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Associated British Foods (ABF.L)Fast-Casual Retail in Sheep’s ClothingLONG, TP £37 (+20%)

RESEARCH TEAM

Tom MooreJane TedjajuwanaAndrew SmithParker KimKlevrin Sitohang

Parker Kim, Tom Moore, Andrew Smith, Klevrin Sitohang, Jane Tedjajuwana

Table of Contents

Investment Thesis


“

Investment ThesisABF’s Clothing Retail Division is Underappreciated by Market

ABF is a food company… with

a fast-casual clothing retail

division

This clothing division’s value is not appreciated by food analysts

covering ABF

The clothing division (Primark)

is priced off of mature peers in

the space

Primark should trade at 30-40x EPS, while food

analysts incorrectly

price it at 24x

As Primark’s growth causes it to grow to 50-60% of ABF’s EBITDA through a 2015 expansion into the US, coverage of ABF should transfer from food

analysts who don’t know how to price it to clothing retail analysts who do.

“


Investment ThesisABF is a Food Company… with Clothing Retail OperationsDivision Contribution to Total EBIT

40%

65%

Agriculture

Grocery

Sugar

Ingredients

Retail

Primark Sales (£mns) by Geography

The stable food business lines’ stable, excess cash flows finance clothing retail’s growth

Clothing retail is growing rapidly and dominates company profits

Primark has strong history of expansion in continental EU and has set sights on US

Absolute sales set to double over next 6 years and triple over next 10


Investment ThesisClothing Retail’s Value is Underappreciated by Market

Market currently prices Primark at 24x retail earnings… …While we believe Primark should be priced at 30-40x…

based on historical peers at similar stages in their growth cycle. We expect to realize this value as Primark dominates ABF

Retail

Company Overview


Company OverviewABF’s 5 Divisions Focus on Food, Though Clothing Retail Will Soon Dominate

Clothing Retail (Primark) Grocery

Sugar

IngredientsAgriculture

38%

10%

25%

16%

9%

Highly-popular fast-casual clothing retail

278 locations across UK and EU

Leads market in prices, discount prices half the average of the industry

Produces enzymes and bacteria that are key inputs in making yeast for bread

Sells directly to bakeries and to intermediaries with bakery end market

Manufacturers array of packaged products covering beverages, foods, and snacks

Vertically integrated production, selling to grocery stores

One of the largest sugar refiners -5mts/yr and 0.6mt/yr of ethanol

Purchases from small sugar farm and refines it for sale

Produces feed and technology-based products and services for farmers and feed manufacturers

Operates throughout the agricultural supply chain


Company OverviewVisibility into Primark’s Business Line

Primark is arguably the most successful textile retailer in Western Europe, combining deep value and up-to-the-minute fashion

1969First store to open in Dublin, Ireland

1973First store to open in Derby, UK

2006First store to open in Madrid, Spain

2009First stores to open in Portugal, Germany, and Belgium

2008First store to open in Holland

2012First store to open in Austria

2013First store to open in France

#3 clothing retailer by value in UK#1 by volume with 14% UK market share#1 by volume in Spain and Portugal165 stores in UK42 stores in Spain38 stores in Ireland13 stores in Germany 6 stores in Netherlands5 stores in France

Primark Today



Deep Value FashionableEmphasis on

Online Presence

Primark can offer deep value for its customers due to the following: Word-of-mouth advertising Bulk ordering and low mark-ups Streamlined production methods such as local sourcing of fabrics




Online Presence

Clean and chic website

Trendy store design

Large crowd expecting Primark store opening in London




Online Presence

Primark has over 3 million online global fan base, saving itself expensive spending for ad campaign


Company OverviewPrimark Growth Has Increasingly Focused Internationally

Same store sales growth has been steady at ~5% while new stores have contributed most of the growth

And square footage expansion is increasingly happening in these new international regions


Company OverviewPrimark is Starting its US Rollout by Leasing from Sears

Geographic map of Primark Store Rollout in the United States

Located in dense, urban areas to build awareness and start a foothold into surrounding suburbia

Maximal footprint while minimizing investment by leasing from Sears and locating in highest-trafficked malls in the US

Central to budget-conscious university student populations

1

2

3


Company OverviewUS Expansion Has Targeted 65% of NE Population with 7 Stores

Using only 7 stores, Primark can target nearly 65% of the Northeast and 12% of the total US population- maximizing its footprint with minimal risk exposure.

