26 November 2012 Readers in all geographies please refer to important disclosures and disclaimers starting on page 12. In the United Kingdom this document is a MARKETING COMMUNICATION. It has not been prepared in accordance with the rules in the FSA Conduct of Business Sourcebook designed to promote the independence of research and is also not subject to any prohibition on dealing ahead of the dissemination of research. Full analyst contact details are shown on the back page. Martin Deboo +44 (0)20 7597 5044 [email protected]Company Research AB Foods (ABF.L) United Kingdom | Food Producers Primark valuation revisited (again) Despite post-prelims sidegrades, the shares continue their climb. With the quantum of profit in Sugars and the quantum of value in Primark the only two debates worth having, we focus on the latter in this note. While we are bullish on the prospects for Primark, we think that the 12-13x EBITDA that the share price is now apparently discounting is full and fair. Our 12-month SOTP price target rises to 1400p, but this adds up to a signal to take some profits for us. Martin Deboo +44 (0)20 7597 5044 [email protected]Caution confounded, again. ABF continues to confound our caution (and Hold reco) with the shares ahead of the FTSE 100 over 1, 3 and 6 months, despite sidegrades post the prelims on Nov 6. Intensely frustrating for us. But we are where we are and the share price starts tomorrow, as we like to say. Rising sentiment on Primark the driver? Primark impressed again at the prelims and we think that it is renewed positive sentiment here that is driving the shares. Our modelling suggests that the embedded Primark Enterprise multiple has expanded by 70% since early 2011 and that Primark is now being implicitly valued at parity with H&M and Inditex. Looking fully valued to us. The extreme bull case on Primark, as we understand it, is that business is set for sustained dynamic growth and is worth the 20+times EBITDA/40+ times earnings multiples that attached to its close analogue H&M in its late 1990s’ growth heyday. However the late 1990s was – well – the late 1990s and buying into H&M at such high multiples was an act of folly, judged with hindsight. Consider taking profits? More sober counsels argue to us that a prospective EV:EBITDA of 12-13x is full and fair for Primark, even in the face of such good prospects and returns. We remain admirers, but cautious Holders, at this level and would be inclined to take some profits on the back of recent momentum. Financials and valuation Year end: 30 September Price Performance Source: Company accounts/Investec Securities estimates Source: FactSet HOLD Price: 1450p Target: 1400p (prev: 1300p) Forecast Total Return: -1.3% Market Cap: £11bn EV: £12bn Average daily volume: 937k 2011A 2012A 2013E 2014E 2015E Revenue (£m) 11,065 12,252 12,776 13,499 14,216 EBITDA (£m) 1,238 1,471 1,530 1,633 1,731 EBITA (£m) 921 1,077 1,130 1,206 1,282 PBT (normalised) (£m) 836 974 1,032 1,115 1,204 Net Income (normalised) (£m) 585 688 728 788 852 EPS (normalised & continuing) - FD (p) 74.2 87.2 92.2 99.7 107.6 FCFPS - FD (p) (21.4) 55.0 47.6 59.0 71.4 DPS (p) 24.8 28.5 30.4 32.9 35.5 PE (normalised) (x) 19.5 16.6 15.7 14.5 13.5 EV/sales (x) 1.1 1.0 1.0 0.9 0.9 EV/EBITDA (x) 10.1 8.5 8.2 7.6 7.2 FCF yield (%) (1.5) 3.8 3.3 4.1 4.9 Dividend yield (%) 1.7 2.0 2.1 2.3 2.4 1,000 1,050 1,100 1,150 1,200 1,250 1,300 1,350 1,400 1,450 1,500 Nov-11 Feb-12 May-12 Aug-12 1m 3m 12m Price 5.5 9.1 33.6 vs. FTSE All Share 5.4 7.8 17.0
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
26 November 2012
Readers in all geographies please refer to important disclosures and disclaimers starting on page 12. In the United Kingdom this document is a MARKETING COMMUNICATION. It has not been prepared in accordance with the rules in the FSA Conduct of Business Sourcebook designed to promote the independence of research and is also not subject to any prohibition on dealing ahead of the dissemination of research. Full analyst contact details are shown on the back
Exhibit 1 highlights this analysis. It suggests that, relative to its recent valuation
nadir in March 2011, when the Primark enterprise multiple fell to 7.4x on the back of
cotton price worries, the multiple has now re-expanded by 70%, to 12.7x. As Exhibit
1 shows, this now puts Primark on broad valuation parity with European peers H&M
(Rec: Not Rated) and Inditex (Not Rated) and at a substantial premium to UK peers
M&S (Sell) and Next (Hold).
