By Robert Sutherland Smith
ABF, otherwise known as Associated British Foods (ABF), is that old fashioned thing, an unapologetic conglomerate dominated by one big family equity stake of 50% – the quoted company which contains the business interests of the Weston business family. Bread, biscuits and sugar have all been part of the Weston family interests. Alongside sugar refining – Silver Spoon is an ABF brand – the company has gone on confusingly to found and promote the highly successful clothing business under the brand name ‘Primark.’
The mix of sugar and fashion is about as bedevilling a combination of activities as one might imagine inside one company. It makes valuation of its shares particularly difficult. It is a company I have frequently looked at with a view to possibly awarding a ‘share to buy’ judgement, only to be put off by the normally high valuation of its earnings.
ABF achieved 104p of earnings last year, which, at a share price of 3088p, puts the shares on a historic price to earnings ratio of a ‘mere’ 30 times. You need a lot of rapid growth in earnings to get your money back on that basis – a somewhat odd expectation since part of the business is a cyclical sugar business. I can never look at ABF without thinking that for those seeking an investment in fashion retail, how much better value Next looks, and how much easier to analyse and understand in comparison.
Yet ABF has its band of enthusiastic supporters despite the fact that by most of the normal yardsticks of value the company’s shares look dear. The market capitalisation of its equity is actually much larger that the balance sheet value of the company’s total balance sheet assets – a market cap. of £24.5 billion versus a total enterprise value £10.5 billion. Balance sheet assets attributable to ordinary shareholders are estimated on the September balance sheet to be worth only about 822p of a share price of 3088p. It even sells on around twice annual sales when the historic net profit margin on those sales is only 6% and the operating profit margin 8%. This is clearly a share in which hope and confidence plays a big part for those who buy its shares. Basically, you are required to believe that Primark will be highly successful in the US, a market it is now entering. Retailing does not always successfully translate from one culture to another, as we have seen with Marks & Spencer and more recently Tesco.
One analyst has recently validated the purchase of the shares by assuming or projecting sufficient success of Primark in the USA for it to in due course command a reported valuation of £13.5 billion, or more than half the current market capitalisation of ABF equity. Reportedly, the share price is described as ‘option money’ on that estimated future success. If so it is option money that seems to some extent to discount that success as well at 30 times last years’ historic earnings per share. Even if you deduct balance sheet net assets around 800p the notional, implied valuation of earnings only, is still 22 times historic and 19 times estimated earnings (118.25p in the year to September 30th 2016). Currently, the market consensus is for 2% reduction in earnings per share this year but a 16% increase next year. On that basis the forward PEG (price to earnings growth ratio) is 1.2. That makes a buy recommendation look much more credible, if you accept the logic of knocking off the value of net assets. That makes it a low(ish)-cost gamble on success in the USA.
Turning to the ‘technicalities’ of the share price chart, I note the share price is down 6.5% from its recent high of 3293p and looks as though it has just broken out from that downtrend, which began in November. The bulls have set a target share price of 3650p. In my personal opinion the share price chart bears such a construction. Have a look! A chart worth inspection. A potential momentum buy, perhaps?