An introductory guide

Transcription

1 Deutsche Bank Markets Research Rating Buy Europe United Kingdom Food Manufacturing Company An introductory guide Reuters Bloomberg Exchange Ticker ABF.L ABF LN LSE ABF ADR Ticker ASBFY ISIN US An introduction to ABF: from field to fork and from teabags to t-shirts This report is intended for readers looking for an introduction to AB Foods and its five divisions. We would direct those familiar with the company to our report "Not just about Primark", also published today, for a discussion of our view of the stock. A diverse conglomerate: around the world in 8 years AB Foods (ABF) is listed in the Food Producers & Processors sector and is the 26th largest company in the FTSE1 by market capitalisation. It is majority owned by the Weston family and CEO George Weston is a grandson of the founder. It operates five divisions: Grocery, Sugar, Agriculture, Ingredients and Retail. Its largest brand by both sales and profits is Primark, a value fashion retailer operating predominantly in Europe. In addition ABF owns consumer food brands such as Twinings, Ovaltine, Ryvita and Kingsmill; it is a manufacturer of sugar on three continents; and develops and manufactures a wide range of ingredients and agricultural feeds. This report describes the history, operations and drivers of the group. 1 things you may not know about AB Foods Whilst this Introductory Guide is aimed at those new to ABF, we see value for more seasoned readers. Ten things we would highlight as being of interest are: ABF s ultimate controlling party is a charitable trust; In % of profits were generated outside the UK, the highest proportion since the global financial crisis; Capital expenditure excluding spend on Primark has declined since 211; When Penneys entered the UK in 1973, it used the Primark brand because Penneys was registered to JC Penney; Primark sells more units than Inditex each year but has one third of its revenues; Primark s average selling price is less than half of H&M s and it makes less than half of the profit from selling 1 items than H&M; Grocery has the second highest divisional ROCE, after Retail, reaching its record adj. operating profit margin of 9.% in 215; Sugar fell from 46% to 4% of group adj. EBIT between 212 and 215. As well as sugar the division grows tomatoes and produces electricity; The Agriculture division is small but has a 1 year adj. operating profit CAGR of over 1%, second only to Retail; The Ingredients business develops enzymes that are not only used in food production but also in textiles, detergents and converting waste to biofuels. Date Special Report Price at 28 Jul 216 (GBP) 2,686. Price Target (GBP) 3,2. 52-week range (GBP) 3, ,35. Warwick Okines Research Analyst (+44) warwick.okines@db.com Jaina Mistry Research Associate (+44) jaina.mistry@db.com Charlie Muir-Sands, CFA Research Analyst (+44) charlie.muir-sands@db.com Distributed on: 7/29/216 18:4:3GMT Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 57/4/216.

2 Model updated: Running the numbers Europe United Kingdom Food Manufacturing Reuters: ABF.L Buy Bloomberg: ABF LN Price (28 Jul 16) GBP 2,686. Target Price GBP 3,2. 52 Week range GBP 2, ,599. Market Cap (m) GBPm 21,219 Company Profile USDm 27,839 Associated British Foods PLC is listed in the Food Producers & Processors sector. It operates 5 divisions: Grocery, Sugar, Agriculture, Ingredients and Retail. Its largest brand is Primark, a value fashion retailer operating mainly in Europe. ABF also owns consumer food brands such as Twinings, Ovaltine, Ryvita and Kingsmill; it is a manufacturer of sugar on three continents; and develops and manufactures a wide range of ingredients and agricultural feeds. Price Performance Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Margin Trends FTSE 1 INDEX (Rebased) E 17E 18E EBITDA Margin Growth & Profitability Solvency EBIT Margin E 17E 18E Sales growth (LHS) ROE (RHS) E 17E 18E Fiscal year end 14-Sep E 217E 218E Financial Summary DB EPS (GBP) Reported EPS (GBP) DPS (GBP) BVPS (GBP) ,18.3 Weighted average shares (m) Average market cap (GBPm) 13,479 2,947 23,59 21,219 21,219 21,219 Enterprise value (GBPm) 14,429 21,497 23,787 21,394 21,16 2,491 Valuation Metrics P/E (DB) (x) P/E (Reported) (x) P/BV (x) FCF Yield (%) Dividend Yield (%) EV/Sales (x) EV/EBITDA (x) EV/EBIT (x) Income Statement (GBPm) Sales revenue 13,315 12,943 12,8 12,997 14,522 15,184 Gross profit 3,22 3,15 3,29 3,76 3,437 3,593 EBITDA 1,623 1,576 1,429 1,568 1,766 1,886 Depreciation Amortisation EBIT 1,88 1, ,92 1,242 1,342 Net interest income(expense) Associates/affiliates Exceptionals/extraordinaries Other pre-tax income/(expense) Profit before tax 868 1, ,47 1,221 1,336 Income tax expense Minorities Other post-tax income/(expense) Net profit ,25 DB adjustments (including dilution) DB Net profit ,35 Cash Flow (GBPm) Cash flow from operations 1,169 1,369 1,143 1,183 1,36 1,497 Net Capex Free cash flow Equity raised/(bought back) Dividends paid Net inc/(dec) in borrowings Other investing/financing cash flows Net cash flow Change in working capital Balance Sheet (GBPm) Cash and other liquid assets ,14 1,629 Tangible fixed assets 4,552 4,665 4,488 4,996 5,126 5,246 Goodwill/intangible assets 1,581 1,467 1,367 1,338 1,31 1,284 Associates/investments Other assets 3,661 3,69 3,53 3,531 3,775 3,871 Total assets 1,374 1,472 1,272 1,83 11,528 12,243 Interest bearing debt 1, Other liabilities 2,689 2,754 2,825 2,829 2,99 3,86 Total liabilities 3,855 3,719 3,721 3,725 3,886 3,982 Shareholders' equity 6,155 6,437 6,336 6,861 7,425 8,45 Minorities Total shareholders' equity 6,519 6,753 6,551 7,77 7,641 8,261 Net debt Key Company Metrics Sales growth (%) DB EPS growth (%) EBITDA Margin (%) EBIT Margin (%) Payout ratio (%) ROE (%) Capex/sales (%) Capex/depreciation (x) Net debt/equity (%) Net interest cover (x) Source: Company data, Deutsche Bank estimates Net debt/equity (LHS) Net interest cover (RHS) Warwick Okines warwick.okines@db.com Page 2

