Being cheap is the chief selling point for Primark, Associated British Foods’ best-known brand. That attribute also should ignite investors’ interest in the stock. Shares in the group, which additionally owns Twinings tea and Ovaltine drinks, have struggled to regain ground since last March and are valued near their pandemic trough at only 12 times forecast earnings for next year.
A stretched balance sheet deserves to be punished, but a company sitting on too much cash also tries investors’ patience. ABF has long been a strong cash-generator. In September, its net cash stood at £1.9 billion. That excluded lease liabilities, although those were lower owing to rent concessions, signing short leases and a switch to monthly payment terms.
Now, though, there’s a better chance that more of the cash churned out by the business will find its way back to shareholders. Its bosses have set out conditions to return surplus cash, namely having “substantial” cash balances at the end of the half-year and financial year-end and net debt consistently below adjusted earnings before tax and other charges. That’s being kicked off with a special dividend of 13.8p a share, in addition to a final dividend of 20.5p. Permission is also being sought from investors at next month’s annual meeting for share buybacks.
Talking up the opportunity for Primark overseas is one thing, but throwing cash behind rolling out more stores is what counts and plans to accelerate the expansion of shops in Italy, Iberia, France and the United States should force a further rerating in the shares. Last year only 600,000 sq ft of new store space was added and this year openings will remain low, at barely 500,000 sq ft. But analysts estimate that a target to develop the estate from 398 to 530 over the next five years will equate to just over a million sq ft of space being added over the next four years.
Cash will be spent, too, on improving its digital shop window, but that doesn’t mean it will be launching home delivery or even click-and-collect — not in the near term, at least. Primark’s lack of online presence could be read in one of two ways: as a competitive disadvantage against digitally savvy fashion rivals, or as evidence that its brand’s bargain-basement reputation is strong enough to continue driving customers to its shops.
Pre-tax profits this year are forecast to double to £1.46 billion, but inflation remains one of the chief risks to fulfilling profit expectations. Higher corn oil prices led adjusted profits for the grocery business — 41 per cent of the group total — 5 per cent lower than last year.
At Primark, higher attrition in staff numbers helped to boost the margin during the second half of the year. Not all those employees will be replaced, which management hopes that, together with an expected £2 billion increase in sales, will hold the division’s adjusted operating margin above 10 per cent this year. That guidance takes into account higher freight costs, on which it has agreed pricing until October next year. Buying most stock in US dollars means the devaluation of sterling against the greenback should help it to absorb higher wage and supply chain costs. Shore Capital, the broker, reckons the benefit could be above £100 million this year.
ABF may suffer from a potential conglomerate discount, as investors aren’t generally fond of disparate businesses bolted together. The level of influence the Weston family exerts by owning a 54.5 per cent stake via its Wittington Investments vehicle may be less desirable, as well. But a bargain valuation, together with the prospect of better cash returns, compensates for the downsides.
ADVICE Buy
WHY The share price does not reflect the potential for surplus cash returns and improving sales
Renewi
Companies around the world are setting lofty decarbonisation targets, conscious of the need to convince consumers that they are taking environmental concerns seriously. Renewi, the European waste management company, hopes to capitalise on this trend.
The FTSE 250 group collects and recycles waste and sells it back to the market. A lack of production of some raw materials has resulted in supply shortages of paper, metals and plastics, boosting demand for secondary alternatives and pushing the price of recycled material higher.
The price inflation might be expected to moderate this year, but that has not stopped expectations for Renewi’s results being raised again. Peel Hunt, the house broker, has raised its adjusted profit forecasts for the next three years, pencilling in €78 million this year, up from €47.4 million the year before.
Over the medium term, margins should benefit from an efficiency programme aimed at cutting office costs, saving €20 million a year by 2023. So, too, should capital expenditure on projects including upgrading sorting lines, which is expected to boost earnings by €20 million by 2025. Other drivers of greater recycling by firms include new regulations, such as increased incineration taxes in Belgium.
The challenges? Commercial waste volumes are not yet back to pre-pandemic levels, with the closure of hospitality during lockdown and the shift to home working resulting in less waste being collected from restaurants, hotels and offices. Some sectors will never recover to pre-Covid levels, management believes.
But its big ATM site, which cleans contaminated soil, water and chemical waste in the Netherlands, is the biggest weak spot. Delays in regaining permits to ship thermally treated soil — on the back of environmental concerns raised in 2018 — combined with a lower volume of inbound soil to the site mean a full recovery in profits here has been pushed back by two years.
The shares have recovered to their highest in three years, rising 11 per cent off the back of first-half results alone. A forward earnings multiple of 12, lower than the pre-2018 range, leaves Renewi looking fairly priced.
ADVICE Hold
WHY Further recovery in waste volumes could boost sentiment towards the shares
