Associated British Food Plc - Case Study Example

Associated British Food Plc Executive Summary The main purpose of the report is to investigate whether ABC Plc, which is a highly successful listed company in the UK, can acquire a renowned company, Associated British Foods Plc, so as to reduce the idiosyncratic risks. It also highlights the global economic condition and compares with that of the UK. The retailing industry in the UK is also taken into consideration so as to compare with the performance of British Foods. The preliminary valuation of British Foods is also essential for examining whether it is a potential target for helping ABC Plc in reducing or eliminating idiosyncratic risks. In order to evaluate the financial performance of British Foods, a benchmark company is considered, i.e. Tesco Plc, which belongs to the same industry. A financial valuation model was implemented, which provided the present value of the company as well as the intrinsic value per share. The ratio analysis combined with the financial valuation model helped the researcher to comprehend the value of the company presently. The study revealed that Associated British Foods Plc is significantly overvalued. Hence the acquiring company should either consider a merger and acquisition option at a discounted price or should look out for other target company options. Table of Contents 1.Review of UK and Global Economy 5 2.Retailing industry in the UK 6 3.Associated British Foods Plc (ABF) 7 4.SWOT analysis of ABF 8 5.Discussion of the financial performance of ABF compared to Tesco Plc 10 Associated British Food Plc operations 12 6.1. Operating segments 12 6.Investments 13 7.Highlights from balance sheet 14 8.Highlights from Cash flow 14 9.Highlights from financing activities 15 10.Overall evaluation 15 11.Financial modelling and Valuation 16 12.Recommendation and conclusion 17 Reference list 19 Appendices 21 Appendix 1: Liquidity ratio of Tesco plc 21 Appendix 2: Liquidity ratios of ABF plc 22 Appendix 3: Financial ratios of ABF Plc 23 Appendix 4: Financial modelling and valuation 24 1. Review of UK and Global Economy The UK economy is considered as the fifth largest economy in the world with respect to nominal Gross Domestic Product (GDP) and also the eighth largest if measured by the purchasing power parity (PPP) (Sentence, 2014; The Heritage Foundation, 2015). During 2013, the UK economy was regarded as the fourth largest exporter and importer in the world. All the sectors in the economy are growing but the UK government needs to concentrate on improving the number of present job opportunities, which will also facilitate economic growth. As compared to the global economy, it can be stated that the UK is considered to be the fastest growing G7 country during 2014 (The Heritage Foundation, 2015). The report published by the International Monetary Fund (IMF) recorded that the UK economy has recovered in the past 8 years with respect to living standard and rise in GDP. Figure 1: Living standard since 1980 (Source: Sentence 2014) From the above figure, it is quite evident that the living standard of individuals in the UK is better as compared to other G7 countries such as Canada, Germany, France, Japan, Italy and the US. It is because of the rise in the GDP of the economy (Sentence, 2014). Two measures can be employed for gauging the importance of the UK on the global economy such as PP and size of the economy. According to IMF report, it can be stated that the UK holds sixth position with respect to PPP and it is regarded as the best measure for examining the relative significance of the country in the global economy (Retail Think Tank, 2015). Secondly, size of the UK economy can be measured with the help of market exchange rates, i.e. the value of the currency at which it is traded at a regular basis (Sentence, 2014). According to IMF, the UK is regarded as the fastest economy in G7countries during 2014, which has experienced a growth rate of 2.7% (Papadopoullos, 2015). Hence, it can be stated that despite the global economic downgrade, the UK has managed its consistent position in the world economy. 