Is Now The Time To Buy Associated British Foods?

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By

Rupert Hargreaves

Published in Company Comment on 4 February 2013

Should you buy Associated British Foods plc (LON: ABF) today?

I'm always searching for shares that can help ordinary investors like you make money from the stock market.

So right now I am trawling through the FTSE 100 (UKX) and giving my verdict on every member of the blue-chip index. Simply put, I'm hoping to pinpoint the very best buying opportunities in today's uncertain market.

Today I am looking at Associated British Foods (LSE: ABF) to determine whether you should consider buying the shares at 1,745p.

I am assessing each company on several ratios:

Price/Earnings (P/E): Does the share look good value when compared against its competitors?

Price Earnings Growth (PEG): Does the share look good value factoring in predicted growth?

Yield: Does the share provide a solid income for investors?

Dividend Cover: Is the dividend sustainable?

So let's look at the numbers:

StockPrice3-yr EPS growthProjected P/EPEGYield3-yr dividend growthDividend cover
Associated British Foods (ABF)1,745p75%18.321.6 %20%3

The consensus analyst estimate for this year's earnings per share is 95p (9% growth) and dividend per share is 31p (11% growth).

Trading on a projected P/E of 18.3, ABF appears more expensive than its peers in the Food Producers sector, which are currently trading on an average P/E of around 11. ABF's relatively high P/E and high double-digit growth rate give a PEG ratio of around 2, which implies the share price is slightly overpriced for the near-term earnings growth the firm is expected to produce.

Unfortunately, ABF's 1.6% dividend yield is about half of the Food Producers sector average, which is 2.8%. That said, ABF does have a three-year compounded dividend growth rate of 20%, implying the yield could soon catch up to that of its peers.

Furthermore, the dividend is three times covered, giving ABF plenty room for further payout growth.

Historic growth is strong but will it continue?

As I say, ABF's historic growth has been really strong and I believe this trend is set to continue. Indeed, within the group's interim results released only two weeks ago, ABF reported continuing growth across most of its divisions and aggregate group revenue was up 10% for the period.

In particular, ABF announced that its retail division, led by high street chain Primark, saw revenues grow 25%. I believe this strong growth was down to new store openings and a larger number of products in store.

In addition, ABF also saw strong growth in its sugar division, which saw revenues up 12%.

Despite these impressive growth figures, there could be some trouble ahead for the group. You see, ABF benefited from favourable commodity prices over 2012. However, I believe commodity prices could move against the group in 2013. For example, the price of sugar is currently at two-year lows, which could squeeze margins for the group's sugar business.

On the other hand, cotton prices remain near five-year lows, thus improving the outlook for Primark.

So overall, despite ABF's historic growth and future prospects I believe the company's current valuation is too high. With that in mind, I believe now does not look to be a good time to buy Associated British Foods at 1,745p.

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In the meantime, please stay tuned for my next verdict on a FTSE 100 share.

> Rupert does not own any share mentioned in this article.

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Comments

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TMFMarkRogers88 04 Feb 2013 , 2:54pm

I love some of the top companies being reviewed on here, I may be wrong, but in my opinion ABF is in the top 3% of quality out of the LSE's ~1600 companies.

Primark is a big reason for that, around 200 UK/Eire stores, plus 40 big stores around Europe, where the business is expanding rapidly. 20% returns on capital employed in those operations, with fairly consistent 10% margins. Now 28% of the group's revenue and 33% of operating profits. I see it as the rock of ABF's business. An excellent low-cost retailing operation with evidently strong growth prospects, and a highly recognisable brand appeal.

The Grocery (branded goods like Kingsmill and Twinings) and Ingredient sectors of the business are competitive, low margin operations. Consistency from year to year is hard to come by, and there's a strong degree of reliance on the underlying commodity price for margins and costs. Restructuring is ongoing to drive down these costs, but you'd be hard pressed to find a competitor that isn't doing exactly the same thing. The Twinings business is attractive though.

The third arm of the business is Agriculture and Sugar, which are ultimately commodity type (price taker) businesses, and are subject to the extent to which given prices are high, and costs per unit can be kept low relative to competition. Returns on capital seem high, but these types of businesses are notoriously tough and can be very inconsistent from year to year.

Overall I would be happier to see Primark become a bigger and bigger portion of ABF's business, especially through international expansion. The Grocery business adds some useful brands, and I'd be happy to see more household names in the ABF portfolio. Meanwhile the Ingredients, Agriculture and Sugar segments form a large part of the business, in ultimately very difficult markets to operate. That may make year to year returns more volatile, but these segments are well placed to benefit from increased global demand for food products in coming decades.

The valuation at the current time is a problem for me though. A very ambitious growth multiple has been placed on the company's market valuation, now at close to £14B. That acquisition price does not allow for a suitable margin of safety for my taste, but everyone is different in their preferences. I'd place fair value at around £10B for 2013, and would be unwilling to pay more than around £8B, so it's some way off my asking price. That's keeping in mind the price of alternative investment opportunities at the moment, and the volatile nature of some of ABF's underlying business. For the Primark business on its own, I might pay as much as £5B. All those figures are just an opinion on what I'd pay to reflect my own risk aversion, not a reflection of what I think the market price should be, I wouldn't want to talk down what is a very high quality company.

It's a testament to ABF that its investors rate the company highly enough to be worth £14B in the market, and I wish them the best of luck!

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