Right now, shares in Associated British Foods (LSE:ABF) — or ABF for short — come with a 3.4% dividend yield. That doesn’t look like much, but that’s the highest it’s been in the last 10 years.
There’s also an ongoing share buyback programme worth £500m (or 3.7% of the current market value). So with a potential return of just over 7%, should investors pay attention?
Why’s the stock down?
The share price has fallen almost 10%. In a volatile stock market, that doesn’t sound like a lot, but the FTSE 100 is up 6% in that time.
Latest results at the company haven’t been good. Sales at Primark – which accounts for around half of overall revenues – climbed just 1.9% (after adjusting for exchange rates).
With inflation above 2%, this means revenues in arguably the most attractive part of the business were down in real terms. And the other divisions mostly fared even worse.
I therefore don’t think there’s much mystery as to why the stock’s been falling. But the question is has it reached a level where it’s a bargain?
Valuation
ABF isn’t just a value fashion/lifestyle retailer – there are also grocery, ingredient, sugar, and agriculture divisions. But none of these fill me with much enthusiasm.
As a result, I view the stock as a bargain when Primark by itself is enough to justify the share price. In other words, when the other parts of the company are essentially free.
Right now, Primark generates £9.5bn in revenues and operating margins are expected to be around 10%. That means investors should probably expect around £950m in operating income.
On this basis, the current £13.5bn market-cap implies a potential return of around 7%. I don’t think that’s bad and the combination of dividends and buybacks create scope for growth.
Dividend growth
With ABF, its revenues depend on a lot of factors beyond its control. The weather – for example – can affect sales and this is a significant risk for investors to consider.
When it comes to issues like this, there isn’t much investors can do. The best strategy, in my view, is to make sure they’re well-compensated for the inherent risks.
On the face of it, a 3.4% dividend isn’t a great incentive. But this overlooks the effect of the ongoing share buybacks, which create significant growth potential.
The current repurchases could lower the share count, so the same overall distribution might result in a higher dividend per share in 2025. And 3.7% is enough to outperform inflation.
A stock to consider
I think now’s a very good time to take a closer look at the stock. It’s down due to weak results, but the time to think about being greedy is when others are fearful.
The dividend yield is the highest it’s been in years and share buybacks create the potential for further increases. Over the long term, I think that could be a good passive income opportunity.
In my view, the stock’s also close to the point where Primark by itself might justify the entire investment. So while there are risks, there could be decent compensation for considering them.
