Associated British Foods PLC (LON:ABF) is a “fascinating equity” according to analysts at well-respected City broker Redburn, but this has not stopped them from downgrading their rating for the food producer to Primark clothing stores group to ‘neutral’ from ‘buy’ due to concerns over the impact of the coronavirus pandemic.
In a note to clients, the analysts highlighted the long-running dichotomy of AB Foods’ position, with a “growth opportunity at Primark courtesy of fabulous store execution and despite no online presence, cyclicality in Sugar and diversification brought by the other Food businesses.”
They added: “It is international but highly sensitive to USD (dollar) and offers balance sheet strength but with limited returns via dividends and is not buying back equity.”
The analysts noted that the current environment has exposed these contrasting characteristics – both the positive and negative.
They pointed out: “The robust balance sheet means the company should still be in a net cash position at the end of this year and see a sharp rebuild thereafter. The retail side of the food business has benefited from an uplift in consumer at-home demand, offsetting the hit to foodservice requirements.”
But, the analysts added, for Primark, the value of its strong store execution has diminished, not only of course whilst stores are closed but also, they expect, as the retail world reopens.
“As the pandemic develops, the longer-term implications beyond lockdown periods for how consumers will likely want and/or be allowed to behave, are becoming more apparent,” they said.
Primark not online
The analysts pointed out that the absence of an online capability for Primark combined with a store-based model premised on volume is challenging even once stores reopen.
They noted that this has major implications for numbers as well as the rating that the Primark segment of the business can carry.
The analysts said, therefore, the cuts to their estimates for AB Foods are hefty, despite initial adjustments made at the start of the virus outbreak, with revenue falling by 22% in full-year 2020 and by 11%-13% in full-year 2021 and 2022, respectively.
Adjusted operating profit is cut by 58% this year and 30%-44% beyond, with earnings per share (EPS) chopped by 73% this year and 45%-59% beyond, they added.
“This leaves us 9% and 48% below (a still moving) consensus for revenue and adjusted EPS this year, and 1% and 45% below for next year", the analysts noted.
They concluded: “The equity debate for retail must evolve from who has sufficient liquidity and margin to weather a temporary storm (ABF/Primark is strong here), to who is best placed (product-, channel- and proposition-wise) to benefit from a different world with altered shopping habits.
“Unfortunately for Primark, its strengths are not aligned to the areas we expect to prove crucial to outperformance as the industry emerges from the virus crisis. This caps the multiple the group can trade on and leaves estimates risks weighted to the downside.”