Industry Overview


Industry OverviewABF Food Industry Trend Overviews

Sugar: Prices stabilizing after record peak Agriculture: Record year and expected price stabilization

Ingredients: Stable, nothing significant expectedGrocery: Twinings driving record profits in market share

Projected


Industry OverviewFast-Casual Clothing Retail Has Been an Explosive Industry

Fast-casual retail has grown to 30% of the overall clothing retail industry, while Primark has captured over 21% of the industry

Fast Casual Market Share

Primark has continued to grow market share in the fast casual industry, despite an overall slowdown in fast-casual’s market share growth.


Industry OverviewPrimark Success Driven by Unique Competitive Positioning

£212 Average

Cost of 9-product price basket by retailer Average AUR of 9-product basket by retailer

£23.57 Average


Industry OverviewPrimark Outperforms All Competitors in Sales Efficiency

Primark outperforms all competitors on a sales per gross square foot of store metric


Industry OverviewDepartment Stores Are Moving Away from Apparel

Ave

rage

Pri

ce

% of Sales from Apparel

Department stores migrating from Apparel to “FAB” and national brands

This frees up department store customers that still need apparel for companies like Primark to capture

Financial Overview


Financial OverviewProjections for International Based off Previous Experience

And previous experience gives us confidence that the international rollout will not be dilutive to margins.

Using fast-casual peers ITX and HMB, we can reasonably project sales growth for Primark.


Financial OverviewOverview of Financial History and Projections for ABF

Revenue by Division (GBP £mns) Operating Income by Division (GBP £mns)

Division Contribution to Total EBIT

40%

65%

Division Contribution to Total Revenue

Agriculture

Grocery

Sugar

Ingredients

Retail 30%

48%

Agriculture

Grocery

Sugar

Ingredients

Retail


Financial OverviewDeeper Dive into Primark Model Shows International Driving Growth

Associated British Foods, plc (ABF.L)Primark Operating Model

Figures in GBP £mns, except otherwise stated

2009A 2010A 2011A 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Revenue 2,314 2,730 3,043 3,403 4,273 4,950 5,262 6,245 7,017 7,782 8,841 9,857 10,862 11,401

Domestic (GBR) 2,103 2,385 2,331 2,516 3,095 3,252 3,417 3,590 3,770 3,958 4,117 4,281 4,410 4,542

International ex-US 211 345 712 887 1,178 1,698 1,845 2,444 2,902 3,112 3,837 4,398 4,754 5,014

US 0 0 0 0 0 0 0 211 345 712 887 1,178 1,698 1,845

EBIT 252 341 309 356 513 662 718 774 926 1,075 1,228 1,390 1,548 1,640

Domestic (GBR) 229 299 236 266 372 434 457 480 504 533 558 585 602 620

International ex-US 23 42 73 90 141 228 262 271 380 470 579 664 718 757

US 0 0 0 0 0 0 0 23 42 73 90 141 228 262

EBIT Margin 10.9% 12.5% 10.2% 10.5% 12.0% 13.4% 13.7% 12.4% 13.2% 13.8% 13.9% 14.1% 14.2% 14.4%

Domestic (GBR) 10.9% 12.5% 10.1% 10.6% 12.0% 13.4% 13.4% 13.4% 13.4% 13.5% 13.6% 13.7% 13.7% 13.7%

International ex-US 11.1% 12.2% 10.2% 10.2% 12.0% 13.4% 14.2% 11.1% 13.1% 15.1% 15.1% 15.1% 15.1% 15.1%