2. Retailing industry in the UK The retailing industry in the UK had registered positive growth during 2013 despite challenging situation of the economy. The spending power of the individuals in the UK was influenced by economic recession. However, the retailing industry managed to contribute positively towards the betterment of the economy and indicated a positive outlook for a forecasted period of time. With the slow recovery in the consumer spending behaviour, the retailing sector not only experienced high growth but also helped the individuals to meet their demands with the best quality products and services (Retail Think Tank, 2015). The improvement in macroeconomic indicators such as GDP, employment and disposable income after the recession helped in reviving the consumer confidence (Retail Think Tank, 2015). The convenience stores, online grocery retailing and discount stores have gained prominence and expansion; along with that many small stores also did good business in the city. The retailing sector in the UK is dominated by the renowned retailers such as Tesco Plc, ASDA Plc and Morrison Supermarkets (Euromonitor International, 2015). The grocery retailers not only sold grocery items but they also concentrated on selling non-grocery items. The small stores are favoured against the supermarkets, but in the UK the retailers made a way in to the market through multichannel retailing. This enabled the customers to purchase extensive range of products from electronic items to home wares. The online retailing also helped them to obtain their necessities without much effort (Euromonitor International, 2015; Center for Retail Research, 2015). The retail sales grew by 2.3% during 2013, which is noted to be the best performance of the sector after recession. However, in 2015, the sales are expected to increase by 2.0% as the GDP is predicted to improve by 2.4%. Nevertheless, concentrating on the figures for 2016, it can be said that the years will experience mixed outlook (Center for Retail Research, 2015). 3. Associated British Foods Plc (ABF) Associated British Food Plc operates across several business segment which has helped the manager to diversify the risks as well as multiply the source of profits. The company has five segments such as sugar, retail, agriculture, ingredients and grocery (Associated British Foods Plc, 2015a; Associated British Foods Plc, 2015b). It is one of the most renowned multinational retailing and food processing company, which is headquartered in London. It is regarded as the second largest producer of baker yeast and sugar in the world and it is also the major producer of enzymes, lactose and emulsifiers. The grocery division of the company is known to be the manufacturer of private and branded label products, which includes Jordans, Ryvita, Ovaltine and Twinings. However, the retail division of the company known as the Primark has 200 stores across Austria, Germany, Belgium, Netherlands, Irelands and the UK (Associated British Foods Plc, 2015c). 4. SWOT analysis of ABF Strength 1) The main strength of the company is its diversified business, which aims at manufacturing and selling grocery items. It operates in five segments, which have encouraged the company to enjoy high level of autonomy in the UK. 2) It holds a significant position in the retail industry of the UK as it aims in providing quality grocery and non-grocery items to the customers. 3) The brand popularity has contributed towards the development of high customer loyalty and as a result, the ABF has concentrated on providing them high quality grocery and non-grocery items. 4) It has expanded internationally and has opened stores in geographically diversified regions around the world. 5) It is regarded as the leading market player, though it has encountered tough competition in the UK market from retail giants Tesco Plc and ASDA Plc. 6) The extensive range of products have encouraged the customers to get their daily necessitates in the UK market. Weakness 1) The main weakness of the company is that it has limited liquidity position in the UK. 2) ABF experiences excessive competition from the market leaders and as a result their poition is threatened in the UK market. 3) The company has also invested in the allied bakery division, which could perform as expected; hence the company has lost quite a huge amount of money. 4) In the UK, ABF has encountered difficulties in implementing common norms and standards that arise due to the lack of national culture in the diversified regions of the world economy. Opportunity 1) ABF has the opportunity for entering new markets in order to increase its market share globally and also concentrate on escalating the total sales revenue. 2) The brand has become quite renowned in order to further diversify its segment in the UK market. 3) Mergers and acquisitions help the company to enter new markets and further diversify its products. 4) ABF has the opportunity to tap the global enzyme market apart from the UK market. Threats 1) The galloping food prices have threatened the sales revenue of the company to a great extent. Moreover, the deteriorating condition of the consumer confidence is also a severe challenge for the company to attract and retain customers. 