This time last year, cost inflation was the biggest nemesis of Associated British Foods, but getting a handle on higher prices has put the owner of Primark on course to finish the year as one of the best performers in the FTSE 100. Yet its value credentials remain intact.
A recovery in margins could provide more fuel for the shares next year. At Primark, which accounts for almost half of group profits, the adjusted operating margin is expected to rise to 10 per cent this year, better than the 8.2 per cent recorded last year and closer to a pre-pandemic margin of 11.7 per cent.
The burdens of higher costs for raw materials, labour and freight hit profitability last year. However, absolute cost pressures are easing, along with the volatility in where they might end up. The group took a hit on margins last year to manage cost inflation, rather than lifting prices enough to compensate.
Any further improvement over and above the 10 per cent margin guidance depends on how consumer spending fares. If the economy performs better than expected, there could be a repeat of the profit upgrades announced for last year. At the moment analysts expect an adjusted operating profit of £1.81 billion, up from £1.51 billion last year.
Cost inflation has been the biggest challenge to Associated British Foods across its businesses. It was also the main source of reticence among investors towards the group. Confidence is growing that the worst is behind it, but the shares remain cheap. A forward price-earnings ratio of just under 13 is markedly below a ten-year average of almost 20.
Advertisement
The balance sheet is solid. Net debt stood at £2.27 billion at the end of September, equating to a leverage multiple of just under one, which triggered another £500 million share buyback, plus a 12.7p special dividend.
Free cashflow should be set for a significant increase this year. Working through inventories built up at Primark during the supply chain turmoil of the last financial year should mean that working capital unwinds. HSBC expects an inflow of about £200 million. The British defined-benefit pension scheme is now in surplus, which should free up £70 million in cash that was being directed towards contributions into the scheme.
That is in addition to higher expected profits. Analysts have forecast a rise in free cashflow to £1.02 billion this year, more than double last year’s figure. That raises the possibility of further special returns for the new financial year. Shore Capital has forecast a decline in net debt to £1.7 billion, against adjusted earnings before interest, taxes and other deductions of £2.58 billion, or a leverage multiple of 0.65. Associated British Foods considers leverage consistently below one as an indication that it has surplus capital.
Like-for-like sales growth is expected to be “modest”, but supplemented by about a million sq ft in new selling space. Indeed, the international expansion of Primark remains the greatest potential catalyst of all. The plan is to open new Primark shops in America, Italy, Iberia and France, increasing the total estate to 530 by 2026. New shops contributed 6 per cent to the 15 per cent sales growth from Primark in the last financial year. They typically take less than a year to become profitable.
The food businesses also look to be on a better footing. The grocery business, which owns brands including Twinings tea and Silver Spoon sugar, is expected to stabilise as inflation recedes and spending on marketing its international brands steps up. The ingredients division, where sales boomed last year, will ease, but sales and profitability for the sugar business are expected to be well ahead, after a poor British crop caused the group to look to third parties for alternative sources of supplies, increasing costs.
Advertisement
If Associated British Foods can keep its margins on track, it could be better appreciated by the market.
Advice: Buy
Why: The shares remain too cheaply valued
Fresnillo
There are few clear catalysts for Fresnillo any time soon and that suspicion is reflected in a torrid performance for the shares since the start of this year. More than a third of the Mexican precious metals miner’s market value has been wiped out, extending a lengthy record of poor performance.
Not even a rally in silver and gold prices in the wake of fresh global political turmoil could prompt investors to look past production hiccups and stubborn cost inflation. In the first six months of the year higher prices pushed revenue 6 per cent higher, but that was more than twice outstripped by the magnitude of cost increases.
Advertisement
Fresnillo has recent form in missing production expectations. Weaker volumes in the third quarter have not helped confidence in the world’s largest silver producer. In the quarter, output missed expectations, with silver production declining. The Fresnillo and Saucito mines were the biggest drag, hit by a lack of equipment availability and lower grades.
Things are not expected to improve in the final quarter. The outlook for this year has been set at between 57 million and 64 million ounces for silver and 590 thousand to 640 thousand ounces of gold. At the midpoint, that implies an annual rise in the latter but a fall of about 3 per cent in its silver output. Production out to 2025 is expected to be lacklustre and the forecast is for a decline in both gold and silver output against this year’s levels.
Cost inflation and the revaluation of the Mexican peso against the dollar, in which a chunk of the miner’s expenses are denominated, will be challenges next year. However, the consensus forecast is for a 5 per cent decline in costs in 2024. Analysts at Morgan Stanley think that is too optimistic, expecting a rise of almost 3 per cent. It will be driven primarily by wage inflation, an appreciation of the Mexican peso and higher energy costs as subsidies expire, the investment bank thinks.
Guidance for capital expenditure has been set at $505 million by 2025, a decline from this year, with heavy investment on opening its Juanicipio mine already spent. The question is whether more spending is needed. Morgan Stanley thinks so if Fresnillo is to extend the lives of its mines, which average six years.
Advice: Avoid
Why: Few near-term catalysts for the shares
