November 7, 2017 / 1:00 PM / a year ago

Breakingviews - ABF's sweet tooth will weigh on valuation

LONDON (Reuters Breakingviews) - Associated British Foods will pay for its sweet tooth. A company that sells everything from sugar beet to cheap party dresses has so far made the most of this somewhat odd mix. But its exposure to sugar prices means its valuation is too rich.

People line up outside a store of clothing retailer Primark before its opening in Berlin, July 3, 2014. Thousands of bargain hunters flocked to a new Primark store in the heart of Berlin on Thursday despite a protest by campaigners demanding the Irish chain improves conditions in the factories that produce its budget tops and jeans. REUTERS/Thomas Peter (GERMANY - Tags: BUSINESS EMPLOYMENT) - GM1EA740ARE01

ABF said on Tuesday its full-year operating profit rose 13 percent. Energy efficiencies and higher extraction rates in its sugar business helped, as did an impressive performance in fashion. Primark, the high-street chain that generates a little more than half of the group’s operating profit, is holding up well despite the spiralling costs of inputs and pressure on British consumer spending.

Like-for-like sales growth of 4.5 percent in the United Kingdom, where about half of Primark’s stores are located, suggests the retailer is taking market share from higher-priced rivals like Hennes & Mauritz and Next. That vindicates ABF’s decision not to hike prices for shoppers even though a weaker sterling has increased the cost of sourcing clothes from Asia. And high footfall through its stores means Primark is one of the few fashion names that can still afford to shun margin-damaging online sales.  

But its fashion flair cannot compensate for the problems that a sugar dependency is going to cause in the coming year. Chief Executive George Weston said on Tuesday that profit from the sugar division would be hit by a decline in EU prices. The commodity has long been a volatile source of earnings, generating almost half of group operating profit in 2013 but only 3 percent three years later.

With sugar prices now expected to slide, the company’s valuation is increasingly hard to justify. Even after a 3 percent drop in the stock price on Tuesday, ABF shares are trading at 23 times expected earnings for the coming year. That is approaching the 25.7 times commanded by Zara-owner Inditex, a pure fashion company with higher operating margins. Investors could be in for a painful sugar slump.


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