2) The financial crisis of 2007-2008 not only affected the business of ABF but it also decreased the consumer demand for its goods. 3) ABF is an extensive producer of sugar; hence the cut down of sugar production in the European Unions have affected the sales revenue of the company. 5. Discussion of the financial performance of ABF compared to Tesco Plc The financial performance of ABF is examined with the help of few ratios, which are significant for comprehending the organization’s financial position. This includes price-earnings ratio, enterprise value to sales ratio, enterprise value to EBITDA ratio and EBTIDA to sales ratio. However, other ratios include liquidity, profitability and gearing ratio. In order to check its financial health in the UK market, the financial performance of one of the market leader, Tesco Plc is compared. Here, Tesco Plc is considered as the benchmark company. Ratios 2014 Price-earnings ratio 31.6 Enterprise value to sales ratio 150.20 Enterprise value to EBITDA ratio 1855 EBITDA to sales ratio 0.809 From the above table it can be noted that the price earnings ratio of ABF is better than the industry average, which is indicative of the fact that it has focused on improving the confidence of the shareholders by maintaining a good performance. The overall performance of the enterprise with respect to sales and EBITDA of the company is competitive in the UK market as the sales have increased over the years. The EBITDA to sales ratio indicates that ABF should concentrate on decreasing its operating expense so as to manage the gap between expenses and income. However, it can be stated that the overall financial performance of ABF is stable enough to compete in the UK market. Moreover, it can be concluded that ABC Plc can acquire ABF in order to reduce the risk in the long run, as the latter has a strong financial performance. 2013 2012 2011 Liquidity ratio Current ratio ABF 1.35 1.26 1.24 Tesco Plc 2.11 1.93 2.03 Profitability ratio Net Profit margin ABF 0.044 0.045 0.049 Tesco Plc 0.0018 0.044 0.048 Gearing ratio Debt-equity ratio ABF 0.12 0.154 0.153 Tesco Plc 0.604 0.56 0.58 From the above table it is evident that Tesco Plc has stringer liquidity position in the UK as compared to ABF. However, the net profit margin of ABF is more than that of Tesco Plc, which denotes the fact that being a string contender of ABF, Tesco Plc has failed to generate higher profit margin during 2011-2013. The main weakness of Tesco Plc is that it finances its capital with the help of debt liabilities hence, the business is bound to encounter risky situation in future as a result of greater debt obligations. As compared with the target company, ABF, it can be stated that it has undertaken conservative mode of financing, which is quite safe for its operation. Associated British Food Plc operations 6.1. Operating segments Figure 2: Revenue and adjusted operating profit according to business segment 2012-2013 (Source: Associated British Foods Plc, 2013) Figure 2 provided above reveal a very strong performance delivered by Associated British Food Plc between 2012 and 2013 across its business segments. As is evident, the company operates in give primary segments namely grocery, sugar, agriculture, ingredients and retail. Associated British Food Plc has realized increasing revenue as well as adjusted operating profit in all its segments between 2012 and 2013. Such an effective performance places the company in an advantageous position in the market. Nonetheless, the consistency of the company’s performance can only be determined by a thorough review of the following year’s financial statements. Figure 3: Revenue and adjusted operating profit according to business segment 2013-2014 (Source: Associated British Foods Plc, 2015c) As opposed to Associated British Food Plc’s performance improvement between 2012 and 2013, the same deteriorated drastically between 2013 and 2014. As far as the adjusted operating profit and revenues across different business segments are concerned, the values apparently decreased between the mentioned period of time. This is an alarming situation and therefore requires managers to rethink their growth strategies. A rather inconsistent performance decreases the company’s prospect and therefore even if it is acquired by another company, the acquisition price will be significantly discounted. 