The analysis in Exhibit 1 is central to our thinking and we are sensitive to the fact
that it looks suspiciously precise, given that Primark is not a traded instrument. So
let us explain it a bit.
We start with ABF’s daily enterprise valuation, defined as its daily market cap plus
our forecast of net debt and the (small) pension deficit on a daily rolling basis. We
then subtract the value of ABF’s Ilovo stake, based on Ilovo’s daily market cap, then
add the capitalised value of the central costs. This gets us to the daily enterprise
value of ABF’s trading Divisions ex. Ilovo. We then value the Divisions ex. Primark
on the basis of daily prospective EV:EBITDA multiple of some relevant benchmarks,
within which the choice of parity with Suedzucker for Sugars ex. Ilovo, and a 40%
discount to Nestle for Grocery, are the key ones. That leaves the value of Primark,
which we re-express as a multiple of prospective rolling EBITDA per our forecasts.
Readers are free to disagree with our valuation benchmarks and there is therefore
legitimate debate over the average ‘height’ of the Primark multiple in Exhibit 1. But
given that our valuation benchmarks are consistently applied over time, and reflect
daily traded multiples in the marketplace, there can be less debate over the trend in
In fact Exhibit 1 may be under-stating the extent of Primark’s multiple expansion if
one takes the view that the market’s embedded valuation of ABF’s Grocery and
Ingredients businesses has been under-performing our chosen benchmarks of
Nestle and ADM respectively, which we would argue they have.
Is the Primark valuation still too cautious? The case of
H&M in the late 1990s Rapid multiple expansion notwithstanding, we are alive to the potential for a bull
case on Primark beyond our estimated 12.7x prospective EBITDA.
This bull case, if we understand it correctly, is that retail concepts undergoing
dynamic periods of growth, particularly international growth, deserve to trade on
high premium multiples. The case rests in particular on the valuation dynamics of
H&M, the Swedish-domiciled value retailer, during its period of rapid expansion in
the late 1990s. This is of course a highly relevant and compelling precedent for
Primark, given that it competes in the same market segment as H&M and is
arguably run on the same sort of ‘managing for long-term value’ principles as its
Scandinavian peer.
Exhibit 2 looks at the long-run trend in the consensus prospective PER and
EV:EBITDA multiples for H&M since the mid-1990s (EV:EBITDA data is only
available from 1999 onwards). As can be seen, H&M went through a period of
explosive multiple expansion from 1995 onwards. At its valuation peak in January
2000, it traded on 67x earnings and 41x EBITDA.
The first and obvious point to make here is that these multiples were achieved in a
rapidly rising market in a period that was, with hindsight, one of extreme value
irrationality. Sales, and growth in sales (as opposed to profit, cash flow or capital
returns), was the only performance metric worthy of consideration. Profit multiples
decoupled from their long-run trends with the result that the FTSE 100 was trading
on 26x earnings, as opposed to 11x now, albeit with a different mix of constituents.
We think that Primark’s embedded
multiple has expanded sharply, to 12-13x
EBITDA
While we think there is room to debate
the absolute valuation on Primark, the
rate of multiple expansion is hard to
argue against
The bull case on valuation from here is
predicated on the valuation of H&M
during its period of sharp expansion in
the late 1990s
At the peak of this period H&M traded on
67x earnings and 41x EBITDA
These multiples were of course achieved
in a rapidly rising market
Page 4 | 26 November 2012 | AB Foods
Exhibit 2: Prospective consensus PER & EV:EBITDA multiples for H&M; 1995-
Source: FactSet; Investec Securities analysis
So we are in a much more sober period and the verdict of hindsight is that it would
have been an act of total folly to invest in H&M at 67x earnings in January 2000.
But that is not to say that there is probative value for Primark in the H&M
experience. While the absolute multiples it achieved were off the scale, it delivered
(and continues to deliver) genuine and durable growth.
So how does what H&M was delivering since the late 1990s compare to what
Primark is delivering now?
The six charts in Exhibit 3 lay out the evidence. The visual logic of each chart is to
look at long-run (since the early 1990s) performance of H&M and then to
benchmark Primark’s current performance against it (the flat red line on each chart).
