Questor share tip: Lasting value to be found with Associated British Foods

Primark offering £2 t-shirts on Oxford Street, London.
Primark's customers, be they students or young workers, have been hit by the squeeze in disposable incomes caused by frozen wages and rising prices Credit: Photo: Geoff Pugh

Associated British Foods

£10.51 -19p

Questor says Buy

As one analyst said, Associated British Foods (ABF) is a bit of a puzzle.

He meant of course that the company is made of such different parts – from sugar beet growing in China to selling cheap handbags in Chester – that it is always a bit of a challenge to forecast how the overall company will perform.

It's a puzzle to some investors, too. How does a food manufacturing business, with some pretty ordinary brands (who really has a cup of Ovaltine before bed anymore?) and a high street retailer that has no flexibility to increase its prices (Primark's millions of weekly customers are attracted by its rock-bottom prices above all) have the ability to increase its share price by 72pc in little over two years?

After all, nearly all of its rivals on the high street have been battered by unprecedented rising costs, from the price of cotton, to rates and rents. Its customers, too, be they students or young workers, are hit by the squeeze in disposable incomes caused by frozen wages and rising prices just as much as other shoppers. When it comes to its grocery division ABF has had to face a surge in costs, as other food manufacturers have, while trying to persuade notoriously difficult customers – the supermarkets – to absorb higher prices. Rising costs have cost ABF, as a group, "hundreds and hundreds of millions of pounds", according to its finance director, John Bason.

And then there is its business of growing sugar beet, which, as any farmer will tell you, is a crop which can be hit hard by heavy snow, as it was last winter.

So why the solid share price growth over the past few years, notwithstanding a bit of a wobble in the first few months of this year? Two reasons. One: Primark is an unbelievably steady performer. ABF's full-year trading update on Monday said that Primark posted like-for-like gains of 3pc, a performance most retailers would give their left arm for. Admittedly, this has come at the cost of margins, which have been hit because of discounting and the high cotton price. Primark's operating profit margins, which hit 12.5pc in the previous year, are likely to have fallen to about 10.2pc over the past year. Investec, the broker, was already forecasting that Primark's operating profit would fall from £341m to £318m and has suggested this might need to be tweaked downwards. But it is expected to recover fast.

The second reason is the potential of the sugar business, not least its operation in China. The sugar business made operating profit of £240m in the previous year and is forecast to reach about £295m in the year just finished. But in 2012 it could power ahead to £330m or even more. Unlike in Europe, where sugar is subject to quotas, China suffers from a sugar deficit and is keen to encourage the likes of ABF to expand its sugar farming operations to close that gap.

The shares are trading on a forward PE of 12.7, with a less than generous dividend yield of less than 2pc. But they are a reliable performer, which in this environment is worth paying for.

The shares are twice the price of Primark's patent bow £5 handbag but they will last longer and probably give their owners more satisfaction over a longer period. Buy.