6. Investments Associated British Food Plc is known for its good track record of long term investments. The company’s net capital investment in the year 2014 was £691m, an increase of £91m from the previous year (Associated British Foods Plc, 2015c). This increase in capital investment was stimulated by establishment and subsequent opening of many new Primark Stores. The company’s five year investment programme behind Allied Bakeries is almost about to close as the company has already devised a state of the art mechanism of manufacturing good quality breads that are to be distributed to its customers. 7. Highlights from balance sheet As of 2014 Associated British Food Plc’s non-current assets was worth £6.8bn (Associated British Foods Plc, 2015c). As far as the intangible assets are concerned, the value decreased by £114m from the previous year as result of changes in amortization for the year and transaction losses incurred in foreign exchange trade (Associated British Foods Plc, 2015c). Plants, equipment, and properties augmented by £113m from the previous year. As far as working capital during the end of the year is concerned, the value decreased by £164m due to decreasing prices of food products (Associated British Foods Plc, 2015c). This reduction in working capital was also driven by the management’s decision to decrease the average working capital level over the year. When the working capital was denominated as a percentage of sales, the value improved considerably when compared to the figures reported in the previous year. An increase in cash flow decreased the value of net borrowings for Associated British Food Plc (Associated British Foods Plc, 2015c). 8. Highlights from Cash flow Associated British Foods Plc realized a greater net cash flow from operating activities (£1,439m). This was a drastic increase from last year’s value of £1,276m (Associated British Foods Plc, 2015c). This exhibits a very strong performance delivered by the company as it recorded a stronger inflow of working capital in 2014 (£100m in the current year from £97m in the previous year) (Associated British Foods Plc, 2015c). 9. Highlights from financing activities As of 2014, the company’s total borrowing facilities is worth £2.2bn (Associated British Foods Plc, 2015c). This borrowing facility can be split into two segments namely the US private replacement notes which is worth £579m and £1.2bn worth of revolving credit facility (Associated British Foods Plc, 2015c). The flexibility and robustness is evident in the financing activities. This robustness has been increased over the last few years through diversification of the company’s sources of funds. The company has a 12 bank syndicate that provides a good reflection of its global presence and scale of operations. 10. Overall evaluation Associated British Food Plc’s financial position seems to be considerably stable. The managers have shuffled its resources very well and have successfully maintained a very healthy balance sheet as well as cash flow. The growth in assets signifies the company’s future growth strategies which are yet to be implemented. Therefore, acquisition of this company will not only prove to be synergistic for the acquiring company but will also be beneficial for the target company itself. The company’s sources of finances are intact and at the same time the mangers have been able to keep the debt to equity ratio considerably lower than its competitor. With not enough debt obligations to be met with and a robust interlink between various sources of external borrowings, Associated British Food Plc looks a very promising investment opportunity. Any company acquiring Associated British Food Plc will be able to attain synergistic benefits from the presence of highly skilled and experienced workforce, international existence and a healthy financial condition. 11. Financial modelling and Valuation The assumptions that were made while forecasting the free cash flows from year 1 through to year 5 are as follows: With the recent growth in the UK food market, sales is expected to achieve the previous growth rate of 11.02% over the next four years. The management believes that they can reduce the operating cost margin from an average of 92% to 87% by implementing effective cost control strategies. It is expected that the increasing cost of labour will augment the operating cost margin by 3% in year 4 and year 5. It is expected that the UK corporate tax rate will remain the same over the next four years (21%) (HMRC, 2015). Net investment as a % of revenue will grow to 7% over the next four years and the management has long term investment plans for enhancing the quality of its operations and service delivery. Working capital normally increases with an increase in sales revenue. Therefore, we will assume that working capital requirements will