Primark can afford price freeze with wider ABF group at its back

Primark, the Dublin-based discount clothes retailer that trades as Penneys at home, may have missed out on the global e-commerce boom during the Covid-19 pandemic due to its lack of online sales.

But George Weston, chief executive of the company’s parent, Associated British Foods (ABF), seems determined the fast-fashion brand will come into its own as households deal with the cost-of-living crisis amid rising inflation and interest rates globally.

Primark’s oversized hoodies – or “snuddies” – and velvet plush leggings are currently flying off the racks as people delay turning on their central heating, Weston said this week, as a more than doubling of the chain’s operating profits drove a 42 per cent increase in the wider ABF group’s earnings in the year to September.

And having already increased prices for its autumn/winter and upcoming spring/summer collections by an average of between 5-9 per cent, Weston signalled this week he’s prepared to sacrifice Primark’s profit margins, for now, to become the go-to location for cash-strapped consumers with a pledge not to increase its prices any further before next autumn.

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“If people have less money, and you put the price up, they will just buy less, so it’s a bit self-defeating,” he said of the fashion chain, which started off as a single store in 1969 in Dublin’s Mary Street by the late Arthur Ryan for the Canadian-Irish Weston family.

“We have to come out of this period with our core proposition of everyday affordability and price leadership intact – and we will.”

Primark’s operating profit margin was running at over 11 per cent in the years before the pandemic.

However, ABF forecasts that it will decline to below 8 per cent in the current financial year as it continues to absorb much of the spike in the costs of the likes of cotton and freight – and impact of a soaring dollar, the currency in which it buys most of its clothes.

Deutsche Bank analysts now estimate that Primark’s operating profits will dive almost 23 per cent this year to £584 million (€666 million) in the current financial year.

They say that there are even downside risks to those forecasts, if consumers become more cautious as the economy weakens and they steer clear of Primark’s clothes racks.

Primark has 408 stores internationally and has set its sights on 530 locations by the end of 2026, focusing in particular on planned openings in Italy, France, Spain and the US.

While like-for-like sales in the Republic – which compares the performance of the same number of stores – had recovered to within 4 per cent of pre-Covid levels in the last financial year and those in the UK had clawed back to within 6 per cent, continental Europe sales remained off by 16 per cent.

Germany, a price-conscious market at the best of times that Primark entered in 2009 and where it has 32 stores, is a particularly weak spot.

The company has been forced to take a £206 million impairment charge against its assets in that country as it slides inexorably into recession.

Primark’s outsized presence within ABF – accounting for over half of the group’s £1.44 billion operating profits and 45 per cent of its €17 billon of sales in the last financial year – has raised questions among some investors over the years over whether it would be better off being spun off from the group.

Indeed, RBC Capital Markets highlighted to clients in a note this week that there is potential in the medium term for a “demerger to release value” for investors.

However, the conglomerate structure of ABF – including a groceries division that’s home to brands like Twinings teas, Blue Dragon Asian noodles and Ryvita crispbreads, as well as sugar, animal feed and bakery ingredients units – served shareholders well when most of Primark’s stores were closed during Covid.

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“The pandemic showed the resilience of the conglomerate nature of Associated British Foods, with its various food businesses thriving under increased consumer demand, offsetting the restrictions on Primark’s trading and ensuring cash keeps flowing,” said Anubhav Malhotra, an analyst with London-based stockbroker Liberum.

To be sure, Primark is making a belated foray into the world of online sales by rolling out a trial click-and-collect services across 25 stores in the north of England and Wales before Christmas.

But the diversified structure of ABF is also allowing Weston to make a bold call on keeping Primark prices on hold to court customer loyalty during a global downturn. It has also enabled it to announce this week that it is buying back £500 million of its own stock, following a 33 per cent slump in the share price in the first 10 months of the year.

Analysts broadly forecast that earnings across the agriculture, ingredients and even the grocery division to be broadly unchanged, with the sugar division seen increasing profits on the back of higher global food commodity prices. This will limit the impact of a Primark earnings slump on the group.

Weston said this week that he sees “no reason” why Primark can’t return in time to an operating profit margin of “some 10 per cent”.

He may be waiting. Goldman Sachs analysts have run their forecasts out to 2027 this week – and only the chain’s margins peeping above 8 per cent by the end of the period.