Recently there’s been good news from the owner of discount clothing chain Primark, Associated British Foods (LSE: ABF). The company announced at its annual general meeting last week that trading at the retailer so far this year has been ahead of expectations. What does that mean for ABF shares? Below I consider where the shares might go next and whether I ought to put them in my shopping basket.
Business is recovering at Primark
In the update, ABF said that like-for-like sales have improved compared to the fourth quarter of its last financial year. But the good news wasn’t limited to sales figures. At a time when supply chain disruption is troubling many retailers, the company said that it’s managing such disruption. And it has stock cover for the “vast majority” of its product lines for the Christmas trading period.
ABF also owns a number of well-known food businesses, as its name suggests. But over the past few years, Primark has become a key part of the investment case for the company. It now has 400 shops spread across a number of international markets. The fast fashion favourite had been the largest revenue contributor to ABF in the years leading up to the pandemic. That’s why Primark trade getting back on track is a critical element of the pandemic recovery story for ABF shares, in my opinion.
Attractive business but not cheap
There was already a lot to like about the ABF business before Primark became quite so prominent. It owns a wide range of key brands such as Twinings, Allinson’s and Silver Spoon. That gives it pricing power. Some of the food sectors in which it operates, such as sugar refining and distribution, have fairly high barriers to entry due to their capital expenditure requirements. That can help support ABF profit margins.
Primark added something very different to the company’s business model. The clothing chain’s business cycle isn’t connected to that of food. In principle that adds to the company’s diversification. But as we saw last year, it can also mean that ABF shares suffer overall when Primark underperforms, even if the food divisions are doing fine. That risk remains. For example, further lockdowns affecting Primark could eat into revenues and profits for the whole company. In fact, lockdowns could hurt Primark more than many competitors because its operations are based only on physical shops, not online channels.
Overall though, I continue to find the investment case for ABF attractive. It has proved that it’s well run, with an efficient business operation. But with a price-to-earnings ratio over 30, I think that’s already reflected in the price of ABF shares.
Should I buy ABF shares now?
Despite its attractive business model and improving performance at the Primark division, I don’t plan on adding ABF shares to my portfolio at the moment. Over the past 12 months, they’ve lost 15% as I write. I think that underlines City nervousness about how deep-rooted the company’s recovery may turn out to be.
Not only is the Primark recovery subject to key markets remaining open, there are risks in the food business too. Ingredients price inflation could hurt profit margins in the foods business if the company can’t pass higher prices on to customers, for example.
