Associated British Foods: There’s More Upside After Nearly Doubling In Price (ASBFY)

Associated British Foods plc (OTCPK:ASBFY) is a business that is hard to understand by most investors. Not because the company operates in a number of different sectors, but rather because of the way it is managed.

When listening to ASBFY’s management conference calls a growth-oriented investor in the equity market could often be perplexed by the decisions made at the company. From keeping large cash piles at hand to postponing certain investment opportunities for the sake of retaining a high return on invested capital.

This strategy is ultimately aimed at serving long-term shareholders and not succumbing to pressure from short-term oriented market participants. The drawback here is that ASBFY could end up underperforming the market over long periods of time when the company is laying the foundation for its next growth stage.

In recent years we have also seen a number of significant headwinds for the company in the form of Brexit, and pandemic lockdowns – which resulted in the temporary closure of all Primark stores.

These developments created significant headwinds for ASBFY in recent years, just as management has become more cautious in the expansion of Primark in the United States. Thus, it is not surprising that the stock price performance has been, to say the least – disappointing over the past 5-year period.

However, I have been taking advantage of the recent lows by adding more shares into my personal portfolio and have also rated the stock as a high-conviction buy for my subscribers in November of 2022. At that point in time, ASBFY had reached unsustainably low levels and the extremely low stock price justified the high conviction rating. ASBFY’s total return since then is plotted on the graph below, which speaks for itself.

In addition to the aforementioned headwinds now being behind us, Associated British Foods is gearing for a period of higher top line growth in areas where the business is earning high returns on capital employed. As a result, the company’s operating profit is already above its pre-pandemic levels, and as management steps up, its reinvestments into business this upward trajectory is likely to continue.

Improving Fundamentals

In spite of its stellar performance since November of 2022, Associated British Foods stock still trades below its pre-pandemic levels. At the same time, however, revenue has grown significantly in each of the company’s 5 business segments shown in the graph below.

In Grocery, Ingredients and Retail the company achieves a return on capital employed in excess of 10% with the Grocery business unit now having a ROCE of 30%.

Top line growth in the two most important segments remained elevated during the first quarter of the current fiscal year, with revenue in Grocery growing at 5.4% in constant currency and sales of Primark increasing by 7.9%.

As growth in high ROCE segments remains elevated, Associated British Foods remains well-positioned to further improve its return on capital. Based on the strong relationship between the stock’s Price/Book multiple and its adjusted Return on Equity, this could lead to an upward multiple repricing in the coming years on top of the high revenue growth.

Right now ASBFY trades in line with its ROE based on the relationship we see on the graph above, which means that the market does not anticipate any further improvements in the company’s return on capital. A scenario that in my view is too conservative given the investment opportunities ahead.

Investing Where It Matters

In FY 2023, ASBFY spent nearly £1bn on capital expenditure which was a meaningful increase from the £680m spend in FY 2022. This is also 113% from the annual depreciation and amortization expense which means that the company is once again in growth mode.

Nearly half of that amount is spent on the Primark business, which is now in its early stages of expanding into the United States. The Sugar and Ingredients divisions also take a sizable chunk of ASBFY’s annual gross investment budget.

When we compare these numbers to the actual revenue derived from each of the five divisions, we can see that the Sugar and Ingredient divisions have been allocated a larger share of the gross investment budget to their respective shares from the company’s total sales.

Both Sugar and Ingredients have experienced a notable improvement in margins to their pre-pandemic levels, while Retail – the largest division by the total amount spent on Capex is still struggling to return to its FY 2019 levels.

The recent inflationary pressures and the strong U.S. dollar have been major headwinds for Retail’s margins as Primark competes on cost and most of its suppliers are invoicing the company in dollars.

Although these pressures are likely to persist in calendar 2024, the high expected revenue growth from the ongoing expansion in the U.S. market would be the key driver for shareholder returns.

Sugar, on the other hand, is where ASBFY now faces a major margin opportunity as sugar prices skyrocketed in recent years.

The higher selling prices, however, did not lead to margin improvements in 2023 as bad weather and higher energy costs were an offset to sales improvements.

Looking ahead, ASBFY’s sugar division is in a good position to report higher margins in FY 2024 as selling prices remain high and the co-product electricity offsets higher energy costs.

Turning to sugar operations; we’ve seen, I think, two offsets that give us confidence in the stability of our sugar businesses. Yes, the crop was down, but prices were higher. Yes, energy — gas prices were higher in the UK, but the co-product electricity just about offset all the extra gas prices we were seeing. So net-net across British sugar in the year that looked like it could have been calamitous.

Source: Associated British Foods Q4 2023 Earnings Transcript.

Conclusion

Associated British Foods’ stock delivered outstanding returns over the past year or so as the business recovers from the pandemic lockdowns and the higher inflationary pressures. Future returns are likely to cool off a bit as the multiple repricing opportunity is not as attractive as it was back in November of 2022. Nonetheless, elevated revenue growth and future margin improvements in certain divisions do not appear to be priced in at the moment, which is likely to drive above-market returns for Associated British Foods plc stock in the coming years.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.