Penneys' American dream taking time to pay off as shares in owner ABF fall 15pc
The Associated British Foods (ABF) share price hit £33.43 on November 6, the day before it published its full-year results. By this week, the share price had fallen by 15pc to £28.37. This was despite the results showing a 15pc increase in sales to £15.4bn and a whopping 22pc increase in operating (pre-interest) profits to €1.36bn for the 52 weeks ended September 16, 2017.
So why, after such a strong performance in 2017, have investors suddenly cooled on ABF?
ABF is a strange corporate beast. First established in 1935, it is still 54pc-owned by the founding Weston family and spans a wide range of seemingly unconnected businesses, including baking, milling, tea, sugar, cooking oils, ingredients, animal feed and discount clothing retailer Penneys (which trades as Primark outside the Republic of Ireland).
However, as its latest set of annual results demonstrates yet again, ABF's disparate collection of businesses is highly profitable.
In recent years, ABF has changed. While its original food businesses remain part of the mix, most of the growth has come from Primark.
In 2007, it had annual sales of £1.6bn and pre-tax profits of £200m. By 2017, Primark sales had grown to almost £7.1bn and operating profits hit £735m.
Primark delivered sales growth of 19pc and a 7pc increase in operating profit in 2017. This growth looks set to continue into 2018 as Primark increases its floorspace by a further 1.2 million square feet.
Over the past decade, Primark sales have risen from 23pc to 46pc of ABF's total sales, while its contribution to ABF's operating profits has risen from 26pc to 54pc over the same period. ABF is increasingly a retail company wrapped up in the packaging of an old-style food company.
And what a retailer. Founded in Dublin in 1969 and still managed out of its original Mary Street headquarters, Primark now has 345 stores with a combined 13.8 million square feet of floorspace spread across 11 countries. Shoppers have found its offering of cheap, disposable fashion irresistible in good times and bad.
From its original Irish base, Primark first expanded into the UK in 1974 and then on to mainland Europe. In addition to the UK and Ireland, it now has stores in Spain, Germany, the Netherlands, France, Portugal, Austria, Belgium and Italy.
Not bad for a business founded with an initial investment of just £50,000 after then ABF boss Garry Weston, father of current chief executive George, lured Arthur Ryan away from Dunnes Stores.
Although Ryan officially "retired" as Primark chief executive in 2009, he is still, at 82 years of age, very much a hands-on chairman.
In 2015, Primark took its first step into the giant US market when it opened a store in Boston. It now has eight stores in the US and plans to open a further store in Brooklyn next summer. However, it is clear that Primark is finding the going tough in America, traditionally a graveyard for European retailers. This year's single store opening compares with the three new stores it opened in the US in 2017.
The results announcement hinted at Primark's teething problems in the US when it told investors that three of its US stores would be reduced in size. However, it wasn't all bad news from the US for Primark, with the original Boston store being extended by 20pc last year.
As many of its competitors do an increasing proportion of their business online - Next generates 45pc of its sales and two-thirds of its profits from online and mail order - Primark has up to now continued to generate all of its sales through its shops.
When questioned on this, the company has argued that with its tight margins, an online channel with home delivery would be uneconomic.
That's not to say that Primark has shunned online. Far from it. The group uses social media to alert customers to its latest hot offers. Its website had 10 million visitors in August and it now has 10.7 million followers on social media. The interest generated on social media then drives traffic through its stores.
However, customers looking to buy Primark clobber online will look in vain. When pressed on the matter, the company has held out the prospect of introducing a 'click and collect' service, where customers will be able to order an item on the company's website and then collect it from their nearest store - and maybe snap up another bargain while they are there. But not yet.
The Primark business model is based on very high sales densities, with the retailer generating far higher sales per square foot in its stores than most of its competitors.
This need for very high sales densities seems to be contributing to its problems in the US, where most of its stores are in malls, rather than, as is the case in the UK, Ireland and mainland Europe, being on traditional high streets.
Analysts also worry that, with sales in its stores being already so high, there is relatively little room for further increases in same-store, like-for-like (LFL) sales, the holy grail of all retail investors.
The consensus forecast is for a 10pc increase in Primark sales to £7.8bn this year. Sounds very good - but when 1.2 million square feet of new space, an extra 9pc, is added, it is clear that the increase in LFL sales will be much lower.
"We think (Primark's) high volume densities may be becoming a constraint to LFL sales growth, it lacks a transactional online offer and we think it will take a long time for it to reach critical mass in the US, where it lacks brand recognition", writes RBC retail analyst Richard Chamberlain, who last month cut his rating on ABF from "out-perform" to "sector perform".
He now expects Primark's LFL sales to be flat in 2018, as against the 1.5pc increase he had previously been forecasting.
While Primark's operating margins fell from 11.6pc in 2016 to 10.4pc in 2017 as a higher dollar pushed up costs - Primark purchases most of it stock in dollars - it is still far more profitable than most of the online retailers.
Amazon had total sales of $150bn (€125bn) in the 12 months to the end of September 2017. Operating profits over the same period were $2.55bn, an operating margin of 1.7pc. In other words, Amazon has to sell more than $6 of stuff to generate the same profit that Primark earns from just $1 of sales.
And Amazon's margins are falling, down from 1.75pc in the third quarter of 2016 to just 0.79pc in the third quarter of 2017.
Meanwhile most analysts reckon that, after last year's fall, Primark's operating margins will be unchanged at 10.4pc in 2018.
Maybe online isn't all it's cracked up to be.
Still, ignoring online isn't an option. The havoc wrought by online on the US retail sector, where 6,800 chain stores - 2,500 of which were apparel outlets - closed their doors in the first nine months of 2017, is surely a precursor of what is about to happen on this side of the Atlantic.
While Amazon and the major online retailers may not be making much profit, they certainly have the ability to prevent traditional bricks and mortar retailers from making profits also.
Already, a slew of major US retailers, most recently Toy 'R' US in November 2017, have been swept away by the online gale. Others, on both sides of the Atlantic, will surely follow.
On Thursday, Debenhams shares fell by almost a fifth when it announced worse-than-expected Christmas trading figures, with sales down 1.8pc, and a profit warning.
While the Next Christmas trading figures, published the previous day, were much better, with sales up 1.5pc, this was very much an online phenomenon, with its online sales increasing by 13.6pc, while its store sales fell by 6.1pc.
How did Primark fare over the festive season? An ABF spokesperson declined to comment in advance of the publication of its Christmas trading figures on January 18. Given what we have already heard from Debenhams and Next, even flat like-for-like Christmas sales from Primark would represent a very good outcome.
In reality, it may even do slightly better than that, with analysts who follow the company reporting that the proportion of mark-downs required to shift slow-moving stock over Christmas was even lower than usual.
Primark is far less dependent on the UK and Ireland than most of its competitors, with only 57pc of its total floorspace being in these islands, as against almost 40pc in mainland Europe.
Many of these mainland European shops also seem to be bigger and better than those in the UK and Ireland, with 15 of the 20 stores with the highest sales densities being located in mainland Europe. This large and growing exposure to mainland Europe allows Primark time to refine its online strategy and sort out its American stores.
Arthur Ryan has successfully ridden many retailing trends over the past 49 years. Getting the US and online right will be his biggest challenge yet.
Sunday Indo Business