It’s become an international brand giant with 373 stores in 12 countries and employing 75,000 staff, and this could just be the tip of the iceberg for Primark if the board of Associated British Foods Plc (LON: ABF) capitalize on its growth and decide to Spinoff the crown jewel segment.
This event may provide a windfall for investors, say The Edge (who source underperforming companies for activist involvement, Special Situations and Spinoffs).
Primark is showing the kind of growth most retailers can only dream of in today’s complex climate. Millions of bargain hunters in cities from Paris to Madrid, Boston, Berlin and London flock daily to snap up the jaw-dropping prices.
The value retailer has perfected the art of making affordable and fashionable items like baby and children’s clothing, womenswear, menswear, homeware, accessories, footwear, beauty products, confectionery, and now tech – and it has no plans to slow down any time soon.
It was the brainchild of the billionaire Weston family who launched their first store in 1969 and who also own upscale department stores Holt Renfrew in Canada, Brown Thomas in Ireland, Selfridges, Fortnum & Mason and Heal’s in the United Kingdom.
Their firm (Wittington Investments) owns the majority stake in ABF, and may open Primark up to its own separate listing to make the most of its enormous recent growth prospects.
Colorful Primark CEO Paul Marchant, who is known to wear the brand from top-to-toe, joined the firm in 2009. He recently unveiled the secrets to Primark’s success insisting “paranoia” is trial.
He said, “You have to be agile and on your toes all the time. That means looking at our formula, prices, experience and service. We are always changing and evolving. We are never complacent, and we are slightly paranoid – that way you can’t really go wrong.”
Dismal performance and stiff supermarket pricing competition are currently holding back the Grocery, Sugar, Agriculture and Ingredients segments.
According to The Edge, Primark is the epicenter of growth at ABF, but its actual value is not achieved in the company’s current share price due to the weak fundamentals of the other businesses.
Therefore Primark’s separation (either through its full or partial Spinoff or sale of other businesses like Sugar and Agriculture) will lead to value creation opportunities for investors.
The Westons, who hold a 51% stake, will also benefit from the potential upside in the case of a Spinoff as they will continue to be a majority shareholder in Primark (based on distribution ratio).
The Logic Behind A Primark Spinoff:
Primark (48.4% of ABF’s total revenue and 56.1% of total adjusted EBIT in FY18) remains the company’s best asset with strong growth prospects. Primark is positioned as a high-volume, low-price operator, applying a hard discount model to clothing retail.
In comparison, other prominent business units Sugar (11.2% of total revenue and 8.2% of total adjusted EBIT in FY18) and Grocery (22.1% of total revenue and 22.3% of total adjusted EBIT in FY18) saw -14.9% and +1.2% Y-o-Y compared to Primark’s growth of 6% Y-o-Y in FY18 revenue, respectively.
Lack Of Synergy:
ABF’s current conglomerate structure makes Primark an entirely different business from its remaining units (largely commodity businesses, especially sugar and agriculture), and The Edge believes the separation of Primark from the remaining company is justified given this dichotomy of focus.
In recent years, agriculture had some success in moving away from commodity animal feed and accelerating growth with high value-added animal feed, like specialty products and premium nutrition, though despite this move, it remains a fragmented market with many players and low margins.
Grocery consists of mostly food and beverage brands with little pricing power. Growth rates are low in this unit, and the operating margin is significantly lower (9.7%) than for large fast-moving consumer goods companies, signifying weaker intangible brand value.
The Ingredient segment enjoys a strong market share in yeast and there is good growth in the enzyme business, which also has high margins. But the Ingredient segment comprises only ~10% of ABF’s total revenue and adjusted segment EBIT in FY18, and therefore doesnot create much economic moat for the company. Falling sugar prices are putting pressure on profits in the Sugar business.
Primark’s Continued Growth Momentum:
Primark has shown improved performance each year as the business increases its scale across Europe, and similarly expanding in the US and in Central/Eastern Europe.
It has seen top-line growth of 11.3%, 18.6%, 6.0% and 4.4% Y-o-Y in FY16, FY17, FY18 and 1HFY19, respectively. Similarly, the adjusted EBIT growth has been very encouraging, mostly over the last 1-2 years, with 2.4%, 6.7%, 14.7% and 24.9% Y-o-Y growth in FY16, FY17, FY18 and 1HFY19, respectively.
Extreme Diversification Restricts Value Creation at ABF:
On a TSR-basis, ABF has underperformed the Index in all instances (1-year, 2-year, and 3-year) and a few of its peers. Based on the 1-year TSR, it is second worst underperforming the Index, while peers HMB, ITX and SZU have outperformed. In the 2-year annualised TSR, ABF was the worst performer among its peers, and continued to underperform the Index into the 3-year period.
This clearly indicates that the current conglomerate structure is not able to reap the benefits of its unique clothing retail format (Primark) considering the weak fundamental performance of other segments (Sugar, Agriculture, etc.), therefore strengthening the case for Primark’s separation.
Unique Retail Format Justifies Higher Multiple:
In the Retail (Primark) segment, the EBITDA margin is estimated to be 15% and 14.6% compared to its peers’ average (HMB, ITX) of 18.4% and 19.3% for FY19E and FY20E, respectively. We believe Primark’s low-cost operating model provides competitive advantage over its peers, thereby justifying a premium to the average peer multiple.
Currently, ABF trades at FY19E and FY20E EV/EBITDA multiple of 8.2x and 7.7x compared to its peer average of 11.9x and 10.7x, providing a multiple expansion opportunity for a separately listed Primark. Furthermore, as stated above, applying a premium widens the upside opportunity.
Currently, the triumvirate of Michael McLintock (Chairman), George Weston (Group CEO) and John Bason (Finance Director) seems to be the trial power center for all decision-making for the entire company. Therefore, The Edge believes the Spinoff of Primark will mean a separate management team focused on the company strategies for potential growth avenues.
In the current conglomerate structure, The Edge has arrived at a target price that implies an upside potential of +24%. However, further value can be unlocked through the separation of the Primark business (either partly or fully), with investors seeing significant potential upside (~50%).
Primark’s low-cost operating model provides it a competitive advantage coupled with a focused management team, which would justify a premium to its peer average following a listing on the market.
Likewise, Primark’s supply chain, operating efficiencies and its best-in-class sales volume result in a low-cost structure, thereby enabling the company to offer the lowest prices in the market.
Shareholder Momentum: Net Selling Over the Last Quarter
The top 5 ABF shareholders have made net purchases of 16,691 shares since the quarter ended Sep 30, which follows the total net selling of 1.2m shares in Q3CY19. The Edge believes this trend in the top 5 shareholders (mainly The Capital Group and BlackRock) indicates cautious sentiments following a net buying of 2.3m shares in Q2CY19.
Graham Allan, the independent non-executive director of the company who joined ABF in September 2018, made an open market purchase of 3,000 shares on March 1, 2019. Additionally, Ruth Cairnie, a non-executive director who joined ABF in April 2014, purchased 1,110 shares on September 11, 2019, via open market operations.
Reach out to Jim Osman and The Edge for more details on this potential break-up and the justification behind the valuations.