Investor and media attention may often focus on growing fashion retail chain Primark but owner Associated British Foods has an extensive grocery business in markets such as the UK, the US and Australia. In this month’s just-food interview, Dean Best spoke to ABF finance director John Bason about the recent changes within the group’s grocery division, its performance and the prospect of having to face rising commodity costs.

Associated British Foods has a grocery basket containing brands from the UK, the US and Australia but, more often than not, when the company reports its results to the City, investors are more keen to hear about the progress of its discount retail chain Primark.

Two weeks ago, when ABF published a set of annual results that included a 26% increase in underlying group profits, the pattern continued. Analysts questioned finance director John Bason and chief executive George Weston – who had called in to the conference from China, where he was part of the UK’s trade mission alongside Prime Minister David Cameron – at length about Primark, which has grown to become the largest UK clothing retailer by volume.

Given Primark now accounts for 27% of ABF’s annual sales and 38% of profits, up from 19% and 24% in 2005, perhaps investor interest in the business is understandable. Five years ago, Primark had 122 stores in the UK and Ireland. By the end of ABF’s most recent financial year, the chain had 204 outlets, an estate that now takes in Spain, Germany, Portugal, the Netherlands and Belgium. It has proved a growth engine for ABF.

By contrast, ABF’s grocery division generated 46% of the company’s sales and 32% of profits five years ago. The business now accounts for 34% of revenue and 25% of profits.

The division has gone through a series of changes in recent years, including the 2007 acquisition of the Patak’s ethnic cuisine business, which led to the formation of the company’s AB World Foods unit alongside the Blue Dragon brand. A year later, ABF bought a majority stake in cereal business Jordans and merged it with crispbread brand Ryvita.

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And these are just a couple of the changes ABF has made to its grocery business. There has been restructuring at Twinings Ovaltine, the company’s global hot drinks division. ABF has formed a packaged oil venture in the US with Archer Daniels Midland called Stratas Foods, which supplies food-ingredients firms, makes private-label products and caters to the foodservice channel. And ABF is now in the middle of restructuring its meat business in Australia. What’s more, amid all these changes, there has been a relaunch of UK bread brand Kingsmill in a bid to revive sales in a fiercely competitive category.

ABF’s annual results included a 20% increase in underlying operating profit from its grocery division thanks to the impact of the more recent restructuring changes and a recovery of the company’s US bottled oils business. Revenues were up 7%, although when the benefit of foreign exchange was stripped out of the numbers, the division’s sales were flat.

Nonetheless, speaking to just-food on the day the results were published, Bason said he was “really pleased” with the performance of ABF’s grocery division.

“We’ve done a lot of restructuring, we’re constantly improving the portfolio of businesses that we’ve got,” Bason said, pointing to the changes at Twinings Ovaltine and the creation of Stratas Foods.

“We’ve also done quite a lot of work at [UK sugar unit] Silver Spoon, Jordans Ryvita and AB World Foods and each one of those has improved its profitability this year. And then, in terms of recovery, we needed it but [we’ve seen] better margins in UK bread as well.”

ABF’s bread business is central to the company’s history. The group has grown into one of Europe’s largest food firms by market capitalisation but its origins date back to the 1930s, when it consisted of seven baking subsidiaries. However, in recent years, there have been questions about ABF’s future in bread amid volatility in commodity prices and fierce competition. Nevertheless, ABF has stood firm, relaunched Kingsmill and is battling it out with the likes of Warburtons and Premier Foods plc.

The UK bread sector has been characterised by a spate of promotional activity in recent months but the challenge for ABF, Warburtons and Premier looks set to be different, if also familiar, in the months ahead.

With wheat costs soaring, the bakers are asking retailers for price increases. Premier, the maker of Hovis, has seen its request to Tesco rejected and lines delisted. ABF has warned that wheat costs could weigh on margins from its grocery business in its new financial year but Bason said the company was in talks with UK retailers over the prospect of securing higher prices.

“Discussions always remain tough with the major retailers but we’ve been here before,” Bason said. When you have an increase of 50% in the wheat price, you have to negotiate a price increase. Negotiations with the retailers are progressing well.”

The ABF finance chief also pointed to the rising cost of vegetable oil and said it would be increasing the price of its Mazola corn oil brand in the US from January. Bason acknowledged the rising cost of commodities would be a decisive factor in how its grocery business performs in the year ahead but insisted ABF could cope.

“I tell you, we showed that we were more than equal to the task in 2007 and 2008 and there’s just a little bit of deja vu about this. It’s part and parcel of business. When you get such big commodity moves, people understand that you’ve got to recover that cost increase.”

As well as Primark and grocery, a significant portion of ABF’s business is in agricultural products and food ingredients or, as Bason describes the division, “B2B food”.

ABF has extensive sugar operations in the UK, in Europe and in China and Bason said its operations in the latter market has benefited from the rising price of sugar.

“We really benefit from these much, much higher prices in China. Two years ago, they went to a low point of more like CNY3,000 a tonne – they’re nearly at CNY8,000 a tonne now,” Bason said.

“The thing I think is important when looking at ABF is that the impact of commodity price increases is quite a mixed bag,” Bason explained. “It’s by and large on sugar favourable for us. On wheat, I think it’s a mixed bag depending on whether we recover the wheat cost input on our bread but then also we’ve got a grain trader in a company called Frontier that benefits from that. In food, it’s a mixed bag depending on where you are in the supply chain.”

Commodity costs, however, are sure to put pressure on ABF’s grocery division as the business moves through its new financial year. The company has warned as much and the outcome of any discussions with retailers are uncertain, particularly in a climate where consumer confidence is projected to remain weak.

The last financial year, 12 months in which all of ABF’s divisions enjoyed either sales or margin growth – or both – could prove difficult to match this year in the face rising raw-material costs.

Bason, however, is optimistic about the prospects for the company’s grocery division and said the group is lining up investment in the UK and overseas.

“In AB World Foods, for example, we have done incredibly well with the relaunch of Patak’s. Blue Dragon is being relaunched by that particular business, so there will be a good investment behind that in terms of taking that business forward,” Bason said.

“In terms of our grocery businesses in the UK and the US, it’s about driving and getting behind those brands that’s important and then, obviously, we’ve got the major capital investment behind the meat business in Australia.”

Bason added: “What’s really pleased me about these results is that we’ve had big profit increases in each of sugar, grocery and Primark. ABF is organised such that we are looking to optimise and to grow each of those business areas. Grocery is very important for us.”