Our observations are as follows:
Sales growth at H&M in the late 1990s (be it total or LFL1) was substantially
ahead of Primark now (of the order of 2-3x)
Operating profit growth was also well ahead (of the order of 2x), apart from
2000 when higher depreciation on new stores and price discounting hit profits
Returns on capital employed were generally somewhat lower than what
Primark is delivering now
H&M’s rate of store openings was substantially higher than Primark (c. one
and half times as high) and H&M was also internationalising faster at that point
1 Note that H&M didn’t report comparable store sales until 2006 and has never reported selling space. We therefore
rely on the rate of increase in sales per store prior to 2006, but concede that this is a crude proxy for true LFL at
best
0 x
10 x
20 x
30 x
40 x
50 x
60 x
70 x
80 x
PER EV:EBITDA
We compare what H&M was delivering in
the late 1990s with what Primark is
delivering now
Sales growth, profit growth and store
expansion were ahead of Primark now,
but ROCE was behind
Page 5 | 26 November 2012 | AB Foods
Exhibit 3a: H&M total sales growth at constant currencies Red line is recent Primark level
Exhibit 3b: H&M ‘LFL’ sales growth1 Red line is recent Primark level
Source: H&M; Investec Securities analysis & estimates Source: H&M; Investec Securities analysis & estimates 1 Growth in sales per store prior to 2006, comparable store sales since
Exhibit 3c: H&M operating profit growth Red line is recent Primark level
Exhibit 3d: H&M return on capital employed (lease-adjusted)1 Red line is recent Primark level
Source: H&M; Investec Securities analysis & estimates Source: H&M; Investec Securities analysis & estimates 1 Adjusted for operating leases assuming reported rents and an assumed 6.5%
yield. Rents prior to 2000 estimated on the basis of a constant proportion of sales
Exhibit 3e: H&M annual growth in number of stores Red line is recent Primark level
Exhibit 3f: H&M number of countries present Red line is recent Primark level
year. Australia grocery is coming off the ropes and should start to benefit from
recent restructuring investment.
But we think there is an argument for a bit of profit-taking on recent strength and
remain in the cautious Holders camp.
Exhibit 6: Risks to our price target of 1400p
Division/line item What have we assumed? What are the risks?
Sugars, particularly EU An EU sugar price of €760/tonne in the UK in FY13, falling to €700/tonne in FY14. A price of €720/tonne in Spain in FY13, falling to €680/tonne in FY14
We think UK prices have been substantially locked in for FY13 but there remains some risk in Spain in H2 FY13 due to shorter-term contracting
A UK beet crop of c.1.15 m tonnes in FY13 and a 17.5% sugar extraction rate
The crop is in the process of being harvested and remains sensitive to both field yields and extraction rates
Primark 4% LFLs in FY13, 11% sales growth from new space (13 new stores)
LFLs are sensitive to the consumer outlook and competitor actions. Flagship store openings have the potential to exceed or undershoot forecasts
A 20bps increase in operating margins in FY13 Principal cost exposures are to cotton, store staff wages and Asian outsourced labour. We expect these to be containable in FY13
Grocery Reversal of £40m of restructuring charges in FY13, slightly increased underlying margins and c.3% LFL sales growth
Consumer demand for groceries in the UK and worldwide remains febrile
UK wheat prices are a major uncertainty in ABF's bread business
Australia may continue to prove problematic
Other Divisions Only modest growth in profits in Ingredients and Agriculture in FY13, from a low base
While competitive pressures persist, Ingredients profits are at an historic low and the business is under new management
Cashflow, net debt & financing costs Net debt falling by c. £50m in FY13 and a further £180m in FY14 on rising EBITDA and falling capex
We think ABF is soundly financed (net debt is c.0.9x EBITDA) and see financing risk as relatively immaterial
A net interest rate on net debt of 6%
Exchange rates A $ fx rate of 1.60 in both FY13 & FY14 c.50% of Group profits arises from outside the UK, so fx is a key sensitivity
A € rate of 1.25 in both FY13 & FY14 The € is a key sensitivity in Sugars as both sales and costs are denominated in €
Tax We follow company guidance of a 25.5% effective tax rate
The tax rate is sensitive to both the geographic mix of profits and changes I local corporate tax rates
In the United Kingdom refers to Investment Banking & Securities a division of Investec Bank plc.