3 Table Of Contents A brief history... 4 Diversification, acquisition and expansion... 4 A summary: the ABC of ABF... 6 The group today... 6 Management team... 7 Shareholder structure... 7 Financial summary... 8 Share price performance Strategy Balance sheet Grocery Grocery division in the group context Description of ABF s Grocery division Track record and performance Market share and competitive landscape Strategy and the future Sugar Sugar division in the group context An introduction to the sugar industry Description of ABF s Sugar division Track record and performance Market share and competitive landscape Strategy and the future Agriculture Agriculture division in the group context An introduction to the animal feeds industry Description of ABF s Agriculture division Track record and performance Market share and competitive landscape Strategy and the future Ingredients Ingredients division in the group context An introduction to the ingredients industry Description of ABF s Ingredients division Track record and performance Market share and competitive landscape Strategy and the future Retail... 4 Retail division in the group context... 4 Description of ABF s Retail division... 4 Track record and performance Market share and competitive landscape Strategy and the future Page 3

4 A brief history Diversification, acquisition and expansion Rising from bakery With its founding roots in a chain of bakeries in Toronto opened by George Weston in the late 18s, AB Foods (ABF) has turned into an international conglomerate with diverse operations. This section highlights some key moments in ABF s history, from processing ingredients and groceries to selling apparel and developing enzyme technologies. Allied Bakeries Ltd was incorporated in 1935 by W. Garfield Weston, president of George Weston Limited that his father had founded in Canada. Allied Bakeries was a group of biscuit and bread factories in the UK and it expanded rapidly. It rebranded to Associated British Foods (ABF) in 196 and acquired Twinings in In 1969 the group opened its first clothing store under the Penneys brand in Mary Street, Dublin. By the 197s, ABF s strengths lay in bakery, milling and its grocery business but its operations also included activities in seed technology, restaurants and catering. Since then, we can divide the modern history of the group into three periods. Period 1 198s and 199s: Diversification The 198s and 199s marked the first key period in ABF s modern history: decades of diversification that shaped how the company looks today. In this time, ABF formed its ingredients business and acquired its sugar and agricultural businesses. Penneys, which had entered the UK in 1973 using the brand Primark since Penneys was registered to JC Penney, continued to grow. In 1992 it opened a 5, sq ft major flagship on O Connell Street, Dublin. Period : Acquisitions which define the group As a result of weak trading in the late 199s, ABF exited its food retailing business in 1997 and focused on strengthening its core businesses through a series of acquisitions. ABF acquired almost 2 companies between These included Ovaltine, which would later be merged with Twinings and together are the bulk of today s Grocery division. Primark developed through acquiring parcels of stores. In 1999 it acquired 11 stores from the Co-Op and in 2 it acquired 11 stores from C&A which exited the UK market. 25 was a seminal year in the development of Primark. During the year it acquired 6 UK stores from department store chain Allders, allowing it to open a major 7, sq ft flagship on Oxford Street, London. This better enabled the brand to begin to express a stronger fashion image. In July 25 ABF acquired Littlewoods stores (12 stores in total, of which 41 stores became Primark). This would propel the growth and development of Primark, which became the largest profit by division in FY Sep-6. Period : The age of Primark Having evolved into a large-sized store format and developed its fashion credentials in the UK & Ireland, Primark then embarked upon continental European expansion in 26 by opening in Spain. A smooth management transition in 29 took place when Arthur Ryan, who had founded the business 4 years previously, was succeeded as Primark CEO by Paul Marchant, who had been recruited from UK value fashion competitor New Look. By 214 the brand was ready to announce its entry into the US, and it opened its doors the following year. By FY Sep-14 Primark had become the majority of group profits and arguably the main driver of ABF s share price. Page 4

5 Figure 1: Key events in ABF s history 1935 Allied Bakeries founded by W. Garfield Weston 196 The company is renamed Associated British Foods 1964 Twinings acquired 1969 First apparel store, named 'Penneys', is opened in Dublin in June under the leadership of Arthur Ryan 1971 Food retail business, Fine Fares, opens its first superstores 1973 Primark opens its first store in the UK 1982 ABF lists on the stock exchange 1986 Fine Fares sold to what became Somerfield 1988 George Weston, grandson of the founder, joins the company as manager of flour-milling operations in Australia 1991 British Sugar (including AB Agri) acquired 1995 ABF acquires Kraft s food ingredients business, first named AC HUMKO and later ACH 1997 Exit of food retail through sale of Irish supermarkets to Tesco 1999 Garry Weston, son of W. Garfield, retires, having run the company since Peter Jackson becomes CEO Garry s son George is appointed to the board and John Bason appointed as Finance Director Ovaltine acquired for 171m AB Mauri (ingredients business) is formed from a number of acquisitions of bakery ingredients businesses 25 Allders & Littlewoods stores are acquired in the UK George Weston succeeds Peter Jackson as CEO in April Fire in Primark distribution centre in Magna Park, Lutterworth 26 Primark's first store in continental Europe opens in Spain AB Sugar acquires a 51% stake in Illovo for 317m 27 Aquires Patak s and takes 2% stake in Jordans for a combined c. 15m Vivergo Fuels formed as a joint venture between ABF, BP and DuPont 28 ABF s Jordans and Ryvita businesses merge to form Jordans & Ryvita, 62% owned by ABF Primark enters the Netherlands AB World Foods is formed 29 Arthur Ryan becomes Chairman of Primark as Paul Marchant joins from New Look to become CEO Primark enters Portugal and Germany AB Sugar acquires Azucarera (Iberian sugar business) 21 Primark enters Belgium 212 Primark enters Austria 213 Primark enters France Agriculture: AB Connect is formed (UK feed business) and AB Vista launches the Quantum blue enzyme Vivergo begins production of bioethanol in Hull (UK) Primark runs 12 week trial of online sales with Asos, subsequently discontinued Collapse of a factory in Bangladesh used by Primark (as well as H&M, Inditex and numerous other brands) sparks controversy about workers' conditions Jordans & Ryvita now fully owned by ABF 214 In April Primark announces its intention to launch in the US 215 Primark enters the US with opening in Boston AB Sugar closes 2 factories in Heilongjiang Province, Northern China 216 Primark opens its first store in Italy Source: Deutsche Bank, company data Acquisition of Illovo minority stake for 245m Page 5

