Value in spinning out Primark from Associated British Foods

Conglomerates were all the rage in the 1960s, but fell out of fashion along with the beehive hairdo. Primark is about to remind us why. The fast-growing clothing operation is part of Associated British Foods (ABF), whose other businesses include sugar processing, food ingredients and brands such as Twinings Tea, as well as agriculture.

It is an eclectic mix, but one that has rewarded investors handsomely.

In the past decade ABF has delivered a total return of 380%, compared with 47% for the FTSE All Share Index.

Diversification helped power Primark from its birth in the 1960s as an Irish discount clothing chain to aggressive expansion across Europe and more recently into the US.

Unusually, compared to other clothing companies, it is been able to grow without a spike in borrowing — its debt to common equity ratio is just 14.1%, compared with 63.3% at Marks & Spencer.

Primark’s growth threatens to upend the balance across all of ABF’s the companies.

It already accounts for 42% of ABF’s sales and 59% of operating profit, and analysts at Liberum forecast that it could double sales and profits over the next five years.

It’s all down to its move across the Atlantic.

Customers of all ages are already responding well to its low prices, but landlords will be falling over themselves to lure Primark into their malls — they have got holes to fill in their properties as the likes of Macy’s, JC Penney, and Gap cut back on stores.

In contrast, profit from sugar operations has dissolved from 35% of ABF’s total in 2013 to just 4% in the year to September 2015.

While Primark is in a growth phase and the global environment proves fragile, the cashflows from the rest of ABF offer a nice safety cushion. But once its growth is more entrenched, Primark’s profits will far surpass that of the rest of ABF.

Then there are the valuations. According to Shore Capital, Primark will generate about £500mn (€646.5m) of post-tax profit in the year to September 2016, and account for £18.5bn, or about three quarters, of ABF’s £25bn value.

That puts Primark on about 37 times the next 12 months earnings, a hefty premium to both Spain’s Inditex, the owner of the Zara retail brand, and Sweden’s Hennes & Mauritz.

However, Shore forecasts that post-tax profits will expand to about £700m in 2018, putting it on valuation of about 26 times, not that far from Inditex.

That’s too lowif the US turbo-charges Primark’s sales, it should command a bigger premium.

The remainder, including sugar production and groceries such as Ryvita crackers and Kingsmill bread, are on about the same valuation as the broader packaged food industry.

That looks fair for now, but might look mean if the sugar business finally recovers. So pretty soon there could be value to be realised by spinning out Primark, or even perhaps the remaining rump of companies under the ABF umbrella.


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