Analysts at UBS downgraded Associated British Foods PLC (LSE:ABF) (AB Foods) to 'neutral' from 'buy' following the Primark owner's pre-close trading update which they said implies little near-term upside.
In a note to clients, the Swiss Bank's analysts cited three reasons for the rating downgrade: "1) group adj. operating profit cuts of -3%/-14% for FY22E/ FY23E, driven mainly by the Primark downgrades of c-8%/-27%, Grocery downgrades of c.-10%, offset in part by upgrades in Sugar; 2) while we expect Primark to bridge back to c10% margin (FY23E: 7%; cut from 9.8%) over the midterm the margin profile over that time is below our prior expectations; and 3) higher capital intensity."
The analysts said they have raised capex (capital expenditure) and working capital requirements for Primark over the forecast period, which leads to a lower valuation for the division both based on DCF (discounted cashflow) and SOTP (sum of the parts).
They noted that these factors drive a reduced target price for ABF of 1,450p down from 2,300p previously. In morning trade on Wednesday, AB Foods' shares were changing hands at 1,323.50p, up 0.2% on Tuesday's close.
The UBS analysts said: "We think Primark is likely to emerge in a stronger competitive position in the midterm following this decision not to raise prices beyond what is in the pipeline for Spring/Summer next year. But we expect the shares to perform in line with (the) market until there is evidence of some progress on sales/margin trends."
They concluded that "with limited potential upside to our PT and an apparent lack of catalysts, we cut our rating to Neutral", adding that their preferred stock in the clothing retail sector is Zara-owner Inditex, with the Spanish firm "demonstrating good sales momentum with more resilient profitability".