6 A summary: the ABC of ABF The group today 5 business segments, with operations throughout the supply chain ABF has 5 separate business segments. These are briefly summarised as: Grocery: owns and manufactures food brands, ranging from hot beverages (e.g. Twinings) to world foods (e.g. Patak s). Sugar: grows, processes and sells beet and cane sugar, predominantly for use in industry. It also produces co-products, for example generating power for its own operations, and in some markets exporting its surplus. Agriculture: focuses on manufacturing animal feed and developing new technologies for animal nutrition. Ingredients: primarily manufactures yeast and bakery ingredients, but also has operations in the pharmaceuticals, chemicals and other industries. Retail: value fashion retailing in all major European markets and in the US through its Primark brand (named Penneys in Ireland but in this report we use Retail and Primark interchangeably). Figure 2: A breakdown of ABF s businesses and brands Business Breakdown Brands/Description Grocery AB World Foods Blue Dragon, Patak's, Levi Roots, Tabasco, Meena's Allied Bakeries George Weston foods Speedibake Twinings Ovaltine Westmill foods ACH Allied Mills Jordans, Dorset & Ryvita Silver spoon company Strata Kingsmill, Allison, Burgen, Sunblest Tip Top, Golden, Burgen, Watsonia, Mauri anz, Don, KR Castlemaine, Jasol, Abbott s Village Bakery Produces bakery products Twinings, Ovaltine Asli, Pride, Lea & Perrins, HP sauce, Stokelys, Rajah, Tolly Boy, Lucky Boat noodles, Levi Roots, Jimmy's, Green Dragon, Guru, Habib, Elephant Atta, Daawat, Asli Atta, Amoy, Patak's Mazola, Capullo, Spice Islands, Durkee, Weber seasoning, Tone's, French's, Patak's, Karo, Argo, Kingsford, Fleischmann's, Henri's Produces flour and semolina Jordans, Dorset Cereals, Ryvita Sells sugar Sells bottled oil products Sugar AB Sugar China, British Sugar, Azucarera, Illovo, Vivergo, Germains (seed technology) Agriculture AB Agri AB Vista, AB Connect, Speciality Nutrition, AB Sustain, AB Agri China, Frontier Agriculture Ingredients AB Enzymes Enzymes for baking, food, animal feed, textile, pulp and paper Ohly SPI Pharma AB Mauri ABITEC Corporation PGP international Yeast extracts, yeast based flavours and speciality powders Supplies pharmaceutical industry Yeast and bakery ingredients Ingredients for toll manufacturing, pharmaceutical industry, nutritional sciences, speciality chemicals, personal care and cosmetics Supplies and manufactures cereal food ingredients Retail Primark & Penneys Clothing, footwear, accessories and homewares retailer Source: Company data, Deutsche Bank Page 6

7 Management team Charles Sinclair: Non-executive Chairman Charles Sinclair was appointed Chairman of ABF in April 29. He joined ABF in 28 from Daily Mail and General Trust plc, where he was CEO for over 2 years. He previously was a director at Reuters, Schroders and Euromoney Institutional Investor. There are two executive directors: George Weston: CEO George Weston, a grandson of the company s founder W. Garfield Weston, became CEO in 25. He succeeded Peter Jackson, the company s only CEO outside of the Weston family. Mr Weston was previously Managing Director of George Weston Foods, Westmill Foods and Allied Bakeries at ABF. He is a non-executive director of Wittington Investments Limited and a trustee of the Garfield Weston Foundation. John Bason: Finance director John Bason was appointed as finance director in May He was previously finance director at Bunzl Plc. He is currently a non-executive director at Compass Group plc. Shareholder structure 55% is family owned... ABF has one class of share and the Weston family holds a 54.5% controlling stake through the company Wittington Investments Ltd (5.9%) and its subsidiary Howard Investments Limited (3.6%). For the remaining free float, the average daily volume traded has fallen since its peak in 27 and has remained stable at 8, shares over the last few years. Figure 3: Top 5 shareholders Shareholder Share Wittington Investments Ltd 54.5% Capital Group companies Inc 1.% Fidelity Management & Research 3.3% Blackrock 3.2% Associated British Foods trustee 2.% Source: Bloomberg Finance L.P.19 July of which a charitable foundation owns a majority stake Wittington Investments Ltd is a company which manages investments in a wide range of assets. Its largest is its shareholding in ABF but it also owns Fortnum and Mason plc and Heal s plc as well as real estate and other assets. The Garfield Weston Foundation was set up in 1958 and is the beneficial owner of 79.2% of Wittington Investments Ltd, and therefore ABF s ultimate controlling party. Its trustees are descendants of the Weston family, including ABF s CEO George Weston. The trustees are not remunerated for their work at the foundation. The foundation states that all income is spent each year, including on grants to a wide range of UK charities. Page 7