US NA NA NA NA NA NA NA 11.1% 12.2% 10.2% 10.2% 12.0% 13.4% 14.2%

Tax Rate 21% 21% 21% 21% 21% 21% 21% 22% 22% 22% 23% 23% 24% 24%

Domestic (GBR) 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21%

International ex-US 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21%

US 40% 40% 40% 40% 40% 40% 40% 40% 40% 40% 40% 40% 40% 40%

Earnings 199 269 244 281 405 522 567 606 722 834 951 1,069 1,177 1,243

Domestic (GBR) 181 236 187 210 294 343 361 379 398 421 441 462 476 490

International ex-US 18 33 57 71 111 179 206 213 299 370 456 522 565 596

US 0 0 0 0 0 0 0 14 25 44 54 85 137 157

Historical Projected


Financial OverviewDiscounted Cash Flow Model at 24x, 30x, 34x, 40x RetailAssociated British Foods, plc (ABF.L)Discounted Cash Flow Model

Figures in GBP £mns, except otherwise stated

2009A 2010A 2011A 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E

Revenue 9,038 10,339 11,283 12,483 13,638 13,193 13,670 14,905 15,937 17,148 18,581

EBIT 594 888 890 919 1,210 1,198 1,197 1,348 1,528 1,727 1,905

EBIT Margin 6.6% 8.6% 7.9% 7.4% 8.9% 9.1% 8.8% 9.0% 9.6% 10.1% 10.3%

Less: Taxes -130 -195 -202 -212 -284 -300 -307 -350 -419 -492 -560

NOPAT 469 701 703 726 955 946 945 1,060 1,198 1,349 1,486

Less: Capex -596 -727 -846 -752 -623 -743 -765 -850 -919 -996 -1,092

Plus: Depreciation & Amortization 375 412 411 508 531 492 533 578 617 662 716

Less: Increases in NWC 26 136 -268 26 -86 113 -106 -58 -54 -59 -58

Plus: Interest Tax Shield Value 20 18 20 23 21 15 15 16 16 16 16

Levered Free Cash Flows 294 541 20 531 798 823 622 746 857 972 1,068

Valuation

Terminal EqVal 32,372

Food @ 18x

Retail @ 24x

PVTV 20,100

PVFCF 3,153

Equity Value 23,253

FDSO 788.6

Share Value £29.49

Upside -2%

Historical Projected

Valuation


Food @ 18x

Retail @ 30x

PVTV 23,643

PVFCF 3,153

Equity Value 26,796

FDSO 788.6

Share Value £33.98

Upside 13%

Valuation


Food @ 18x

Retail @ 34x

PVTV 26,005

PVFCF 3,153

Equity Value 29,158

FDSO 788.6

Share Value £36.97

Upside 23%

Valuation


Food @ 18x

Retail @ 40x

PVTV 29,548

PVFCF 3,153

Equity Value 32,701

FDSO 788.6

Share Value £41.47

Upside 38%


Financial OverviewMultiples Show Retail is Being Priced Like it’s Average…Company Ticker CY14E PE CY15E PE CY14E EV/EBITDA CY15E EV/EBITDA

Sugar

Suedzucker SZU GY 32.4x 25.4x 7.5x 7.4x

ADM ADM US 16.5x 13.9x 8.9x 8.0x

Average 24.4x 19.7x 8.2x 7.7x

Agriculture

Suedzucker SZU GY 32.4x 25.4x 7.5x 7.4x

ADM ADM US 16.5x 13.9x 8.9x 8.0x

Bunge BG US 15.3x 12.3x 10.7x 9.3x

Average 21.4x 17.2x 9.1x 8.3x

Grocery

Ebro Foods EBRO SM 15.1x 14.2x 8.8x 8.3x

Greencore GNC LN 16.1x 14.1x 11.7x 10.5x

Danone BN FP 20.0x 18.2x 12.4x 11.4x

Unilever ULVR LN 19.1x 17.8x 12.4x 11.7x

Nestle NESN VX 20.6x 19.0x 13.8x 12.9x

Kerry Group KYGA LN 19.4x 17.8x 13.8x 12.8x

McCormick MKC US 21.1x 19.6x 14.3x 13.4x

Arzyta ARYN VX 17.9x 16.9x 12.1x 11.5x

Average 18.7x 17.2x 12.4x 11.6x

Ingredients

DSM DSM NA 18.2x 15.0x 9.0x 8.2x

Arzyta ARYN VX 17.9x 16.9x 12.1x 11.5x

Average 18.1x 16.0x 10.6x 9.8x

Retail

H&M HMB SS 25.5x 22.6x 16.1x 14.2x

Inditex ITX SM 28.1x 24.6x 16.2x 14.4x

NEXT NXT LN 16.7x 15.2x 11.6x 10.8x

The GAP GPS US 14.1x 12.5x 6.6x 6.2x

Fast Retailing 9983 JP 40.9x 36.9x 20.2x 18.4x

Abercrombie ANF US 16.4x 13.2x 4.6x 4.3x

Average 23.6x 20.8x 12.6x 11.4x

Peers like HMB and ITX are substantially more mature than Primark. With more growth opportunities should come a higher multiple.

