Consumer

Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.

Conglomerates were all the rage in the 1960s, but fell out of fashion along with the beehive hairdo. Primark is about to remind us why.

The fast-growing cheap-chic clothing operation is part of Associated British Foods, whose other businesses include sugar processing, food ingredients and brands such as Twinings Tea, as well as agriculture.

ABF's Outperformance
Diversification has helped it beat the broader market
Source: Bloomberg

It's an eclectic mix, but one that has rewarded investors handsomely. In the past decade ABF has delivered a total return of 380 percent, compared with 47 percent for the FTSE All Share Index.

Diversification has helped power Primark from its birth in the 1960s as an Irish discount clothing chain to aggressive expansion across Europe and more recently into the U.S. Unusually, compared to other clothing companies, it's been able to grow without a spike in borrowing -- its debt to common equity ratio is just 14.1 percent, compared with 63.3 percent at Marks and Spencer.

ABF's Low Leverage
Primark's expansion hasn't required a spike in debt, unlike some of its rivals
Source: Bloomberg

Primark's growth threatens to upend the balance across all of ABF's companies. It already accounts for 42 percent of ABF's sales and 59 percent of operating profit, and analysts at Liberum forecast that it could double sales and profits over the next five years.

It's all down to its move across the Atlantic. Customers of all ages are already responding well to its low prices, but landlords will be falling over themselves to lure Primark into their malls -- they've got holes to fill in their properties as the likes of Macy's, J.C. Penney and Gap cut back on stores.

In contrast, profit from sugar operations has dissolved from 35 percent of ABF's total in 2013 to just 4 percent in the year to September 2015. The end of EU sugar sales quotas in September next year has forced producers to fight for big contracts.

While Primark is in a growth phase and the global environment proves fragile, the cashflows from the rest of ABF offer a nice safety cushion. But once its growth is more entrenched, Primark's profits will far surpass that of the rest of ABF.

The Creeping Dominance of Primark
US expansion means retail may cast an even longer shadow over the rest of ABF
Source: Bloomberg

Then there are the valuations. According to Shore Capital, Primark will generate about 500 million pounds ($716 million) of post-tax profit in the year to September 2016, and account for 18.5 billion pounds, or about three quarters, of ABF's 25 billion-pound value.

That puts Primark on about 37 times the next 12 months earnings, a hefty premium to both Spain's Inditex, the owner of the Zara retail brand, and Sweden's Hennes & Mauritz.

But Shore forecasts that post-tax profits will expand to about 700 million pounds in 2018, putting it on valuation of about 26 times, not that far from Inditex. That's too low -- if the U.S. turbocharges Primark's sales, it should command a bigger premium.

The remainder, including sugar production and groceries such as Ryvita crackers and Kingsmill bread, are on about the same valuation as the broader packaged food industry, which is about 18 times earnings. That looks fair for now, but might look mean if the sugar business finally recovers.

So pretty soon there could be value to be realized by spinning out Primark, or even perhaps the remaining rump of companies under the ABF umbrella.

ABF's management -- helped by the stewardship of the Weston family, which still has an interest -- has done a pretty good job so far of balancing the needs of the very different businesses. But as Primark races away from the other divisions, that could become, well, unmanagable.

It’s the type of situation that made conglomerates fall out of fashion in the first place.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andrea Felsted in London at afelsted@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net