ABF plc is part of your everyday life

Who has never heard about Primark, Twining tea or bought a specific sugar or bakery brand? All these make Associated British Food plc

Diversification. This is the first an most successful rule for the Associated British Food plc (ABF) company. From its inception in 1935 until nowadays, ABF has grow broad-based food manufacturing and retail organization through market and product development strategies.

Its business splits into five segments that it makes them to be present in everyday life for many different people. But, what exactly does the company do? This differentiated conglomerate include products from cheap clothes, sugar and cozy brands that it has been always attractive to shareholders.  ABF plc works as a global manufacture in 46 countries and the group operates in the UK, Europe, U.S. and Asia. It is headquartered in London, the UK and employs about 96,915 people. Modernization and expansion has always been the core of its business.

Nowadays, the largest part of the Associated British Food profit is generated by sugar. And it is specially successful also in its retail market. “AB Sugar delivered a first-class result, exceeding last year's record profit following the investment made in recent years”, explains Charles Sinclair, ABF plc Chairman. He also emphasizes the Primark's rate of growth that it “increased this year with sales of £3.5bn, more than double those of five years ago”. Primark retail segment was encourage by the weakening of the euro having a 15% increase in revenue and operating margin profit in 2012 compared with last year results.

However, demand has slowed and commodity prices continue to rise. Grocery and Ingredients business sector are the ones that face more challenges due to strong competition, a continued strain on consumer spending and high costs for a number of commodities that it has led to lower profitability in both of these segments. The market developing that faces the major problems is Australia. The high cost supplier and the management teams in George Weston Foods, along with difficulties in Allied Bakeries in UK, are the biggest challenges nowadays because competitive pressures persist.

The weakness in the economies of ABF developed markets will be the most difficult challenge to overcome. ABF exposure to sales in the eurozone is about 20% what it is been affected by uncertainty and the government austerity measures. However, ABF strategy of market and product development make the businesses operating more successfully and the innovation of technology in the ingredients sector, for example, will make ABF to obtain better results in a near future. Specially important is the combination of high costs and competition environment in this sector, something that the group is counteracting with more differentiated bakery ingredients proposition.

ABF plc main strategy is continuing to review of longer term growth opportunities. The company´s success can be also seen in its decentralized approach, where developing its own corporate responsibility model (risk management) is one of the ABF plc greatest strengths. All their principles are part of the company´s long-term corporate strategy.




How good?

ABF plc is one of the FTSE 100 companies in UK. According to the information revealed in the London Stock Exchange, ABF plc has a market capitalization of £11035.94m. This is a result of the £791.674m shares outstanding with each one has a value of £1394.00 at 16 Nov, 2012. If the appendix two about adjusted earnings per share information is taking into account, this has increased by 18% from 74.0p to 87.2p EPS in 2012. Here, we can deduce that the Price-earning ratio (P/E) for the stock would be 16, referring to the quantity ($16) investors are willing to pay per $1 of current earnings.

However, we need to ask the question: is the company’s stock a good investment? To find out the answer the book value is essential here. Shareholders equity of ABF in 2012 has a value of £5,834m. Therefore, to determine if the stock is over- or under-valued, and to answer the previous question we will estimate that the martek-to-book ratio is 1.9, what means the stock in undervalued.

To understand now ABF´s future performance, a quantitative analysis of revenues, expenses, profit and other financial aspects must be done. In 2012 the group's revenue increased by 11% to £12.3bn.

As the graphs show, revenues and operating cost increase proportional through the time, the former being higher by £873m operating profit. The percentage of increasing revenue (11%) is faster than the operating cost increase (10%) in 2012 compared with the previous year. However, what it can give insights about the competitive advantage is the return of sales (ROS), where the net profits are a total of £583m. Therefore, ROS has a degree of 5% profitability in 2012. If this data is compared with previous years´ revenue and net profit, the trend of profitability is quite the same over time. Nevertheless, the company is still making profit when taxes and operating profit are compared. In 2012, ABF plc has an interest covering of three times taxation costs (EBIT). Besides, there is a positive trend if depreciation and amortization are taking into account along with the previous data (EBITDA £1,431m in 2012).

Another data that indicates the profitability of ABF plc is the gross margin deduced from the cost of good sold (COGS) and the sales, what it has a value of 8%. This high percentage means that the company has some money left to spend in other business operations. But, what will it happen if we compared the revenue with the assets or equities? Taking the net profit again, we will look now how much the assets cost, to investigate the company´s earnings. Here we see that the return of assets (ROA) is 6% in relation to capital in the business. On the other side, the return on equity (ROE) has a value of 10% in 2012. Therefore, it can be concluded that there is a higher return on equity than in total assets value.

Also, the graphs show the relationship between net capital investment and net debt. We can see that when net capital investment decrease, also debt does. Notwithstanding, the reduction of debt decreases faster (-17.43%) than capital investment (-14.30%).

