Associated British Foods, the Primark-to-Kingsmill bread group, said today (9 September) its second-half performance came in ahead of expectations. However, shares slid on concerns over the longer-term outlook for its sugar business. As sugar turns sour for ABF, the company could be forced to look elsewhere for growth. Katy Askew reports.

In a trading update today (9 September) ahead of its annual results in November, Associated British Foods said its second-half adjusted operating profit would beat market expectations.

During the final six months of the year, the company’s bottom line was boosted by a “strong finish to the year” from its clothing retail arm, Primark, a lower tax rate and reduction in interest charges.

ABF’s grocery business, which includes brands like Ryvita and Jordans, also continued to see top-line growth.

However, there is one ominous cloud on the horizon for ABF. Concern that the sugar business, which generates 35% of profit, will face headwinds in the coming fiscal year put pressure on ABF’s stock price, which had slipped 1.73% by 10am (BST).

ABF said the sales and profit performance from sugar in fiscal 2013 was “in line” with management expectations. 

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British Sugar’s production levels were down on lower beet yields but prices remained “strong” in the second half and Illovo benefited from a recovery of South African production. In contrast, ABF said its Chinese business sustained “significant” losses due to an increase of sugar supply, which drove down prices in the market. The company said it has embarked on a “major cost reduction and factory efficiency programme” in China.

ABF sounded a note of caution on the outlook for its European sugar business next year. “Current negotiations with our EU customers regarding prices for the 2013/14 marketing year are proving challenging with an increasingly negative sentiment driven by the higher availability of sugar with the conversion of non-quota sugar to quota, additional tariff rate quotas for raw sugar imports and low world sugar prices,” the company said. 

Prices in Europe are being driven down due to the increased availability of sugar due to the conversion of non-quota to quota sugar, additional tariff rate quotas on imported sugar and low world sugar prices. 

Investec analyst Martin Deboo warned the trading update points to the “sugars bubble deflating”.

He said ABF’s comments “corroborates our intelligence that pricing in EU Sugars is getting tough”.

He added: “Market prices for FY14 down by as much as EUR120/tonne (US$158/tonne) (relative to a reference base of mid to high EUR700s/tonne in FY13)… ABF are guiding to sugars profits in FY14 in the mid GBP300m’s (US$470m), relative to our current forecast of GBP400m.”

Panmure Gordon analyst Graham Jones suggested the outlook for sugars is possibly less bleak, pointing to the “strong” performance of ABF’s Illovo venture in South Africa. “We had already anticipated lower EU sugar prices in subsequent years so we see the sharper fall in prices in 2014 earnings as largely a phasing issue,” he wrote. 

However, he added: “For 2014 we are reducing our forecast EBITA from GBP400m to GBP345m reflecting a weaker pricing environment in EU sugar.”

ABF’s trading update included positive news from its grocery business, which in its 2011/12 financial year accounted for 30% of sales but just over 17% of adjusted operating profit, albeit in a year when restructuring costs dented grocery profits. During 2012, parts of the grocery unit in the UK and Australia under went a reorganisation process that saw restructuring costs resulting in a 23% fall in adjusted operating profits at the unit. 

The absence of the restructuring charges mean earnings from grocery are expected to be higher in the year to 14 September. ABF said its grocery arm is expected to show a “substantial improvement” in adjusted operating profit over last year. Revenue is also set to be up. 

Hot beverages business Twinings Ovaltine appears to be the star of the division.

ABF said that Allied Bakeries grew market share, after winning a significant new supply contract with The Co-operative Group and establishing Kingsmill as the UK’s second-largest bread brand, although competition has put pressure on margins.

Jordans and Ryvita both had an “excellent year”, with strong UK sales growth while, AB World Foods made” good progress” achieving revenue growth in the UK and internationally for both of its core brands, Patak’s and Blue Dragon.

However, its UK retail sugar business Silver Spoon looks set to post lower revenue and profits amid competition in the sector.

In Australia, ABF pointed to further positive signs from its efforts to revitalise its George Weston Foods arm.

According to Wood, in all, the update suggests ABF’s grocery unit appears to have maintained the momentum it built up in the third quarter, after weak first-half and 2012 sales. “Grocery had a weak 2012 and H1 2013 reported sales growth (+1%) was no better…although H1 margin growth was very healthy (+115bps). Sales growth accelerated sharply in Q3 to +7% and management indicated that revenue “continued to improve in the second half”. Given this, our estimate for H2 growth of +6% seems reasonable.”

Bernstein analysts anticipate a 170 basis point improvement in margins in the second half, which would equate to a 145 basis point gain in the full year.

Nevertheless, Deboo describes ABF’s sugar and Primark businesses as its “major profit centres”. If ABF’s sugar business is turning sour, the company will have to look elsewhere to drive growth. According to Deboo, the answer for ABF could lie in Primark. 

“We expect the sugars downgrade, offset by a Primark upgrade, to impact our FY14E EPS by low to mid-single digits. But the big picture for us is that, with the… sugars profit bubble deflating, it is now Primark that needs to carry the profit can for ABF going forward.”