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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.
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.
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.
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.
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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