The Weston family still owns 55% of Associated British Foods (LSE: ABF), the clothing-to-tea company they founded in 1935. This long-term focus has helped drive the business forward over the past eight and a half decades – a rarity among FTSE 100 organisations.
In some respects, ABF is two companies under one banner: there’s the retail side of the business, which owns the Primark brand; then there’s the food side of the business, which owns well-known brands such as Twinings Tea as well as food production facilities, including bakeries and British Sugar.
This diversification is both a benefit and a drawback. On the one hand, it gives the firm a foothold in many different markets, allowing it to capitalise on growth wherever it sees an opportunity. On the other hand, the market struggles to value the business. Is it a retailer, consumer goods company, agricultural giant or manufacturing enterprise?
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Grouping the businesses together brings strength through diversification, but there's a reason other conglomerates have been forced to split up: it’s hard for the market to distinguish what’s what, which tends to lead to a lower valuation, commonly known as a “conglomerate discount”.
ABF’s valuation does seem to suggest it suffers from this – the stock is trading at a forward price/earnings ratio (p/e) of 12.7. That’s compared to a mid-teens multiple for the consumer goods sector as a whole and 18.8 for Primark’s closest competitor, H&M Hennes & Mauritz. This could be an opportunity for investors.
Associated British Foods offers strength through diversification
ABF’s diverse corporate structure is a unique quality, and it’s one that has helped the group build value year after year for its investors. For example, during the pandemic the food businesses booked strong profits, offsetting the losses from the retail side. Primark is well known for its refusal to move its operations online even in the pandemic, and it paid a heavy price as it was forced to close its brick-and-mortar stores.
The group looks well-placed to navigate today’s economic climate. According to its latest trading update (covering the 36 weeks to the end of May), sales rose 29% year-on-year. Sales at the food businesses rose 9% reflecting “price actions to recover input cost inflation and volume increases in ingredients.” Meanwhile retail sales jumped 69%, reflecting the fact that Primark stores were able to trade without restrictions throughout much of the period.
The company also said it “remains on track” to deliver a full-year adjusted operating profit margin of 10%. When so many other businesses are reporting deteriorating trading conditions, this update is quite impressive. It looks as if ABF is able to pass higher costs onto its buyers, protecting its profit margins. This sort of pricing power is an impressive competitive advantage for any organisation.
ABF is also now planning to move Primark into online shopping, starting with a click-and-collect service for children’s clothes later this year. The trial will start with just 25 shops in the northwest of England as management looks to expand sales of children’s clothing. The company believes it has a “very strong kidswear business,” but it has always been “short of space” to store and sell products. The click and collect service should help alleviate some of this pressure.
But while it is planning to introduce click-and-collect services, it does not seem as if management is planning to go fully online anytime soon .“It’s very high cost, the return rate is horrible, and I think it’s environmentally questionable,” ABF’s CEO told the market in the company’s trading update.
The company’s best qualities are often overlooked by investors
Primark is the most visible part of ABF, but the food and ingredients businesses account for 55% of sales. These defensive operations provide the group with stability and diversification, and, in my view, that’s far more valuable than anything else.
ABF might not be the most exciting business, but its valuation, 2.8% dividend yield and large family ownership, which encourages long-term investment, are all desirable qualities in my opinion.
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