ABF stock downgraded to Underweight amid slowing UK income growth and online competition

On Tuesday, Morgan Stanley (NYSE:MS) lowered its rating on Associated British Foods (ABF:LN) (OTC: OTC:ASBFY) stock from Equalweight to Underweight and reduced the price target to £19.00 from the previous £25.50. The stock, currently trading at $24.58 and near its 52-week low of $23.60, appears undervalued according to InvestingPro analysis. The firm's analysts expressed concerns about the company's fashion retail division, Primark, highlighting several challenges it faces within the UK apparel retail sector.

The downgrade is based on the anticipation of macroeconomic risks in the UK, gains in online market share by competitors, and margin pressures stemming from increased costs and necessary investments. According to Morgan Stanley, Primark is particularly vulnerable in this environment, more so than other companies in their UK apparel retail coverage. Despite these challenges, InvestingPro data shows ABF maintains a strong financial health score of 3.15 (rated as "GREAT"), with a moderate debt level and current ratio of 1.78x.

The firm's 2025 Retail Outlook, also released on Tuesday, provides a broader context for the downgrade, indicating that Associated British Foods is likely to be more affected by the slowdown in disposable income growth and the rise of online retail. Morgan Stanley's analysts are also projecting that Primark's margins will shrink going forward.

Morgan Stanley's forecasts for ABF's earnings before interest and taxes (EBIT) for fiscal years 2025 and 2026 are 3% and 8% below the consensus, respectively. The projections for Primark are even more conservative, sitting 4% and 13% below the market consensus. These lower expectations for Primark, a significant factor in ABF's stock sentiment, contribute to the rationale behind the downgrade.

The new price target of 1,900 pence implies a 5% potential downside from the stock's current levels, which contrasts with the expected upside for other UK retail stocks covered by Morgan Stanley. As a result, the firm now positions ABF stock as a relative Underweight in its sector analysis. The stock currently trades at a P/E ratio of 10.2x and offers a 3.8% dividend yield. For deeper insights into ABF's valuation and 11 additional ProTips, including detailed financial analysis and Fair Value estimates, visit InvestingPro.

In other recent news, Associated British Foods (ABF) has seen some significant developments. Citi analysts have downgraded the company's stock rating from Neutral to Sell, citing concerns about the future earnings and sales outlook, particularly for its Primark brand. The analysts anticipate challenges in both the fashion retail segment and the UK food businesses, projecting a 4% to 7% decrease in Primark's sales compared to consensus figures.

Despite these concerns, ABF reported robust financial results in its recent earnings call. The company announced a significant increase in operating profit and adjusted earnings per share, alongside a substantial rise in cash generation and return on capital employed. Group revenue rose to GBP 20.1 billion, a 4% increase on a constant currency basis, and the company proposed a 50% increase in total dividends, amounting to over GBP 650 million.

However, Citi's proprietary analysis predicts a negative impact on Primark's gross margin, forecasting a 170 basis point decrease by the fiscal year 2026 due to the strength of the US dollar. This anticipated drag on profits adds another layer of concern for the retailer's performance. For ABF's UK food businesses, the analysts foresee risks related to growth and pricing power, in light of the expected acceleration of UK food inflation in 2025, which could put additional pressure on the company's earnings.

Despite the downgrade, ABF remains focused on growth, with ambitious investment plans, especially for its Primark brand. The company targets mid-single-digit growth for 2025, with expansion plans in the US and Europe.

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