Primark’s Secret: Thrift is Cool

The Credit Crunch of 2008, and its aftermath, changed the way we think and spend. From the time that the banks messed up, ordinary people’s wages in the UK barely rose for six years, while prices of staples like food and energy soared.

The luxury sector continued to thrive because the modern rich (amongst whom, the very people who broke the banks) are impervious to recession. Their salaries and bonuses actually went up, even though they had been bailed out by the state.

Meanwhile ordinary folk felt the pinch. Even people paying higher rate 40% income tax where, in the UK, the threshold is still a lower-middle-class annual salary. Hence Mr Milliband’ cost of living crisis, which was real, even if the British people didn’t buy his prescription in May 2015.

Red Ed had a valid political point; but I have an economic one. It is the discount end of the retail market that started to excel. If they are rational, consumers will prefer lower-priced goods to higher-priced goods of the same quality (utility in economist’s jargon).

But of course consumers are not entirely rational. Purchase decisions are directed by extraordinarily subtle judgments rooted deep in their psychology. The choice of product is intermediated by prejudices – positive and negative – which we carry unconsciously about brands.

These dispositions to particular brands are pre-primed. Daniel Kahnemann[i], author of Thinking Fast and Slow, has changed the way progressive economists think about consumer behaviour. It turns out we are much less rational than we thought.

For decades psychology, as a discipline, seemed like an earnest enquiry into why Viennese hysterics made erotic word associations while reclining on couches. At last, however, it is turning out to be quite useful, after all. It can now explain what type of schmooze music works in supermarkets or how shelves should be stacked to maximise sales.

Call me a Northern European Protestant, but I still regard thrift as a virtue. Despite JM Keynes’s vilification of thrift[ii], there are many people who agree with me.

So here is my point. Retailers that appeal to thrift – defined by the Oxford English Dictionary as the quality of using money and other resources carefully and not wastefully – will attract enduring customer loyalty. Thrifty consumers look for good value for money in a wholesome ethos. They know that the price-quality continuum is often skewed. What they hate most is being ripped off.

They know that while cheap isn’t always cheerful, it doesn’t always mean nasty. Two years ago Which? announced the result of a blind tasting of those festive British favourites, mince pies.

Their panel found that the most popular mince pies were, in fact, the cheapest – Aldi’s Specially Selected 6 Luxury Mince Pies at £1.69 a packet. Next came Lidl’s Snowy Lodge 6 Luxury Mince Pies at £1.79 a packet. The most expensive brand, Fortnum & Mason’s Traditional Mince Pies came last. At £12.95 for six they were nearly eight times the price of Aldi’s winning product[iii].

The high streets of the late twenty teens will be dominated by retail brands which celebrate thrift. One such brand is the discount clothing and household goods chain Primark.

Primark’s extraordinary rise is owed to a simple retailing model. It doesn’t advertise, rather relying on word-of-mouth; it grinds overheads down to an absolute minimum; it operates superb logistics and it prices its own-brand stock so as to turn it over at rates that would make Marks & Spencer dizzy. And it manages to keep abreast of fashion trends. In its own words, Primark offers up-to-the-minute fashion at amazing prices. Its customers love it.

This formula has fuelled rampant growth. As well as the UK it is present in Ireland (its head office is in Dublin), Spain, Portugal, Germany, the Netherlands, Belgium and Austria. The company now employs nearly 50,000 people across Europe in 260-or-so stores, plus the online offer.

You can’t buy shares in Primark because it is the retail division of a British holding company, some of whose food brands you probably also buy: Associated British Foods PLC (LON:ABF). Primark accounts for about a third of ABF’s group sales but nearly a half of its operating profits. Other divisions, however, have equally impressive business models.

ABF is a diversified group of food, ingredients and retail businesses selling into more than 100 countries worldwide and with operations in 47 countries across Europe, southern Africa, the Americas, Asia and Australia. It has managed to achieve compound growth in revenues and profits of around 10% over the last ten years or so.

The group operates through five strategic business segments: Sugar (20% of group sales), Agriculture (11%), Retail (32%), Grocery (29%) and Ingredients (8%). All these business segments exhibit returns on capital employed of between 15% (Grocery) and 25% (Retail – Primark), with the exception of Ingredients, which has been coasting.

Sugar, of itself, is a very significant global commodity business. In the UK, ABF’s beet sugar factories produce over one million tonnes of sugar every year. In Spain, Azucarera produces over 400,000 tonnes of beet sugar and has a cane sugar refining capacity of a further 400,000 tonnes. In China, ABF operates five cane sugar mills and four beet sugar factories. Recent investment has raised annual sugar capacity in China to over 900,000 tonnes.

In Southern Africa Illovo is Africa’s largest sugar producer with agricultural and production facilities in six countries (South Africa, Malawi, Zambia, Swaziland, Tanzania, Mozambique).