Wall Street Food & BeverageAnalysts are pricing a clothing retaildivision outside their knowledge the only way they can: by taking the average and leaving it at that.

As a second-mover in the fast-casual market, Primark has much more information on market behavior, making its move less risky. With less risk comes a higher multiple.

A

B

C


Financial OverviewPrimark is Being Priced The Only Way Wall Street Knows How

Primark is clearly priced off of Fast-Casual peers H&M and Inditex, despite both being much more mature.

…and more than tripled their market caps over 10 yearsAt this stage in their lives, H&M and ITX traded at 30x…

HMBITX

HMB

ITX

Considerations


Considerations

Holding company with wide variety and complex structure (valuation issues)

Volatile market forces could drag down valuation of the overall company despite Primark outperformance (other divisions make up 44.8% of EBIT)

Agriculture, Grocery, and Ingredients are capital-intensive and operate on low margins

Sugar division risks: <20% of EBIT, collapse in EU sugar prices, no profits expected 2015

Financials Take Into Account Market Volatility in Other Divisions

40%

65%

Agriculture

Grocery

Sugar

Ingredients

Retail

Financials take into account projected cyclicality

Retail division projected to contribute to majority of total ABF operating profits, reducing risks of other divisions to bottom line

Division contribution to total EBITMitigations

Company Complexity


Considerations

US has many incumbent retailers pure-play apparel and accessory retailers (Macy’s, Dillard’s, Forever 21, Uniqlo, Zara, JC Penney, Marshall’s, etc.)

Incumbents have established brand reputations globally and domestically in US

Overall, the brick-and-mortar, pure-play clothing retail considered highly fragmented industry with no one competitor having significant/controlling share

Capital-Light Pilot Entry into US Will Offset Saturation Risks

Leasing 7 stores from Sears with focus in the Northeast

Flag-planting in North-east likely to yield strong brand recognition

By 2016, estimated addressable population (assuming 25 mile radius coverage per store) equal to 65% of Northeast population and 12% of US population

Announced and potential Primark locations - mapMitigations

Market Saturation


Considerations

UK apparel industry went through inflationary period from 2011-14 with trends pointing towards inflation going forward ; similar risks expected for US

Deflationary trends coincide with increased discount clothing market share 2000-10 deflationary period in UK aligned with increase from 5% to 30% share of

discount retailers

Primark entry contributed to deflationary risks

Primark’s Position on Low-End of Apparel Pricing Limits Deflationary Risk

Vulnerability remains an issue for pure-play, low price retailers (see chart on right) but this factored into growth projections

Department stores unlikely to be greatly impacted in lowest price points due to shift away from pure apparel into FAB categories (footwear, accessory, and beauty) and increased focus on core national brands

Pure-play discount apparel retailers at most riskMitigations

Deflationary Risk


“

Investment ThesisABF’s Clothing Retail Division is Underappreciated by Market

ABF is a food company… with

a fast-casual clothing retail

division

This clothing division’s value is not appreciated by food analysts

covering ABF

The clothing division (Primark)

is priced off of mature peers in

the space

Primark should trade at 30-40x EPS, while food

analysts incorrectly

price it at 24x

As Primark’s growth causes it to grow to 50-60% of ABF’s EBITDA through a 2015 expansion into the US, coverage of ABF should transfer from food

analysts who don’t know how to price it to clothing retail analysts who do.

“

Associated British Foods (ABF.L)Fast-Casual Retail in Sheep’s ClothingLONG, TP £37 (+20%)

RESEARCH TEAM

Parker KimTom MooreAndrew SmithKlevrin SitohangJane Tedjajuwana


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Date post:	18-Jan-2017
Category:	Economy & Finance
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