Associated British Foods plc Up, Home Retail Group Plc Down: Which Is The Better Buy Today?

Primark owner Associated British Foods (LSE: ABF) and Argos owner Home Retail (LSE: HOME) both released Christmas trading updates this morning.

Associated British Foods was among the top FTSE 100 risers when the markets opened, while Home Retail dived to the bottom of the FTSE 250 fallers’ board.

Primark bounces higher

ABF reported that revenue for the 16 weeks ended 3 January was 3% ahead of the same period last year at constant currency (1% at actual exchange rates). There was mixed news from the conglomerate’s sugar, grocery and ingredients businesses, but all eyes were on the group’s jewel in the crown, Primark.

Early last month, ABF had told shareholders at the company’s AGM that Primark’s autumn sales were around 10% ahead of the previous year, with like-for-like sales “currently below expectations as a result of the unseasonably warm weather”.

However, ABF this morning reported that Primark’s sales had bounced back in the five weeks including Christmas to such an extent that the business saw 15% growth at constant exchange rates (12% at actual rates) in the 16-week period to 3 January.

Looking ahead, ABF expects its sugar business to continue to be a drag on the group’s top and bottom lines for the next nine months, “but this will put much of the effect of the structural changes in EU prices, seen over the last three years, behind us”.

As a result of current weak sugar prices, and the strength of sterling, ABF expects a “marginal decline” in earnings for company’s financial year to September 2015.

Argos flat

Home Retail reported sales growth of just 0.8% (0.1% on a like-for-like basis) for Argos in the 18 weeks to 3 January. Sales at the group’s smaller Homebase business declined 2.7%, but with store closures reducing net space by 3.3%, like-for-like sales were up 0.6%.

Home Retail said Argos was impacted by a competitive retail environment of “aggressive promotions”, and that the draw of discounts affected trade both before and after Black Friday “as consumers satisfied their Christmas shopping lists with bargains”.

The company pursued a cautious trading stance, and by not chasing sales volumes achieved improved margins and good cost management. As such, management expects profit for the company’s financial year ending 28 February to be in line with consensus expectations.

Which company is the better buy?

On the face of it, Home Retail is a clear winner as the better buy based on the popular valuation measure of price-to-earnings (P/E). At a share price of 200p, Home Retail trades on 17 times forecast earnings, while ABF, at 3,100p, trades on 30 times forecast earnings.

However, there’s one line of argument — and I find it quite compelling — that says ABF is undervalued, even though the P/E is so high. A research report last year from Morgan Stanley argued that Primark could be worth £30bn as a standalone business. Right now, ABF, as a whole, is valued by the market at just £25bn.

Behind the Morgan Stanley analysts’ valuation is a comparison of Primark with H&M:

“Primark’s global network is less than a tenth of H&M’s but already generates sales equivalent to H&M a decade ago … Ten years from now we believe Primark should be at least as valuable as H&M is today … history shows that growth stories in the retail space have systematically been undervalued”.

According to Morgan Stanley, historical research shows the best returns for investors in retail have come from buying shares in companies with more than 20 years of double-digit space growth ahead of them, irrespective of valuation.

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G A Chester has no position in any shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.