coldsnowstorm
Overview
This is a follow-up update on my take on Associated British Foods (OTCPK:ASBFY) 1H results. Overall, ASBFY performed much in-line and my thesis stays the same. ASBFY is a multinational corporation that operates in the food and retail sectors and holds dominant market shares in the majority of the industries and geographies in which it participates. Primark (the gem of the business), its value retail business, has a more inspiring store environment and, in my opinion, offers a winning combination of competitively low pricing and fashionability. The 1H results, however, did have two highlights that have reinforced my thesis. Firstly, Primark continues to gain shares – which validates my thesis that Primark is enjoying the tailwind of consumers trading down. Secondly, management has reaffirmed its EBIT margin guide for Primark at a specific value, rather than a range provided previously. All in all, I reaffirmed my buy rating for the stock.
Primark continues its momentum
The core of my thesis – Primark – continues to perform very well in this market environment. In the face of rising prices and shrinking disposable incomes, I anticipate that consumers will continue to trade down, benefiting Primark’s market share. What has made Primark appealing now is the new growth opportunities from new spaces – US and Europe. In particular, the underlying performance in newly open areas have shown very positive feedback – specifically the densities that some of these new stores have achieved. A key indicator that I monitor to track the growth momentum and demand for Primark is the opening of new stores and DC. Evidently, it remains strong as ASBFY opened the second US DC to support growth plans for penetrating the Southern states and has also entered Hungary. These are clear indicators of two things: demand remains strong and the TAM for Primark is a lot higher than I expected as it can continue to penetrate the entire of Europe. While I do acknowledge the pushback that these are margin dilutive (need more discounts in new zones and also cost to supply chain), but I believe the amount of absolute profits made is more important than the optics of having high margin. If ASBFY can 2x its profit in dollar terms, but margin goes down, I would take that any day. I also like the fact that management is not sleeping on its existing base of stores. They’ve declared a reorganization and expansion strategy for the German market, which includes the closure of some stores, the consolidation of others’ spaces, and the opening of others’, all while also funding the opening of some new, smaller stores in untapped areas. This tells me that there are still inefficiencies in the network that can be further optimized for more margin improvement and growth. Other initiatives at Primark are developing well too. For example, the online stock checker has been very successful, with adoption rates of 20%, and the click and collect trial is going to be expanded to 32 more stores across London, for a total of 57 stores, thanks to strong attachment rates.
My overall assessment is that Primark will continue to gain market share across all regions, with the exception of Germany, which is undergoing a restructuring phase at the moment. My assessment of Primark is consistent with the company’s management’s, though they remain cautious about the strength of consumer spending in the face of high inflation. Management also now explicitly guide for FY23 Primark operating margin of around 8.3%, which is within its prior range of more than 8%. While I expected higher margins, I believe this is positive as well given the investments required for digital and click & collect roll-out.
Valuation
ASBFY continues to trade at an attractive valuation of 13x forward earnings, which is one standard deviation lower than its 10-year average of 20x. I believe that the headline risk of inflation and household spending cuts has led many investors to take a wait-and-see approach. This has created a compelling entry point for investors who can see through the haze and recognize that ASBFY is one of the winners in this environment (due to Primark’s value proposition to consumers). If ASBFY continues to meet its targets and grow, I believe the stock will benefit from a reversion to average multiples.
Conclusion
I reaffirm my buy rating for the stock. The standout performer, Primark, continues to gain market share, benefiting from consumers trading down in the face of rising prices and shrinking disposable incomes. The expansion into new markets, particularly the US and Europe, presents growth opportunities for Primark, with positive feedback and strong demand observed in newly opened areas. ASBFY’s commitment to optimizing its existing store network and implementing reorganization and expansion strategies demonstrates a drive for margin improvement and growth. Although cautious about consumer spending in the face of high inflation, management’s guidance for the operating margin of around 8.3% in FY23 is within the prior range and accounts for necessary investments in digitalization. From a valuation perspective, ASBFY presents an attractive opportunity, trading at a lower multiple than its historical average.
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