Investec Bank plc is authorised and regulated by the FSA and a member of the London Stock Exchange. Registered in England No. 489604
Registered Office Address: 2 Gresham Street London EC2V 7QP Telephone: +44 20 7597 4000 Fax: +44 20 7597 4070
In South Africa refers to Investec Securities Limited an authorised financial services provider and a member of the JSE Limited. Registered in South Africa Number 1972/008905/06
This report has been issued or approved for issue by an entity forming part of Investec (as defined below) and has been forwarded to you solely for your information and should not be considered as an offer or solicitation of an offer to sell, buy or subscribe to any securities or any derivative instrument or any other rights pertaining thereto (“financial instruments”). This report is intended for use by professional and business investors only. This report may not be reproduced without the consent of Investec.
The information and opinions expressed in this report have been compiled from sources believed to be reliable, but, neither Investec, nor any of its directors, officers, or employees accepts liability for any loss arising from the use hereof or makes any representations as to its accuracy and completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this report. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied is made regarding future performance. This information is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed and it may not contain all material information concerning the company and its subsidiaries. Investec is not agreeing to nor is it required to update the opinions, forecasts or estimates contained herein.
The value of any securities or financial instruments mentioned in this report can fall as well as rise. Foreign currency denominated securities and financial instruments are subject to fluctuations in exchange rates that may have a positive or adverse effect on the value, price or income of such securities or financial instruments. Certain transactions, including those involving futures, options and other derivative instruments, can give rise to substantial risk and are not suitable for all investors. This report does not have regard to the specific instrument objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities, financial instrument or investment strategies discussed in this report.
Investec (or its directors, officers or employees) may to the extent permitted by law, own or have a position in the securities or financial instruments (including derivative instruments or any other rights pertaining thereto) of any company or related company referred to herein, and may add to or dispose of any such position or may make a market or act as a principal in any transaction in such securities or financial transactions. Directors of Investec may also be directors of any of the companies mentioned in this report. Investec may from time to time provide or solicit investment banking, underwriting or other financial services to, for or from any company referred to herein. Investec (or its directors, officers or employees) may to the extent permitted by law, act upon or use the information or opinions presented herein, or research or analysis on which they are based prior to the material being published. Investec may have issued other reports that are inconsistent with, and reach different conclusions from, the information presented in this report. Those reports reflect the different assumptions, views and analytical methods of the analysts who prepared them.
The securities or financial instruments described herein may not have been registered under the US Securities Act of 1933, and may not be offered or sold in the United States of America or to US persons unless they have been registered under such Act, or except in compliance with an exemption from the registration requirements or such Act. US entities that are interested in trading securities listed in this report should contact a US registered broker dealer. Investec Securities (US) LLC accepts responsibility for the issuance of this report when distributed in the United States to US persons who meet the definition of a US major institutional investor. The distribution of this document in other jurisdictions may be prohibited by rules, regulations and/or laws of such jurisdiction. Any failure to comply with such restrictions may constitute a violation of United States securities laws or the laws of any such other jurisdiction.
For the purposes of this disclaimer, “Investec” shall mean: (i) Investec Bank plc; (ii) Investec Limited and (iii) from time to time, in relation to Investec Bank plc and/or Investec Limited, the ultimate holding company of that entity, a subsidiary (or a subsidiary of a subsidiary) of that entity, a holding company of that entity or any other subsidiary of that holding company, and any affiliated entity of any such entities.
When the subject stock is listed on the LSE, this report is issued and disseminated in the United Kingdom, United States and Europe by Investec Bank plc. When the subject stock is listed on the JSE, this report is issued by Investec Securities Ltd and disseminated to our readers in South Africa and the United States by Investec Securities Ltd and in the United Kingdom and Europe by Investec Bank plc. When the report contains subject stocks listed on both the JSE and LSE and issued by Investec Bank plc, it is disseminated into the United Kingdom and Europe, by Investec Bank plc, and it is disseminated into South Africa by Investec Securities Limited. When the report contains subject stocks listed on both the JSE and LSE and issued by Investec Securities Limited, it is disseminated into the United Kingdom by Investec Bank plc, and into South Africa and the United States by Investec Securities Limited. Any reports issued or disseminated by Investec Bank plc are not for distribution to retail customers.
In all instances this note is disseminated or approved for issue in the Republic of Ireland by either Investec Bank plc (Irish branch), a firm authorised by the FSA and regulated for investment business by the Financial Regulator or Investec Ireland Limited which is authorised and regulated by the Financial Regulator.
For our readers in Switzerland this report is disseminated by Investec Bank (Switzerland) AG.
This report is not intended for use by, or distribution to, US corporations that do not meet the definition of a major US institutional investor in the United States of for use by any citizen or resident of the United States.