US Edition Associated British Foods
£29.62+240p
Questor says HOLD
SELLING a combination of sugar, discount clothing and hot drinks doesn’t appear to be a recipe for success, but it provided the right ingredients for Associated British Foods (ABF).
A strong first-half trading update sent the shares almost 9pc higher yesterday, as the odd mix of businesses increased pre-tax profits by 6pc at one of the few remaining conglomerates in the FTSE 100.
That profit performance was also marginally ahead of analysts’ expectations, and this, alongside the news of an accelerated entry of the Primark clothing brand into the US retail market, resulted in broker Panmure Gordon upgrading the shares to a buy.
The US expansion provides an intriguing opportunity to accelerate the growth of the highly profitable Primark brand, but exporting a UK retail format Stateside has proven a graveyard for many a British company, with Tesco the most recent and high-profile example.
Questor was more impressed by the cash generated during the first 24 weeks of trading. Cash from operations soared to £508m, up £158m on the same period last year. That means even after spending some £321m opening 16 new stores across Spain, France and the UK, and expanding retail space by 8pc from a year earlier, to 9.6m sq ft, the company could easily pay its £179m in dividends. In fact, the net debt of £827m at the end of March was £510m lower than the same stage last year. That leaves the balance sheet looking fairly solid with £827m of net debt against £6.1bn of shareholders’ equity.
A better cash performance and lower debt levels than expected meant ABF could repay some of its more expensive borrowing, such as a $167m (£100m) US bond that had an interest rate of 6.75pc. Reducing borrowing costs added an extra £15m to profits during the first 24 weeks.
That kind of prodigious cash generation is impressive, and it means that the dividend payments are looking relatively secure. ABF said it would increase the interim dividend by 4pc to 9.7p, ex-dividend June 4, payable July 4. What’s more, market consensus is for the full-year dividend to increase by about 9pc to 34.8p, with another 9pc increase next year.
The standout performance on the trading side came not from the Primark clothing, but the grocery business that increased total group operating profits by 1pc to £497m. Strong sales of Twinings tea and Ovaltine helped increase operating profits in the grocery business by 31.3pc to £126m. This performance coincided with another period of growth for Primark clothing, which reported operating profits up 25.7pc, to £298m, representing 60pc of the group total.
The real problems continue to be in the sugar business. Operating profit here collapsed by 60.5pc to £64m during the first half, after a record period of sugar production in the UK resulted in prices tumbling. ABF warned it expects little improvement in sugar prices during the second half, adding that profits will be significantly lower than the £272m earned during the second half last year.
Elsewhere, the sale of farm animal feed was stable, leaving first-half operating profits in the agriculture division largely flat at £19m. ABF’s ingredients business made a profit of £15m, having broken even in the first half of last year.
ABF has an excellent record of delivering revenue growth and profits, backed by a sharp focus on cash generation; that has allowed the dividend to increase by 52pc during the past four years to 32p, up from 21p. The dividend is also covered almost three times by earnings and more than twice by free cash flow. However, it is difficult to get too excited about the investment prospects at ABF with the shares trading on a price-earnings ratio of 26.6 times, falling to 24.8 times next year. The shares also only offer a fairly paltry dividend yield of 1.3pc at the current price. Questor thinks ABF is one to stick on the watchlist but can’t be tempted to buy at these prices. Hold.