Is ABF plc solvent? 
Examining the business, we can see in the balance sheet how assets, liabilities and equities are distributed. The current ratio of the firm is 1,26%, what indicates a good ability of the company to repay its short-term obligations. However, we need to go one step further analyzing the liquidity of ABF plc, taking the most important part of the assets, the inventory. The figure here is 0.7% quick ratio, smaller that the previous year. This data is specially important for this company since its business are related to manufacturing and retail, as well as finished goods.

ABF plc shows not so good shape when liabilities and equity are not that close to 50%. Nevertheless, there is something that always attract investors, cash. ABF plc  has a 9% cash ratio, a strong signal of the company performance, the magic formula to know the future growth.

So, what is the company´s ability to produce cash? ABF plc has produced this year more cash from its operating activities with a substantial increase from £736m to £1,240m. This is a consequence of inflow working capital, adjusted amortization and depreciation and higher operating profit. What it is significant here is the different amount of income if net profit (£583m) and cash flow (£245m). That can be because the company might be speeding or slowing its booking of income or costs.

There are some significant changes on the cash flow statement that should have affected the lower cash flow this year than the previous one like the reduced amount of long-term loans, the purchase of intangibles or the lower increase in inventory. Although there are other activities that have increased, the result is still £46m less in cash flow in 2012.


SWOT analysis:

Strengths
Diversification of products (unrelated activities, independent and complementary)
Decentralized approach and own corporate responsibility (leadership on sustainability)
Weakness
Need for better implementation technique in Australia and China
Better establishment on strategy
Overdependence on the UK market
Opportunities
New markets development (market knowledge)
Innovation technology

Threats
High environment competition
Decline in global economic growth
Commodity prices costs rise
Slow in productivity


Who is out there? 
Now lets have a broader picture. There are many sugar and food companies that compete with ABF plc in the international market. Some of them are the follow ones:


In the UK, Tesco plc is the principal competitor, specially in groceries and bakery. It affects ABF plc in these sectors, both in UK and in the rest of its world market. Tesco is the grocery market leading in UK and one of the world´s largest retailers. Its market value is much higher than ABF plc and it is also ahead in revenues and employees, as the table shows. However, Tesco plc adjusted earnings per share (37.52p EPS at Feb, 2012) is quite smaller than ABF plc (87.2p), what indicates good news of ABF´s profitability.

Next big ABF plc´s competitor is Südzucker Aktiengesellschaft, the largest sugar producer in Europe. This German food group operates across all Europe, specially France (25.8%) and Germany (21.7%), what it is a threat for ABF operations there. Even if the market capitalization data and other financial results as the EPS (16p at Feb, 2012) is smaller than ABF plc ones, there is a tough competition on the European market.

The other important competitor is Nestle SA. This company is the world´s leading in nutrition and its size is much bigger than the other firms together. It is a well-established brand worldwide and its main strategy is development in emerging markets. Although it is difficult to compare financial data between Nestle and ABF plc, they only compete for certain products as cereals or food services. Here also the Nestle EPS estimated at Dec, 2012 (33p) is smaller figure than the ABF plc EPS.

The competition environment is quite high if we look at specific sectors or geographic market (Unilever and Danone are also big particular competitors). The competitive advantage of ABF plc is still is massive international diversification into five sectors. ABF plc approach is based on market development and decentralization approach that make ABF plc follows a differentiated focus mass market strategy, while it costs leadership. Besides, ABF plc functional strategy is not defined as good as Tesco or Nestle. This implies ABF has not a unique competitive position in the market nor high degree of operational effectiveness.

Global presence
Before we saw the total revenue for ABF plc, and which is the financial position of the firm in the market, but what geographic area is more profitable?
As the graphs show (see also appendix) the more profitable area is the UK with more than 40% of ABF plc market. The European market is specially important for ABF retail segment, which it is giving most of the profits along with AB sugar (even though the strong competition we have mentioned). New acquisitions and stores in these sectors have expanded business in the EU. In the Asia Pacific, innovation techniques are necessary to improve management of its business, specially in Australia and China. Also in The Americas, market development strategy is needed to gain better penetration of ABF´s products there.

As ABF plc recognizes, its main strategy is to create a great brand portfolio, specially in grocery in UK. However, this could be seen as negative for shareholders when they can invest in a single company, and do not have the need to  invest in those unrelated sectors at once. Besides, its expansion through Europe in retail and sugar, and also in ingredients, can be affected by the eurozone macroeconomic crisis, as it represents a very important faction of the market´s company.

Everything in one
Now we are breaking down revenue and profits by business segment. ABF´s strategy includes an expansion plan of growing even more global. Each segment includes different business sectors, consumers, markets or competitors. Lets have a thorough analysis of them.

