Analysts at Barclays have cut their rating for Associated British Foods PLC (LSE:ABF) (ABF) to 'equal-weight' from 'underweight' after chopping their target price for the owner of Primark and some well-known food brands in the wake of a cautious year-end trading update.
The analysts noted that with sterling plunging to its weakest level versus the dollar since 1985 combined with record energy costs, Primark’s margins are coming under pressure. In H2 this year, the new expectation is for a margin of 8% but the main disappointment is that 2023 margins will be lower than H2-22 (ie less than 8%), they added, which compares to the analysts' previous forecast of 10%.
In a note to clients, they said: "Despite Primark taking HSD pricing, it can’t justify taking more pricing simply to hit a percentage margin when there is massive near-term volatility on all key cost lines. Neither currency or energy is within Primark’s control, but we do think the weakness in Continental European LFLs is a concern. European LFLs of -18% in Q4 is worse than -15% last time and the concern is the weakness is quite broad."
READ: Primark not immune to the cost-of-living crisis, says owner ABF as it issues profit warning
The European apparel market is weak with consumers cautious with priorities elsewhere, the Barclays analysts noted, though one positive is that UK Primark trading is very solid with higher footfall and densities.
They also noted that ABF’s Sugar revenues are expected to be well ahead of last year, due to higher sugar and co-product prices and, despite higher energy and Vivergo costs, the analysts still have an upgrade in sugar due to the strength of EU sugar prices.
On the flipside, they added, Grocery is facing challenges, particularly in UK bread, where they estimate that losses have widened to £60mln. "In our view these losses need to be addressed more aggressively," the analysts said.
The Barclays analysts said they have cut their full-year 2023 (FY23) EBIT forecast for ABF by 23% to £650mln on the weaker outlook and have increased their tax rate forecast to 25%.
Despite their sugar estimates moving up by 10% as well as higher net financial income due to better interest rates on cash, the analysts said they still are left with a 10% cut to EPS forecasts for FY23.
They noted: "Whilst most of the downgrade (FX, energy) is outside of ABF’s control, there are question marks on Primark European LFLs and UK bread. Whilst we view the ambition to get back to a 10% Primark margin positively, it is far from clear that will happen in 2024. With net cash a bit lower (due to inventory timing) any buyback is to be modest and not a big catalyst."
The analysts concluded: "Until we get more visibility on the numerous moving parts, we take our rating down to EW and lower our PT to £15 (from £23)."
In early afternoon trading on Thursday, ABF shares were 7.6% lower at 1,344.50p.