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Smart Investor: ABF – a good example of a share to avoid

Sometimes it is helpful looking at why a stock is not attractive. Associated British Foods  (ABF), whose brands include store-cupboard stalwarts Kingsmill, Ovaltine, Patak’s and Twinings, may sound like a defensive company but its numbers just don't add up. Smart Investor explains why.

 
Smart Investor: ABF – a good example of a share to avoid

Associated British Foods (ABF.L) may not be a household name, but many of its products are. Brands such as Kingsmill, Ovaltine, Patak’s and Twinings are well known, and ABF’s Primark chain is a mainstay of fashion-conscious spendthrifts.

However, ABF is more than just brands. The company is split into five segments: sugar, agriculture, retail, grocery and ingredients, which enables it to operate in a wide range of markets across the world.

ABF’s history goes back to 1935, when it was called Food Investments Ltd before it changed its name to Allied Bakeries just five weeks after inception. Since then, a large number of acquisitions have helped the company to grow, with a market capitalisation of £10 billion, making it the 38th-biggest company on the FTSE 100.

Performance

In terms of performance, the past five years have seen ABF’s net profit increase at an annualised rate of 8%, which is quite impressive given that this has been a challenging trading period. Of course, it could be argued that the company’s focus on consumer staples should stand it in good stead during economic slowdowns.

However, net profit was flat between 2010 and 2011; falling slightly from £546 million to £541 million. Over the five years return on equity averaged just 8.8% and was 9.4% last year, both of which are disappointing.

Disappointing dividends

Further disappointment comes in the size of ABF’s dividend yield. With the FTSE 100 average being around 3.6%, ABF’s 1.95% is simply not good enough, especially when the payout ratio is analysed.

In 2011 the payout ratio was just 36% and, although a higher ratio would not make the yield index-leading, it would certainly help. Of course, ABF could argue that dividends have grown at an annualised rate of 4.9% over the past five years (which is encouraging), but the current payout ratio remains mean.

The balance sheet, encouragingly, does not suffer from excessive financial leverage, with the debt to equity ratio being just 28.3%. Although this goes some way to explaining the low levels of return on equity (ROE), the explanation is not a full one, and single-figure ROE unfortunately indicates a lack of profitability.

Back to the topic of debt levels, and interest cover is perfectly adequate at nine, meaning that debts are comfortably serviced.

Weak cash flow

Interestingly, high levels of capital expenditure mean that free cash flow disappoints. It averages £207 million over the past five years versus average net profit of £434 million. However, ABF undoubtedly benefits from a substantial economic moat: the company operates in a wide range of markets across most of the world and, in addition, owns a significant number of valuable brands.

This means that it is likely to be in existence in the long run, even if a minority of its products and/or geographies prove to be challenging.

Valuation

Moving on to valuation, with shares currently trading at £12.67 ABF currently has a price-to-earnings (P/E) ratio of 18.4 and a price-to-book ratio of 1.75. Although the price-to-book ratio is not excessive, the company’s disappointing profitability means that the P/E ratio is unappealing.

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12 comments so far. Why not have your say?

alan franklin

Jul 13, 2012 at 07:10

Its is a possessive pronoun; it modifies a noun.

It's is a contraction of it is or it has. The apostrophe takes the place of a letter or letters.

Smart Investor should learn that when he writes about "its numbers" he shouldn't put an apostrophe between "it's" - writing it like that means "it is."

In that event the missing character would be indicated by the apostrophe - as in "shouldn't" ( should not.)

Please take a smarter English course.

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Harry Brooks (Citywire)

Jul 13, 2012 at 08:41

Thanks Alan, that's been corrected now. To be fair to Smart Investor, the mistake was introduced after he submitted his copy.

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Hotrod

Jul 13, 2012 at 09:11

Mr. Market would not agree with you. It is a top performer in my virtual portfolio of defensive stocks.