8 5,622 5, , ,235 9,255 1, ,65 1,77 12,252 13,315 12,943 12,8 1,18 1,163 1,92 ABF is not affiliated to other Weston family businesses such as George Weston Limited in Canada, which owns the publicly traded Loblaw and Weston Foods, or Selfridges & Co. in the UK, but ABF does have common key management personnel with these companies. Financial summary A 13bn revenue business ABF s diverse operations generated c. 13bn of revenues and profits of over 1bn in 215. Figure 4: ABF generated revenues of c. 13bn in Figure 5:... and group adjusted profits of over 1bn 14, Group Sales ( m) 1,4 Group adj. EBIT ( m) 12, 1,2 1, 1, 8, 8 6, 6 4, 4 2, Source: Company data, year end September Source: Company data, year end September A number of P&L adjustments A fuller P&L record is shown in Figure 6. Adjusted operating profit (adj. EBIT) is reported after charging central costs and booking ABF s share of post-tax profits/losses from joint ventures and associates. There are numerous JVs and Associates but these include Vivergo Fuels in Sugar (prior to 215), and Frontier Agriculture. Figure 6: A bridge from adjusted operating profit to profit before tax YE September * Revenue 5,996 6,8 8,235 9,255 1,167 11,65 12,252 13,315 12,943 12,8 Adjusted operating profit (adj. EBIT)** ,77 1,18 1,163 1,92 Net Profits on sale of non-current assets Amortisation of non-operating intangibles Exceptional items Operating profit ,88 1,8 947 Net Profit/(loss) on business sale/closure Net financial income/(expense) Adjusted Profit Before Tax ,88 1,15 1,34 Profit Before Tax ,2 717 Adjusted EPS p EPS p Source: Company data, Deutsche Bank * restated; ** includes central costs and share of JVs/associate profits and losses Below adj. EBIT there are three charges taken which bridge to Operating profit. These are [1] net profits on sale of non-current assets, [2] the amortisation and impairment of non-operating intangibles. These are intangible assets that arise Page 8

9 on business combinations and typically include technology, brands, customer relationships and grower agreements; and [3] exceptional items. Exceptional non-cash impairment charges in 212 were taken for the Australian meat business within George Weston Foods and in 215 were taken largely for shareholder loans to Vivergo Fuels. Figure 7 sets out these adjustments to operating profit, sliced by division. Figure 7: The adjustments to EBIT shown by division * Adjusted operating profit (adj. EBIT)** ,77 1,18 1,163 1,92 - Grocery Sugar Agriculture Ingredients Retail Central costs Discontinued activities (within Adj EBIT) Total adjusting items Grocery Sugar Agriculture Ingredients Retail Central costs Operating profit ,88 1, Grocery Sugar Agriculture Ingredients Retail Central costs Discontinued activities (within Adj EBIT) Source: Company data, Deutsche Bank * restated; ** includes central costs and share of JVs/associate profits and losses Below operating profit sit net profits/losses on business sale/closure (Figure 6). The two largest charges taken were in 213 and 215. In 213 this was mostly for disposals and closures in Ingredients in US, China and India, but also for the disposal of a sugar business in Chifeng, north China. In 215 these charges were taken on ABF s sale of two beet sugar factories in north China and to account for the effective disposal of ABF s original equity-accounted stake in the Vivergo JV prior to assuming BP s 47% interest in the business. Retail (Primark) is today the largest division by both sales and adj. EBIT... Retail is currently ABF s largest division. It accounts for c.4% of group sales and c.6% of group adj. EBIT (measured before central costs). Grocery is the second largest division, generating a quarter of group sales and adj. EBIT. Hence, after Primark, ABF s second biggest brand in the group is Twinings, we estimate representing c.5% of group sales and c.9% of group adj. EBIT. Page 9

10 The remaining divisions (Sugar, Agriculture and Ingredients) make smaller contributions to sales and profits today. Retail has only recently begun to dominate the group financially. As recently as 212 the Sugar division represented 46% of group profits and in 25 Grocery accounted for 46% of revenues. As of 215, ABF s most profitable sugar business, Illovo, was fully consolidated in adj. EBIT but 51% owned, with its non-controlling share deducted as a non-controlling interest at the net income level. It announced the acquisition of the minority stake in 216. Figure 8: Retail currently generates c.4% of group sales... Group Sales Split 215 Figure 9:...and c.6% of group adj. EBIT Group adj. EBIT before central costs 215 Grocery 25% Grocery 25% Retail 42% Sugar 14% Retail 59% Sugar 4% Agriculture 5% Ingredients 1% Agriculture 9% Ingredients 7% Source: Company data Source: Company data... and has been the main driver of sales and adj. EBIT growth in past decade The summary growth rates of ABF s separate divisions are shown in Figure 1. Figure 1: Retail and Agriculture have grown profits fastest in the past 1 years Sales m Adj. EBIT m Adj. EBIT margin % Sales CAGR % Adj. EBIT CAGR % FY Sep-15 FY Sep-15 FY Sep Group 12,8 1,92 8.5% 9% 7% Grocery 3, % 2% 4% Sugar 1, % 1% -13% Agriculture 1, % 5% 12% Ingredients 1, % 8% 2% Retail 5, % 18% 17% Central/eliminations -45 na na na Source: Company data. Deutsche Bank The story of the past decade is perhaps best summarised in Figure 11 and Figure 12. Primark represented 6% of the group s sales growth and virtually all of the group s adj. EBIT growth over the last decade. It has achieved this through expansion in the UK and entering continental Europe. Sugar has, in particular, experienced difficult trading since 213 as a result of falls in World and European sugar prices which have essentially been caused by over-supply from larger than expected harvests. 215 was notable for its poor Sugar performance: divisional adj. EBIT fell from 189m to 43m as low prices pushed down margins. Page 1

