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Why I’d buy Associated British Foods plc to complement Unilever plc in 2018

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Whenever I look over the companies in the FTSE 100, I often see some that I think go together hand-in-hand. One such pairing, in my view, is Unilever (LSE: ULVR) and Associated British Foods (LSE: ABF)

With its vast array of everyday brands, encompassing Dove, Sunsilk, Lipton, Marmite and many more,  it’s hard to go shopping and not buy any Unilever brands.

Add to that ABF’s brand portfolio, which includes Twinings, Ovaltine, Jordans, Ryvita, Silver Spoon… and together the two could just about fill the consumables aisles at any supermarket. And of course, ABF also owns the Primark value clothing chain — I’ve always thought that an odd match, but it’s a great performer.

Healthy outlook

I was surprised to see the ABF share price shed 3% on Thursday, to 2,770p, after a trading update told us that “our outlook for the group is unchanged” and that the company is expecting progress “in adjusted operating profit and adjusted earnings for the full year.

Revenue from continuing operations for the 16 weeks came in 4% ahead of the same period last year at constant currency, with total sales growth across all businesses (but excluding an expected fall in sugar revenue) reaching 6%. 

Primark was the star pupil again, with expansion of selling space helping it to a 7% rise in sales.

Progressively profitable

Operating margins should be about the same as last year, and the company expects to add new capacity to the tune of 1.2m square feet by the end of the current year.

ABF doesn’t offer particularly high dividends, which are yielding around 1.5%, but they are progressive and the company’s total long-term return is impressive.

A pretty flat three years and a recent dip has held the five-year share price performance to 68%, but that trounces the FTSE 100’s meagre 24%. And over 10 years we’re looking at a 227% gain compared to the index’s feeble 28%.

Best in class?

October’s third-quarter update from Unilever showed underlying sales growth of 2.6% for the quarter and 2.8% for the nine months, or 2.8% and 3.2% respectively, excluding the spreads business which is to be sold to the KKR investment firm for €6.825bn.

Unilever shares haven’t performed quite so well over 10 years, but their 133% gain still beats the index and most of its constituents, and Unilever’s dividend yields have been around twice those from ABF. Over the last few years, Unilever shareholders have been pocketing around 4% per year (or, if they’re sensible and haven’t needed the cash, reinvesting it). 

And with a 20% rise in EPS forecast for the full year, investors will be keenly awaiting full-year figures set to be released on 1 February.

Progressive dividends

Analysts expect the next couple of years to provide yields of 3.4% and 3.7%. And with a strong spell for rising earnings per share on the cards, cover should be ample — around 1.7 times by 2019.

As a sign of how much cash Unilever is generating, between May and December 2017 the company bought back shares to the value of €5bn.

It’s very nice being on the receiving end of high dividend yields today, but if they don’t keep up with inflation, their long-term value will suffer. Unilever’s are set to do far more than that, with hikes of 8.5% and 10% predicted for 2018 and 2019.

Time to buy

With the share prices of Unilever and Associated British Foods both in a short-term dip, now could be a great buying opportunity. But what other dividend payers can you add for diversification?

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.