and Australia. Full year sales will be higher than last year, reflecting growth in Twinings and UK Retail among others. COVID-19 boosted sales in the second half, but revenue was held back by lower demand for Ovaltine, particularly in Vietnam and Thailand. Allied Bakeries has realised a non-cash charge of £15m, as the value of some assets have been written down. £30m in insurance payments have been received in relation to the Wakefield bakery fire in February.

Overall, underlying operating profit will be "significantly ahead", as margins grew thanks to the increased volumes sold.

Retail has seen strong trading since all Primark stores reopened. Cumulative sales since reopening to the year-end are expected to be £2bn, with higher transaction rates being driven by increased footfall. Customers are buying more per-trip, which includes some initial pent up demand but basket sizes are still higher than last year. At the half year the group posted an exceptional charge of £284m against extra inventory on hand and items yet to be delivered. Stronger trading means Primark has now sold a lot of its excess inventory, and will only be carrying £150m worth of stock into next year's Spring/Summer collection.

Overall like-for-like sales in the UK are expected to be down 12% since reopening. Like-for-like sales are expected to be down 17% and 9% in Europe and the US respectively.

Higher EU Sugar prices mean sales and underlying operating profit will increase for this division. China returned to normal yields, following a poor crop last year, and the operating performance in Spain improved significantly. All of these factors offset a more disappointing performance at Illovo.

The Ingredients and Agriculture businesses have seen increased demand for their products due to COVID-19, and expect operating profits ahead of last year.

The better-than-expected inventory position at Primark contributed to an improved net cash position. This is now expected to be around £1.3bn (excluding lease debt), and the group fully repaid its £1.1bn revolving credit facility in August.

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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.