11 Figure 11: Retail was over 6% of sales growth... Figure 12:...and almost all the adj. EBIT growth , Sales bridge, 25 to 215 ( m) 4,341 12,81 1,2 Adj. EBIT bridge, 25 to 215 ( m) 533 1,92 12, 1, 1, 8, 6, 4, 5, , (24) 1 (123) , 2 25 Sales Grocery Sugar Agriculture Ingredients Retail 215 Sales 25 adj. EBIT Central costs Grocery Sugar Agriculture Ingredients Retail 215 adj. EBIT Source: Company data, continuing revenue Source: Company data The UK remains the biggest market The UK and Europe & Africa are key regions for ABF. In 215, the UK generated 42% of group revenues and Europe & Africa a little behind at 32%. The regional shares have seen little change since 21, with the exception of Europe & Africa growing in importance at the expense of Asia Pacific. Figure 13: Over 7% of revenues come from the UK, Europe and Africa... Revenues by geography, pre disposals 215 Americas 1% Asia Pacific 16% UK 42% Figure 14:...and 8% of profits Group adj. EBIT by geography, pre disposals 215 Americas 13% Asia Pacific 7% UK 49% Europe & Africa 32% Europe & Africa 31% Source: Company data Source: Company data Exposure to a range of currencies ABF is exposed to currency movements because of this diverse geographic exposure. The company does not actively hedge the translation impact of foreign exchange rate movements on the income statement but receives foreign currency earnings and fixes its currency rates at the point of purchasing goods and services. The currency exposure varies by division but generally a weak Sterling against Euro and US Dollar is favourable for the group. In Grocery the effects are mostly translation. We estimate that around 4% of Grocery sales are UK with the other main currencies being Euro, US Dollar and Australian Dollar. In Sugar there are translation effects from China, Southern Africa and Spain. There is also a transactional effect at British Sugar, where its end sale is priced in Euros but its costs are in Sterling. As a result we estimate that less than 1% of Sugar sales are in Sterling. In Retail the movement of Sterling is more conflicting. With around half of sales and profits in the UK and the rest in Page 11

12 Dec 4 Dec 5 Dec 6 Dec 7 Dec 8 Dec 9 Dec 1 Dec 11 Dec 12 Dec 13 Dec 14 Total shareholder return relative to FTSE1 EPS (p) Euros, weak Sterling has a positive translation effect. However, about 8% of costs of goods sold are in US dollars, so strength of USD against Sterling and Euro causes higher purchasing costs. In Agriculture, the main business AB Vista supplies yeast and natural nutrients to the global animal nutrition industry. It is headquartered in the UK but operates regional hubs in Brazil, India, North America, Singapore and Spain. Agriculture also operates AB Agri China and some UK-only businesses such as the Frontier Agriculture JV. In Ingredients, the majority of the division is AB Mauri which is a global supplier of yeast and bakery ingredients to more than 9 countries. It has both non- Sterling sales and operating costs. Share price performance Total shareholder returns have closely followed EPS. Since 21 the expansion of Primark in Europe has helped ABF shares outperform the FTSE1. In recent years Sugar profit declines have partly offset the profit growth in Retail. Figure 15: ABF has outperformed the market since 21, largely as a result of Primark s success ABF performance relative to FTSE1 Total shareholder return (LHS) EPS (RHS) Figure 16: EPS revisions were downward in FY Sep EPS momentum (p) Source: Deutsche Bank, Datastream, company data. We have used annual adjusted EPS and the latest reported figure is for FY Sep-15; data correct as of 22 July 216 Source: Deutsche Bank, IBES, Datastream; data correct as of 22 July 216 Strategy The five business segments are managed separately, with the corporate centre agreeing divisional strategy and budgets as well as managing the group balance sheet. The corporate centre also provides some shared services, such as finance, procurement, and sharing best practice. Broadly the group-wide strategy is to develop strong and sustainable positions in their markets through both organic growth and acquisitions. On a divisional basis, the strategies differ: In Grocery it is to develop and grow its brands, depending on their stage of development, in new and existing markets. This can be through both product innovation and range extension. It also selectively pursues M&A; In Sugar its aim is to be a world-leading sugar business. Its strategy is to reduce the cost base to make it more profitable at current sugar prices and for a post-quota world. Additionally the division aims to Page 12

13 expand its co-product operations, including ethanol and power generation; Agriculture aims to improve the sustainability of food production and make agri-food production more efficient through innovation and partnerships. It aims to diversify geographically both organically and through the pursuit of strategic acquisitions and partnerships; In Ingredients the strategy is to provide a relevant supply of ingredients and technology to its customer base. It aims to grow by serving its customers backed by high levels of research and development and investment in technology; In Retail the focus is on organic expansion opportunities in Europe and in the US, in regions where it already has operations. Balance sheet A strengthening balance sheet ABF currently has the lowest level of gearing in a decade. In FY Sep-11, net debt was 1.3bn but by the end of FY Sep-15 it had declined to.2bn. Net debt balances tend to be higher at the H1 balance sheet date, implying average annual net debt is several hundred millions higher than at year end. Adjusted net debt/ebitdar currently stands at 1.2x, after a steady decline since 211. Management has indicated on several occasions that it is comfortable that the cash position of the company would enable it to carry out any investment projects. To quote George Weston at the company s full year results presentation for FY Sep-12:...the balance sheet is the servant of the business, not the other way round. Figure 17: Net debt has been declining Figure 18: Adjusted net debt/ebitdar is 1.2x , -1,2-1,4 Net cash/(debt) m ,61-1, Adj net debt/ebitdar Net debt/ebitda 1.4 x 1.6 x 1.6 x 1.5 x 1.4 x 1.4 x 1.2 x 1.2 x 1. x.9 x 1. x 1. x.9 x.7 x.7 x.4 x.4 x.5 x.3 x.1 x.1 x -.3 x Source: Deutsche Bank, company data Source: Deutsche Bank, company data. Leases capitalised at 8x 2bn of firepower from committed debt facilities ABF has total committed facilities amounting to 2.1bn, of which over half ( 1.2bn) is in the form of a revolving credit facility that matures in July 22. The remainder of the group s debt facilities consist of.6bn of US private placement notes and.3bn of locally committed funds in Africa and Spain. ABF owns a large proportion of its land and buildings... ABF s operating lease charge on property rentals in FY Sep-15 was 192m. These are typically fixed leases with no contingent (turnover-related) portion. We know from Primark s UK subsidiary accounts (Primark Stores Ltd) that the UK rental charge was 81.1m (42% of the group operating lease charge). Page 13

