ABF shares fall 5.6% as Primark demerger announced

It hardly inspires confidence when a company's share price falls sharply as it announces a demerger aimed at maximising shareholder value. This was the reaction faced by Associated British Foods (ABF) this morning, an hour after it confirmed what many investors had expected; that its Primark arm will become a separate company.

The announcement means you will soon be able to buy shares in the discount retailer, should you wish. The investment vehicle belonging to ABF's founding Weston family will keep majority stakes in both businesses. Other existing shareholders can see their stock split too.

ABF's aim is to complete the demerger by the end of next year, creating the only "pure play food producer" on the FTSE 100 and maximising "the future potential" of Primark which should also land in the top tier of the London stock market.

The remark covering Primark's future potential is the crucial bit. It has been one of the UK's great retail success stories of this century but the past six years have been more challenging as its operating model and consumer budgets have been tested by multiple economic shocks.

The brand has typically flourished in good times but disruption from COVID lockdowns exposed its failure to have embraced online sales beforehand. It corrected that, in a limited way, through a click and collect offering but it has kept its attention firmly on physical sales from large, well-stocked stores offering low prices compared to most high street rivals.

The brand now trades from 486 sites in 19 countries and continues to do well generally but it has faced intensifying competition from Chinese online giants Shein and Temu. In January, ABF warned that profits would be hurt, partly due to discounting at the chain. Today it reported that after an encouraging start to spring/summer trading in March, softer sales had followed due to customers starting to feel the effects of the Middle East conflict.

Shares, which were down by 11% in the year to date ahead of the demerger announcement, fell by 5.6% in early dealing. In fairness to ABF, that reaction will also likely reflect nerves over Primark's recent trading performance. ABF flagged a risk to Primark sales if the war persisted. It reported a 2% fall in group revenue and an 18% drop in its adjusted operating profit for the first-half of the year.

The decision to demerge was a difficult one as the differing segments of ABF - including sugar, ingredients and agriculture - have given the company a form of protection if any one division is enduring headwinds.

Dan Coatsworth, head of markets at AJ Bell, said: "There is the potential for Primark to trade on a higher valuation as a standalone listed business.

"ABF currently trades on 10.7 times next 12 months' expected earnings. Conglomerates often trade at a discount to reflect a sprawling empire of interests. In contrast, British retail giant Next trades on 16.8 times forward earnings - a much higher rating versus ABF.

"There is no guarantee that Primark would trade on a comparative rating, but it is fair to suggest it could warrant a much higher valuation than is currently attributed under the ABF umbrella."

The US-Iran war, like the cost of living crisis that followed Russia's invasion of Ukraine, will only harm consumer spending power but the lessons of these shocks consistently show that value-focused retail will fare better than most rivals when it comes to the battle for discretionary spending.