be proportional sales revenue growth. The cost of equity was calculated using CAPM equitation: 3.81% Cost of debt: 7.44%. Appropriate weights was assigned to debt and equity and Weighted average cost of capital was calculated (WACC) = 5.10%. The WACC was considered as the discounting rate which was used to calculate the present value of all future cash flows. The same WACC was used to compute the present value of the terminal cash flow. The obtained present values were then added together in order to quantify the present value of the company at year 0 (GBP 2,359,829,383). Existing debt of GBP 760,000,000 was subtracted which provided the new present value at year 0 (GBP 1,599,829,383). The new present value at year 0 was divided by the number of shares issued by Associated British Food Plc (790,000,000). This gave an intrinsic value per share of GBP 2.03. On the contrary the current price per share of Associated British Food Plc is GBP 29.35 (Yahoo finance, 2015) . This highlights that the company is significantly overvalued. 12. Recommendation and conclusion Given the fact that there is a drastic difference between the intrinsic value per share and the actual market price of the company’s shares with the former being considerably lower than the latter, it will never be suitable for an acquiring company to buy such an overvalued company. However, provided that the company has maintained a consistent performance over the past five years and have sustained a healthy financial performance, an acquiring company can make an offer of acquiring company at discounted price by citing synergistic benefits as the major reason. Moreover, the valuation has shown that the target company’s performance will deteriorate over the next five years which in turn has reduced its present value at year 0 thereby reducing the intrinsic value per share. Therefore, it should be highlighted that such deterioration in performance can be prevented through a mergers and acquisition if the target company is willing to do so. If approved, it will allow the acquirer to acquire the target company at a discounted price and gain synergistic benefits. However if the offer is not accepted, then other target company options should be evaluated. Reference list Associated British Foods Plc, 2009. Annual report 2009. [pdf] ABF. Available at: [Accessed 24 March 2015]. Associated British Foods Plc, 2011. Annual report 2011. [pdf] ABF. Available at: [Accessed 24 March 2015]. Associated British Foods Plc, 2013. Annual report 2013. [pdf] ABF. Available at: [Accessed 24 March 2015]. Associated British Foods Plc, 2015a. Our Businesses. [online] Available at: < http://www.abf.co.uk/about_us/our_group/our_businesses > [Accessed 23 March 2015]. Associated British Foods Plc, 2015b. Investor relation. [online] Available at: < http://www.abf.co.uk/investorrelations > [Accessed 23 March 2015]. Associated British Foods Plc, 2015c. Annual Report 2014. [online] Available at: < http://www.abf.co.uk/investorrelations/annual_report_2014 > [Accessed 23 March 2015]. Center for Retail Research, 2015. The Retail Forecast for 2015-2016. [online] Available at: < http://www.retailresearch.org/retailforecast.php > [Accessed 23 March 2015]. Euromonitor International, 2015. Retailing in the United Kingdom. [online] Available at: < http://www.euromonitor.com/retailing-in-the-united-kingdom/report > [Accessed 23 March 2015]. HMRC, 2015. Rates and allowances: Corporation Tax. [online] Available at: [Accessed 24 March 2015]. Papadopoullos, C., 2015. 2015 IMF Growth Forecast: UK Pulling Ahead But Global Economy Downgraded. [online] Available at: < http://www.cityam.com/207484/uk-economy-grow-strongly-global-growth-downgraded > [Accessed 23 March 2015]. Retail Think Tank, 2015. Demand Drives the UK Retail Market Forward. [online] Available at: < http://www.retailthinktank.co.uk/News/demand-drives-the-uk-retail-market-forward > [Accessed 23 March 2015]. Sentence, A., 2014. UK Set To Recover 5th Place In Global Economic League. [online] Available at: < http://pwc.blogs.com/economics_in_business/2014/04/uk-set-to-recover-5th-place-in-global-economic-league.html > [Accessed 23 March 2015]. The Heritage Foundation, 2015. United Kingdom. [online] Available at: < http://www.heritage.org/index/country/unitedkingdom > [Accessed 23 March 2015]. Yahoo finance, 2015. Associated British Food Plc. [online] Available at: [Accessed 24 March 2015]. Appendices Appendix 1: Liquidity ratio of Tesco plc Appendix 2: Liquidity ratios of ABF plc Appendix 3: Financial ratios of ABF Plc Appendix 4: Financial modelling and valuation (Refer to excel sheet for calculation and formulas) Read More