AB Foods' Fast Fashion and Pensions Mashup

Slumping U.K. fashion sales meet unwelcome pension deficit

Conglomerate Associated British Foods is fighting a war on two fronts.

The first is at home. Its fast fashion retailer Primark reported its biggest annual same-store sales drop on record, falling 2 percent in the fiscal year that ends next week. AB Foods said this was due to unseasonable weather, but the decline shows that even the superstar of cheap chic is not immune from the vagaries of the British consumer after Brexit.

Shares in AB Foods took a nasty 9 percent tumble on the report. 

Dollar Discount

AB Foods slumped amid concerns that a weaker pound may hit Primark's sourcing costs

Source: Bloomberg

Domestic conditions are about to get trickier. Primark pays for most of the products it buys in dollars, so the slump in the pound makes them more expensive. It is hedged for now. But these contracts will run out before the end of this calendar year.

Although it can do its best to negotiate with suppliers, taking into account, for example, the low oil price, it looks like its sourcing costs will rise. Its commitment to low prices means that margins will suffer in the new financial year that begins on Sept. 18.

That also means that, as conditions in the mature U.K. retail market become more difficult, Primark should still be able to outperform more-expensive rivals. 

It's also worth remembering that the retailer's growth story in the U.S. remains intact. With American mall owners keen to sign Primark up, and brand awareness growing, it still looks like it will be the first British retailer to crack one of the world's biggest retail markets. 

Gadfly has argued that there would be value in spinning out Primark, because of the prospects for success in the U.S. That still stands.

U.K. Bond Gains Hit AB Foods Pensions

Falling yields have turned last year's surplus into a deficit

Source: Bloomberg

The battle on AB Foods's second front is more abstract, as it's finding itself caught up in an unwelcome trend on pensions. AB Foods said Monday that plunging long-term bond yields, used to put a present value on future defined benefit plan liabilities, had transformed last year's small pensions surplus into a 200 million pound ($265 million) deficit.

AB Foods warned that this would lead to a higher cost of servicing the pension, and a bigger interest cost. Were it to have to raise pension contributions, that may not be too much of a problem, as it's cash generative and has low net debt, it's likely to be another nagging doubt for investors going forward. 

It is unlikely to be the last company to report a detrimental effect on its pension situation over the coming months, and its deficit is still relatively small. But it does give an early indication of what to expect. One to watch out for is Tesco's half-year results early next month. It had a pension shortfall of 2.6 billion pounds in the year to February, even before the post Brexit fall in long-term bond yields.

Prime Position

Primark dominates Associated British Foods' sales so any slowing is a problem

Source: Bloomberg

AB Foods trades on a price earnings ratio of 24 times, a discount to Primark's fast fashion rival Inditex. That's understandable, given that ABF's other businesses, which range from grocery brands such as Kingsmill and Ovaltine, to even pig feed and sugar production, complicate the valuation picture and may not be so fast growing.

Hiving off Primark would help narrow the gap. Until then, investors must deal with AB Foods's constant juggling. And that includes dealing with the pension situation.

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

    Before it's here, it's on the Bloomberg Terminal.