Grocery

This sector has incurred in some problems recently. The financial data tells grocery is the sector that provides more revenue to ABF plc, however its adjusted profit has decrease significantly in 2012. Why? AB World Food operates in a competitive trading environment, both regarding to food industries and geographical location (for example in Australia). ABF plc needs restructuring changes and reorganizing sales distribution (lower transport costs for example) in this sector if they want to reduce its operating costs.

Twinings or Ovaltine are its most profitable grocery products. However, Silver sugar faces a strong competition, as we have seen. ABF plc strategy in the grocery business is promotional activity, though the wheat price rising will make some further pressure in the sector. Nevertheless, there are positive sales in some countries as Canada or Poland. ABF plc healthy products´ campaign (for example the “Truvia sweetener brand in the UK, the first stevia-based, zero calorie sweetener”) can be seen as successful initiative in the grocery segment, as it is mentioned in its annual report 2012. Being environmental sustainable (as reducing water usage at Jordans Ryvita) can make ABF plc looks a more valuable business, but remember, costumers seek for cheaper alternatives.

Retail

ABF plc policy in its retail market is quite successful thanks to its fashionable price/quality clothes. Market expansion has been received positively in its accountability. Retail segment is the second most profitable sector inside ABF plc and also ranking in the same position in its sales (29% of total revenue). It has recovered from its loss in profit in 2011 due to the exchange rate from the euro currency.

Primark is a leader value-fashion across Europe. It has a relatively short time (first store in Ireland in 1969), but it has already 250 stores. Recent shops have been opened in Spain and Germany. Fashion environment, working conditions and knowing the costumer´s needs are Primark best strategy, and it is working very well for ABF plc. Lets see if this expansion in the eurozone gives positive results in a near future.

Sugar

As it is possible to observe, AB sugar is the most profitable of the five sectors in ABF plc. This year the £2.5bn increase in revenues ahead by 25% and profit up to 62% reflect a higher production and strong commercial markets in EU and Africa. In 2008 ABF closed the deal to buy Azucarera Ebro, the major producer in Iberia, a Spanish sugar producer. Also, British sugar owns Illovo, Africa´s largest sugar producer since 2006. This has helped improve its financial performance in the sector, as the 2012 annual report explains. The other side of the story is its AB sugar factories established in China which reduced their profits because a weakening of sugar prices.

AB sugar sector has been able to grow and strength internationally by sharing skills, expertise and the best processes across its operations. The strategy, ABF plc follows in the sugar business, is to grow sustainable, meaning growing efficiently in the use of its resources but also exporting the power it generated back to the grid. This has made AB sugar a global producer looking forward more expansion development in the future, ending sugar quotas in 2015 (proposed by the European Commission), without jeopardizing sugar production in the European industry.

Agriculture

AB Agri is been more or less stable in the last five years. Its revenue and profit are, along with the ingredients sector, the least profitable for ABF plc. However, agriculture is improving slowly and slightly better than the ingredients business. AB Agri faces problems on high production costs and supplies, besides high crop prices that underpinned farm markets.

Operating and manufacturing products in UK and China, AB Agri strategy seeks to become more global. As ABF plc explains in the annual report 2012, this business “provides an added-value service to food, drink and bioethanol companies internationally”. At the beginning of 2012, a new product, called Quantum Blue, was launched to the animal nutrition market thanks to the partnership between AB Enzymes and AB Vista partnership. Remember that name because it could be a major improvement for the company´s revenue.

Ingredients

As the numbers say, ingredients sector is the most trouble one among the fifth of ABF plc. Revenue and profit has fallen in 2012 due to, for example, the competitive yeast market in Europe. This sector comprises ABF ingredients and AB Mauri. The latter is the one which is making a sustainable progress delivering a more differentiated bakery ingredients products like Gilde Bakery. AB Ingredients operating profit was below expectations reflecting restructuring charges and higher commodity costs. Their sales and distribution operations are in France, Benelux and Italy, including the Casteggio wet and dry yeast plant, as it is shown in the annual report 2012.

Their strategy here was through investment in new yeast plants, innovation in their products and improving productivity, to reduce raw material costs. China and Europe reported negative data in their sales, while Mexico and U.S. maintained revenue growth in molasses and grain, respectively.


But, what if...
ABF plc´s diversification strategy is giving positive overview results. However, what if the retail sector became, not only an independent management enterprise, but a different company? What if sugar productivity slowed down and sugar prices growth within the EU affecting negatively to adjusted profits? What would be ABF plc´s overview results?

There are many risks and uncertainties ABF plc has to bear in mind if they want to achieve strong, sustainable leadership positions and high levels of operating efficiency, for example wheat, cotton and cereals prices, apart from strong competition, failure in market development and innovation technology in Asia and the Americas or  because the EU economic recession. What will be ABF plc´s capacity to anticipate, sense and respond to volatility in its markets to its advantage?