14 ABF had land and buildings on its balance sheet of 2,255m at cost with a net book value of 1,759m as at September 215. The majority of this, we believe, relates to Primark store freeholds in UK and Ireland. The company does not revalue its properties within its balance sheet but in September 27 disclosed a valuation of Primark properties: 1.bn on a vacant possession, 1.26bn with a Primark covenant and.58bn in net book value. Since 27 ABF has added c. 14m of Primark UK freehold at cost and c. 55m of freehold across the group and all of its divisions. If we assume three-quarters of this relates to Primark then we estimate a rental shield of c. 75m, which in turn implies that Primark s EBIT margin is around 14bps higher than it would be if it operated on a fully leased basis. Figure 19: Net Book Value of land and buildings within ABF and Primark UK Sep-7 Sep-8 Sep-9 Sep-1 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Net book value of Land & Buildings 1,97 1,278 1,487 1,61 1,778 1,751 1,796 1,824 1,759 - Freehold ,161 1,249 1,385 1,365 1,388 1,399 1,36 - Long leasehold Short leasehold ow Net book value of Primark 579 NA NA NA NA NA NA NA NA ow NBV of Primark UK* Primark valuation on vacant possession 1,2 NA NA NA NA NA NA NA NA Valuation on Primark covenant 1,262 NA NA NA NA NA NA NA NA Source: Deutsche Bank, company data, * Primark Stores Ltd accounts Note: Company disclosed an external valuation in its FY Sep-7 annual report... although off balance sheet liabilities are significant Despite ABF s property ownership it still has significant operating lease liabilities. As at September 215 its minimum future lease payments were 3.5bn and total operating lease charges during the year were 26m. Dividing the two gives a rough sense of an average lease length being 17 years. However, management has suggested that the leases coming on balance sheet under the new accounting standards at the end of the decade would be in the order of some 2bn. Page 14

15 Figure 2: ABF s operating lease base has increased by 5x since 25 4, 3,5 Future minimum operating lease payments at YE (land & buildings) 3,311 3,511 3, 2,5 2,518 2,733 2,884 2, 1,5 1,21 1,525 1,657 1,898 1, Within 1 year 1-5 years After 5 years Source: Deutsche Bank, Company data Capital expenditure is increasingly focussed on retail Capex has been spent at Primark on store openings, expansions, relocations and improvements to its distribution facilities. In the other businesses, management has focussed on improving efficiency (e.g. Allied Bakeries), opening new production plants (e.g. AB Mauri) and re-launching brands (e.g. Twinings). Figure 21: Capex* has declined since 211, but investment into Primark has remained steady 1, Other ( m LHS) Primark ( m LHS) Capex/Sales (% RHS) Source: Deutsche Bank, company data, * excluding acquisitions Return on capital is highest in retail Returns vary by division, as Figure 22 shows. Returns are highest in Retail and Grocery, although historically Sugar returns have been higher. The returns shown for Retail are influenced by the proportion of freehold in its mix, which has been declining. We discuss Primark s returns in the Retail chapter. Page 15

16 Figure 22: Return on average capital employed* is highest in the Retail and Grocery divisions Sep-1 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Grocery 19.7% 17.6% 12.2% 16.9% 2.8% 22.5% Sugar 14.% 17.3% 26.5% 23.3% 1.5% 2.4% Agriculture 18.1% 19.% 16.5% 16.4% 17.3% 19.2% Ingredients 8.3% 8.3% 4.3%.6% 5.8% 11.1% Retail 23.5% 18.2% 19.2% 26.% 33.2% 31.1% Source: Company data (pre-tax, ex leases), *Company definition: Adj EBIT/average capital employed Pension fund is well funded The company has defined benefit pension schemes which mostly relate to the UK. The UK scheme was closed to new entrants in October 22. At FY Sep-15 it had an IAS19 net deficit of 16m with scheme assets and liabilities of 3.6bn and having made cash contributions of 39m during the year. A triennial valuation of the UK scheme was undertaken as at 5 April 214. The scheme had a surplus of 9m so there is no recovery plan in place. Figure 23: ABF has relatively low valuation sensitivity to changes in discount & inflation rates FY Sep-15 Market Cap m Assets m Liabilities m Net -25bps discount rate ( m) +25bps Discount Inflation inflation sensitivity/m sensitivity/m ( m) arket cap arket cap Discount rate used (%) Inflation rate used (%) ABF UK pension 21,264 3,343-3, % 1% 3.8% 3.3% ABF Overseas pension 21, na na na na % -7.4% Irrecoverable surplus -6 na na na na na na Total 21,264 3,634-3, na na na na na na Source: Company data (last financial year), Deutsche Bank, Thomson Reuters (29 Jun 216) Dividends are considered against adjusted EPS Dividends have steadily risen over the last decade and were 35p per share in 215. This resulted in a payout ratio of c.5%, significantly higher than its 1 year average of c.4%, as shown in Figure 24. The board has a progressive dividend policy and considers dividends against its Adj EPS metric. Figure 24: Dividends have been rising since 25 Figure 25: 215 had a bumper payout ratio DPS (LHS) Growth rate (RHS) % 25% 2% 15% 6% 5% 4% 3% 37% 49% 42% Dividend payout ratio 45% 46% 36% 36% 34% 44% 1 yr average 35% 52% % 2% 5 5% 1% % % Source: Deutsche Bank, company data Source: Deutsche Bank, company data Page 16