The flagship of the Agricultural Division is AB Agri which supplies products and services to farmers, feed and food manufacturers, processors and retailers. It buys grain from farmers and supplies seeds through its joint venture arable operation, Frontier Agriculture. It employs over 2,000 people in the UK and China and markets products in more than 65 countries.

ABF’s Grocery division is a cornucopia of well-known brands. British consumers sip Twining’s at tea-time and brew an Ovaltine before bed. They start the day with Jordan’s cereals and toast made with Kingsmill bread. They make curries and stir-fries using Patak and Blue Dragon sauces. They fry eggs in Mazola corn oil and snack on Ryvita. Baking enthusiasts use Silver Spoon sugar and Billington’s unrefined cane sugar in their cakes. Not to mention other leading food brands in Australia, the USA and elsewhere.

On the Ingredients front, AB Mauri operates globally in yeast and bakery ingredients with 52 plants in 26 countries supplying mass market and artisanal bakeries. It has developed a technological lead in dough conditioners and bakery mixes. ABF Ingredients manufactures and markets enzymes, lipids, yeast extracts and cereal by-products worldwide from facilities in Europe and the US.

These five independent business segments generate synergies through management expertise, operational capability and market intelligence. Operational decisions are made locally. A lean corporate executive panel monitors and supports.

Any discussion of Primark and other discount retailers comes up against the rightly topical issue of ethical trading. There is a widespread view in contemporary Britain, often expressed at dinner parties and even in pulpits, that if goods are cheap then, crudely, somebody is getting screwed.

Any suspicion that labour in developing countries has been exploited should be examined seriously since the collapse of the Rana Plaza garment factory complex in Savar (a suburb of Dhaka, Bangladesh) on 24 April 2013, which killed more than 1,100 workers and left over 2,500 injured.

There were dozens of garment manufacturers located in Rana Plaza supplying 28 different retailers around the world, of which one supplied Primark. In October 2013, Primark announced that it would compensate employees of this supplier[iv] and urged other retail brands to do likewise.

Primark chose to enter this debate full-on and carries a spirited defence of its record on its website. In 2006, Primark joined the Ethical Trading Initiative (ETI) bringing together businesses, unions and NGOs to work on labour rights issues in their supply chains. ETI members are committed to the implementation of a code of conduct based on the conventions of the International Labour Organisation.

Too often in this debate, however, emotion trumps fact. In June 2008 the BBC’s Panorama broadcast a documentary alleging poor working conditions in Indian factories supplying Primark. Although Primark subsequently stopped doing business with the Indian supplier, the BBC’s Editorial Standards Committee (ESC) subsequently concluded that footage in the programme was more likely than not to have been fabricated. The ESC directed the BBC to make an on-air apology to Primark.

Under the Ethical Trading Programme, Primark has appointed 40 in-country ethical trading specialists, of which eight are now permanently located in Bangladesh. If you shop at Primark you can be reasonably confident that there has been some scrutiny of the conditions of the workers who make the goods you buy.

Add to this ABF’s group level commitment to the environment and numerous national social initiatives – such as Illovo’s National Malaria Control Programme in Mozambique – and ethical investors can buy this stock without guilt.

Some investors talk about a conglomerate discount and it is true that equity analysts often find it difficult to value multi-activity companies. Yet such companies have highly diversified product portfolios, thus business risk is lower, and profits less volatile. Synergies can be created to drive down costs, so that profits grow faster than revenues. Moreover, stocks with strong, dominant brands are advantaged because investors expect that their earnings growth is likely to exceed that of the market as whole.

For the last 52 weeks to 13 September 2014, ABF reported group revenue of £12.9 billion yielding adjusted profit before tax of £1.105 billion. For the 24 weeks to 28 February 2015 sales were up by one percent. Profits were slightly down due to the sharp decline in the sugar price in the EU.

On 09 July ABF announced that group revenues had edged 2% higher during the 40 weeks to 20 June, with its Sugar and Retail divisions both performing strongly. Primark is rocketing, with plans to roll out three stores in Italy next year. Its first store in the USA will open in Boston during the autumn.

On 22 July Goldman Sachs reiterated its bullish stance on ABF, setting a target price of 3,445 pence. That is a level about eight percent above the current share price, plus ABF pays a decent dividend too. I buy.

[i] Thinking Fast and Slow

[ii] In the General Theory, Keynes argues that too high a savings ratio chokes off consumption and therefore output.

[iii] Cheap Christmas champagne is Which? Best buy, by Lucy Bannerman, The Times, Thursday 21/11/2013, page 3.

[iv] Primark offers long-term compensation to Rana Plaza factory collapse victims, The Guardian, 24/10/2013, accessed at: http://www.theguardian.com/world/2013/oct/24/primark-compensation-rana-plaza-factory-collapse-bangladesh