ABF: Anatomy of a hatchet job
Posted on January 9, 2008 by Richard Beddard
Filed Under Companies |
I’m a bit nervous about a forthcoming iBall episode (for broadcast next week). In it I compared a perfectly good company to an uninspiring rock cemented together by sludge from the bottom of a river and based my analysis on a ratio I’ve never been comfortable with. Time for an explanation.
There’s much to like about Associated British Foods. Profits and dividends have been rising steadily for years. Its cash flows (i.e. the money that actually comes in less the costs it actually incurs) exceed its accounting profits, which lends confidence, and its interest payments are covered many times by its profits, another sign of financial strength.
So what’s not to like about ABF? At 830p, ABF is trading at 20 times its long term average earnings, a conservative measure I favour, or 17 times 2007 profits. For profitable companies that’s about average, so the shares aren’t obviously cheap.
They’re not attractive to income investors either as ABF’s dividend yield is 2.3%, less than half the interest you’d get in decent savings account.
As an investor looking for reasons to buy shares in this blue-chip company, I’m running out of hooks on which to hang my valuation, the old stalwarts, the price earnings ratio, and dividend yield having failed me.
Since the price is so high, investors must be banking on growth, so maybe the PEG ratio will reveal the value in ABF. Jim Slater imported the PEG into the UK but it was already widely used in the United States. Here it is described by legendary fund manager, Peter Lynch, in the investment book that inspired a thousand careers, including mine, ‘One Up On Wall Street’:
We’ve gone on about this [the PE ratio] already, but here’s a useful refinement. The PE ratio of any company that’s fairly priced will equal its growth rate. I’m talking about the growth rate of earnings here…
…If the PE of Coca Cola is 15, you’d expect the company to be growing at about 15% a year etc… [A] growth rate of 12% a year (also known as a “12 per cent grower”) and a PE ratio of six is a very attractive prospect. On the other hand, a company with a growth rate of six per cent a year and a PE ratio of 12 is an unattractive prospect and headed for a come down.
Although I’m a big fan of Peter Lynch, I’ve never been a fan of this refinement. I just don’t think you can take growth for granted. And it seems more than a little convenient that it should be related to value in the precise ratio of 1:1.
Putting aside my prejudices though, if we’re to assume ABF is a growth stock, we should use the tools of growth investors to see how it measures up.
For nearly a decade ABF has been growing steadily at about 5% a year, which puts it firmly in the “unattractive” bracket. Of course, its the future that counts, and it could grow more rapidly now it’s invested heavily in sugar production in ‘high growth’ regions like Africa and China and new industries like ethanol, a fuel that can be produced from sugar.
That’s what analysts must be reckoning. They are forecasting 12% earnings growth a year for the next few years. But even 12% compares unfavourable with a PE ratio of 17 or 20 and, curiously, 12% earnings growth is just below average for company’s forecast to be profitable over the coming years.
Perhaps that’s because ABF is a conglomerate, a rock maybe, but not a rocket. And growth in sugar is not what’s required for ABF to take off, but growth across all its businesses.*1
Those include Primark, Britain’s second biggest clothing retailer, major food brands like Ovaltine and Patak’s, food ingredients (think yeast extract), and animal feeds.
Anyway, when you run out of ratios to value a company by, and you run out of holes to pigeon it into (value, growth, income), it’s difficult to find a reason to buy the shares, however good the company is.*2
Footnotes:
- Here’s a spreadsheet showing ABF’s segmental analysis for 2007. I’ve calculated operating margin, asset turn and return on assets for each unit.
- That is, of course, a personal view and not intended to be a recommendation that you sell your shareholding in ABF!
Comments
Leave a Reply