17 46% 43% 38% 34% 34% 34% 33% 3% 27% 26% 25% 32% 32% 24% 28% 26% 24% 25% 17% 18% 22% 25% 54% 57% 62% 66% 66% 66% 67% 7% 73% 74% 75% 68% 68% 76% 72% 74% 76% 75% 83% 82% 78% 75% Grocery Grocery division in the group context Grocery s contribution to ABF has been declining Over the past decade Grocery has reduced as a proportion of group sales. In 25 it was ABF s largest business, accounting for 46% of group revenues. This has steadily declined to 25% by 215, as a result of Primark s fast growth. Figure 26: While its contribution to group sales has declined since Figure 27:...its adj. EBIT* contribution has been more stable and has recovered to a quarter of the group 1% Grocery as a % of sales Grocery Other 1% Grocery as a % of adj. EBIT Grocery Other 75% 75% 5% 5% 25% 25% % % Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank; * adj. EBIT before central costs Description of ABF s Grocery division Manufactures and sells grocery brands Grocery is the second largest division within ABF, producing a quarter of revenues and adj. EBIT. The grocery business manufactures and sells a variety of consumer facing brands. It operates across hot beverages, sugar, vegetable oils, world foods, baked goods, herbs & spices and meat, and a comprehensive list of brands were shown in Figure 2. Figure 28 and Figure 29 show an estimated breakdown of revenue and profit by brand. The company does not disclose these figures, however we estimate Twinings Ovaltine to be its leading subdivision, generating c.3% of Grocery revenues and c.6% of Grocery profits. ACH and Allied Bakeries also produce a significant proportion of revenues; however we estimate they achieve singledigit profit margins. Page 17

18 Figure 28: Twinings Ovaltine generates an estimated c.3% of Grocery revenues... Other 25% Grocery Revenue 215E Twinings Ovaltine 31% Figure 29:...and 6% of Grocery Adj. EBIT at a margin of 17% Jordans Dorset Ryvita 6% World Foods 7% Grocery Adj. EBIT 215E Other 5% World Foods 5% Jordans Dorset Ryvita 5% ACH 15% Allied Bakeries 19% Allied Bakeries 1% ACH 12% Twinings Ovaltine 6% Source: Deutsche Bank estimates Source: Deutsche Bank estimates Below we summarise the key businesses and brands: Twinings Ovaltine: merged in 23 after the acquisition of Ovaltine for 171m, these two brands are sold internationally. Twinings sells a range of premium teas and Ovaltine sells malt based drinks. We estimate Twinings to be slightly bigger than Ovaltine; Jordans, Dorset & Ryvita: Dorset Cereals was acquired in October 214 for 6m, and has been integrated with the Jordans Ryvita business. Jordans and Dorset sell premium cereals, and Ryvita sells crispbreads; ACH: operates in North America and Mexico and its main business is in edible oils (corn, olive, canola or rapeseed) through the brands Mazola (in the US) and Capullo (in Mexico). ACH also sells herbs, seasoning and spices; Allied Bakeries: produces and sells bread in the UK. Its primary brand is Kingsmill; Other businesses include George Weston Foods (the Australian bread, meats and baked goods division), AB World Foods and Westmill Foods that sell a range of ethnic food brands (including Patak s, Blue Dragon and Elephant Atta) and Silver Spoon which sells refined sugar. Track record and performance Becoming a higher margin business Over the last decade, grocery sales and profits have benefitted from several acquisitions as well as strong performances from key brands including Twinings and Ovaltine. As of recent years however, the business has faced pressures from food commodity price deflation and tough competition, which has resulted in declining revenues. Grocery adj. EBIT has been volatile over the last decade and after a dip in 212 (due to restructuring costs at George Weston Foods and Allied Bakeries and the price pressures mentioned above) it has significantly recovered. Indeed while revenues have fallen, adj. EBIT has risen since 212. This is a reflection of successful investment programmes and cost reduction measures at Allied Bakeries as well as strong performances from Twinings Ovaltine, ACH and Page 18

19 George Weston Foods. FY Sep-13 was also restated to transfer a flour milling business of George Weston Foods from Grocery to Ingredients. The main effect was to remove 272m from Grocery revenues in FY-13 and also boosted margins by 3bps. Figure 3: Revenues have fallen due to price deflation... 4, Grocery sales m 3,671 3,726 3,568 3,46 3,5 3,337 3,188 3,177 3, 2,82 2,59 2,578 2,65 2,5 2, 1,5 1, 5 Figure 31:...but adj. EBIT has risen on the back of increased efficiencies and product innovation 3 Grocery adj. EBIT m Grocery adj. EBIT margin % % 9% 8% 7% 6% 5% 4% 3% 2% 1% % Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank Market share and competitive landscape Due to the diverse brands owned by the grocery business that span numerous industries and geographies, in this section we delve deeper into the key brands by looking at the markets in which they operate and their key drivers. Twinings: developing its premium range globally We estimate that Twinings is a c. 7m brand by revenues and that the UK contributes around one fifth of its sales. Twinings is the number 2 brand in the 8m UK market (Euromonitor, 215) and it has rapidly grown its market share since 212. Its 17% share however masks key differences within the different subsectors, as shown in Figure 33 to Figure 35. Twinings dominates the fruit/herbal and green tea markets by a clear distance as a result of its refreshed product ranges, formats and advertising campaigns. In black tea the market is less concentrated, with Twinings holding a 13% share in 215. Figure 32: Twinings is the second largest player in the UK tea market, with a 17% market share UK tea market 215 Clipper (Koninklijke Wessanen) 3% Typhoo (Apeejay Surrendra Group) 4% Other 14% PG Tips (Unilever) 18% Twinings (ABF) 17% Figure 33: It is the number 4 player in Black Teas... Clipper (Koninklijke Wessanen) 3% Typhoo (Apeejay Surrendra Group) 5% Twinings (ABF) 13% UK Black Tea market share, 215 Others 7% PG Tips (Unilever) 25% Yorkshire (Betty's & Taylors Group) 1% Private label 13% Tetley (Tata Global Beverages) 14% Yorkshire (Bettys & Taylors Group) 15% Private label 15% Tetley (Tata Global Beverages) 17% Source: Euromonitor Source: Euromonitor Page 19

