Stock of the day: Primark can cushion ABF's sugar comedown

A 4% share price fall by Primark owner Associated British Foods shows its sugar high is well and truly over

Stock of the day: Primark can cushion ABF's sugar comedown

Sugar rush

Associated British Foods shares have just seen their third-biggest fall this year after running as high as 43% since February. One partial explanation is that the advance had already priced the 22% jump in annual adjusted operating profit unveiled on Tuesday. In fact, the stock has extended losses for most of the day, as investors shrugged off a stack of solid metrics.

  • Underlying profits from ABF’s sugar businesses rushed 374% higher
  • Primark revenue rose 19%
  • Positive Primark like-for-like sales in first 7 weeks of 17/18,  bucking the high street trend

Market sours

And although ABF’s cut-price fast-fashion chain hasn’t been totally immune to another prevailing trend, shrinking margins, ABF still reversed a negative £500m cash position at the end of the prior financial year by ending 16/17 a solid £637m in the black. The comedown is all about sugar. The world’s second largest sugar producer has reduced its cost base in preparation for the abolition of EU quotas that kicked last month. ABF, like the entire industry, expects EU prices to be lower in 2017/18, with an impact on profits. The scale of the comedown wasn’t quantified though, another potential reason for Tuesday’s stock price punishment. Even though ABF sees a strong EUR/GBP cushioning UK profits, investors are restive. After all, EU production is forecast to surge. France’s agriculture ministry sees output up 6mt, and Germany’s sugar industry association sees a 27% increase there. More widely, Australian government forecasters cut their average view of New York spot prices to the lowest average since 2007/8.

More cash, less margin

Still, whilst we agree ABF’s 2017/18 earnings growth will struggle to match the one before we think some shareholders’ pessimism is overdone. True, it’s difficult to look through ABF’s premium rating of 24 times the new year’s earnings. Sports Direct, rated the same, is a pure cheap fashion play bereft of sugar exposure. Next Plc. way down at 11 times, boasts an operating margin almost double the 10.4% ABF saw over the last twelve months. Even weighed down by sugar though, ABF is still generating cash faster than high street clothing rivals M&S, Next and Sports Direct (see Figure 1). The lead vindicates Primark’s decision to reject price rises after the Brexit vote, whilst others pulled the trigger. With ABF’s cost base optimised ahead of a potentially deeper retail chill, we expect Primark to remain ABF’s trump card.

Figure 1 - price-to-free cash flow daily time series / key: MKS – M&S; SPD – Sports Direct; NXT - Next

Source: Thomson Reuters and City Index

Technical price chart

ABF’s stock price chart confirms the comedown has truly begun. Note the decisive breach of the clear rising trend channel that commenced in April. The stock has also sliced past 3183p, the top of its range during the punishing autumn of 2016, when the stock lost 24% in a month. We would expect 3030p-3060p to become magnetic now, given that that range played resistance in September last year and over June-August in 2017. Support is possible there. If not, the prior 61.8% (2895p) marker of September/October 2016’s fall could be in play again. Worse, perhaps 2816p may be needed, where ABF reversed to the upside in July.

Figure 2 - share price chart: Associated British Foods (daily intervals)

Source: Thomson Reuters and City Index

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