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.
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.
Reuters Breakingviews is the world's leading source of agenda-setting financial insight. As the Reuters brand for financial commentary, we dissect the big business and economic stories as they break around the world every day. A global team of about 30 correspondents in New York, London, Hong Kong and other major cities provides expert analysis in real time.
Sign up for a free trial of our full service at https://www.breakingviews.com/trial and follow us on Twitter @Breakingviews and at www.breakingviews.com. All opinions expressed are those of the authors.