20 Norway Dominican Republic Finland Australia Sweden Italy Greece United Kingdom Denmark Nigeria France Switzerland Guatemala Iran Ireland Cameroon Belgium New Zealand Hungary Thailand USA Saudi Arabia Spain United Arab Emirates Slovenia North America Bulgaria Austria Slovakia Hong Kong, China Romania Uruguay Canada Figure 34:... but it is the clear market leader in an otherwise fragmented fruit/herbal tea market... UK Fruit/Herbal Tea market share, 215 Figure 35:...as is the case in the green tea market, in which Twinings has a 32% market share UK Green Tea market share, 215 Others 31% Twinings (ABF) 33% Jacksons of Piccadilly (ABF) 3% Others 21% Twinings (ABF) 32% Tetley (Tata Global Beverages) 1% PG Tips (Unilever Group) 3% Private label 6% Yogi Tea (East West Tea Co) 4% Pukka (Pukka Herbs) 6% Private label 1% Tetley (Tata Global Beverages) 17% Clipper (Koninklijke Wessanen) 17% Source: Euromonitor Source: Euromonitor We estimate that Twinings is the division s most profitable brand, though management has only gone so far as to confirm that it generates margins in excess of 1%. Twinings has driven growth by successfully expanding its premium product range and improving packaging. The re-launch of its Infusions range combined with marketing investment drove sales in 213. This was subsequently furthered by developments in their green tea and specialty black tea ranges, which have been particularly successful in developed markets. International expansion is the second part to the growth story and Twinings is now sold in over 1 countries. Figure 36 shows the countries with the largest market shares. Despite having a global presence, Twinings only holds more than a 1% market share in less than a quarter of the countries (where data is available). In particular, Twinings holds a large market share in primarily developed countries and it has a long tail of smaller shares in less developed regions. Of this, we estimate that the UK, USA and Australia are Twining s key markets by sales. Figure 36: Twinings key markets are the UK, Australia and the USA Figure 37: Twinings has grown its market share in Australia and the UK since % 4% Twinings market share by country, 215 3% Twinings market share in its key markets 35% 3% 25% 2% 25% 2% Australia 15% 1% 5% 15% UK % 1% USA 5% % Source: Deutsche Bank, Euromonitor, Key markets are highlighted in grey Source: Deutsche Bank, Euromonitor Page 2

21 Brazil Austria Belgium Netherlands Hungary Thailand Switzerland Canada France North America USA Taiwan Saudi Arabia China Hong Kong, China Ireland United Kingdom Vietnam Germany Indonesia United Arab Emirates Portugal New Zealand Philippines Singapore Australia Greece Malaysia Venezuela Ovaltine: a high margin business in concentrated markets Ovaltine was acquired from Novartis in 22 for 171m and management and operations were combined with ABF s existing Twinings business in 23 to create a single business unit called Twinings Ovaltine. Like Twinings, it is an international brand. However, its focus is on developing markets due to the nutritional content of malt barley: indeed its advertising slogan is Nutritiously Delicious. We estimate that Ovaltine s sales were around 3m in FY Sep-15. According to Euromonitor estimates, Thailand is Ovaltine s largest market, generating sales of 63m in 215. Other important markets are China, USA, Nigeria and Indonesia. As the market shares in Figure 39 demonstrate, the niche malt-based drinks market is highly concentrated and is characterised by one player dominating each regional market. In Asia, Ovaltine s largest competitor is Milo (owned by Nestle). In 6% of the 29 markets in which data was available, Ovaltine has a market share of over 2%. This affords a level of pricing power and thus EBIT margins above 1%. Figure 38: We estimate that Ovaltine s largest market by sales is Thailand 7 Ovaltine: Top 5 markets by sales m, Figure 39: Ovaltine has a large market share in c.6% of the markets studied* Ovaltine market share (%) by country, Thailand China USA Nigeria Indonesia Source: Euromonitor, Deutsche Bank Source: Euromonitor, Deutsche Bank, *key markets highlighted in grey Jordans, Dorset & Ryvita: a venture into healthy snacking Jordans, Dorset & Ryvita was formed in 214 and is the product of acquisition, acquiring Ryvita back in 1949, Jordans over the period and Dorset Cereals in 214. All three brands have a growing international presence though their principle market is the UK. Ryvita is the clear market leader in bread substitutes in the UK, a 78.1m market, with a 42% market share. Jordans and Dorset Cereals operate in the much larger breakfast cereals market, worth 1.9bn in the UK and hold a 2% and 1% share respectively. Key drivers of these brands are product innovation, the continuation of the shift towards healthy eating, international expansion in targeted markets and increases in disposable income. An example of innovation was the 28 launch of Ryvita Thins, a snack product designed for dipping and positioned for the trend towards healthier snacking. The launch created a new product category in the UK and has seen significant growth. Page 21