Firstly: It must be accepted that food processing, and wholesale supply are low margin. Always have been. That is why the decision was made to improve the business model by expanding into retail clothes, where margins are much higher.

Secondly: I think it is important to point out that the founders, The Weston family have held executive and consultative roles throughout the company's distinguished development.

Thirdly: No matter what happens to the world's economy, people must eat, so I cannot think of a more solid business to invest in.

Fourthly: When the company changed its branding to Kingsmill, the resulting products were not high standard, but a lot of work was put in and the varieties of bread which they now offer are much improved. I would rank them amongst the best.

Finally: The company has been steadfastly innovative and expansionary, I see no reason why this trend will not continue.

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William Phillips

Jul 13, 2012 at 09:40

The payout ratio and yield are low because the Westons don't want highly taxed dividend income, but that may not always be so as share stakes become diffused down the generations.

Writing a long deprecation of ABF's present valuation while barely discussing Primark, one of the most brilliant retail success stories of the last decade, seems unduly myopic unless every share in a portfolio is to be bought and sold on a one-year outlook.

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Jeremy Bosk

Jul 13, 2012 at 09:45

Smart Investor argues on financial valuation grounds more than brands. Having it both ways, I suggest that price conscious consumers will increasingly avoid brands for own label and no name products. Primark is a well known brand but is known for cheap and nasty rather than quality. Wear it once, as cheap imitation fashion, then throw it away is a limited market.

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Ivor Nestegg

Jul 13, 2012 at 09:48

From my point of view, the fact of the matter is that this is one of the best performing shares in my portfolio at present. Up by 18% in the last year compared with a fall of 9% for the FTSE100 over the same period.

Quid nunc?

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Daniel Victor

Jul 13, 2012 at 10:09

If your profitability is low,you probably need to plough back most of the profits you do make in order to grow at a sensible rate.In any case,a company is better off using its profits to repay debt rather than to pay a higher dividend.

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YORKIE

Jul 13, 2012 at 10:26

I worked for an ABF Company for five years, many years ago.

I enjoyed it and was impressed by the very efficient way the organisation was run, particularly on the financial side.

In the long run I don't think you will ever lose money with ABF.

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Beamtree

Jul 13, 2012 at 10:29

Sometimes financial commentators have to write some form of claptrap in order to earn a living & platforms such as Citywire, on a unexciting no bad news day (China growth was according to expectations!) have to have some form of rubbish to put out there in order to pretend to say something remotely relevant for a company that declared some excellent results yesterday, given the economic times we live in!

I am gradually losing faith in Citywire & its "young pups", pretending to know it all when they know "jack", just as I have with Hargreaves & Lansdowne`s "Beared One" as someone so aptly called him yesterday in his comment on the much-plugged Artemis Special Situations Fund by HL!

Fact is that ABF is a strong solid company operating in some of the most basic, unpretentious "absolute need" industries whose products we all need. As stated above, its a best performer in my portfolio too - and is likely to carry-on being so, unlike some of my other more glamorous stocks& funds that I previously foolishly bought into listening to similar claptrap as the one spouted by this so-called "Smart Investor" - what a misnomer!!!

Thankfully, I am now gradually changing my portfolio, and doing my own homework, & yielding much better results than listening & letting other people manage my money & enriching them in the form of commissions & fees! We live & we learn!!!

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David Mason

Jul 13, 2012 at 21:01

Following in his father Gary's footsteps, George Weston is doing a great job of running ABF, but if people prefer the Banks, M&S or a host of other badly manged company's, with a share price going nowhere and overpaid Chief Exec's ...good luck to them!

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John W Plant

Jul 15, 2012 at 07:21

I was amazed to read the general thrust of the argument, since I consider ABF to be one of the best defensive shares - So do the respondents who have commented!

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Steven Heath

Sep 11, 2012 at 03:23

ABF , has held it's share price , when most collapsed . Wish i had bought at the beginning of this year . Good Solid Share .

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