Primark turns up the pressure on high street with £409m Littlewoods buy

Associated British Foods' decision to splash £409m of its closely guarded cash on the Littlewoods Stores business to expand its Primark clothing arm sets a new marker in the budget clothing battle that is raging across the retail sector.

Even excluding the 70-odd stores that ABF plans to sell on, yesterday's deal combined with its recent purchase of six former Allders stores will increase the size of Primark's UK footprint by more than 50 per cent over the next two years.

The long-awaited acquisitions - Littlewoods has topped its shopping list for the past five years - mean Primark can power ahead, unencumbered by the sorts of space restrictions that have hampered its growth for the past few years. Meanwhile, the Littlewoods name will disappear from the high street by March, living on only in the group's home-shopping arm.

Edward Whitefield, the chairman of Management Horizons Europe, which provides strategic advice to retailers, warned: "The value-retail tidal wave that has been gradually developing over the last 20 years is here. It will swallow up the middle market."

Value retailers from Matalan to Asda's George have doubled their share of the clothing market over the past eight years, grabbing one-fifth of the market from M&S, Bhs and Littlewoods. With fashion magazines such asVogue happy to vaunt the merits of mixing high-street bargains with designer labels, analysts believe there is plenty more for the likes of Primark to aim for. Richard Hyman, at Verdict, the retail consultancy, said: "The democracy of shopping means traditional value retailers are attracting more affluent shoppers. That is increasing the potential market share gain they are able to make. The losers are the middle market players."

George Weston, ABF's new chief executive, adds: "The fashion magazines have given people permission to wear a top [from somewhere expensive] with a Primark skirt. We have benefited from that trend." In buying Littlewoods, Mr Weston is fulfilling a prophecy his father, Garry, made 10 years ago when the company sold its food retail interests to Tesco. David Lang, at Investec Securities, recalled: "Back then, Garry told me, 'One day we're going to be very big in retailing.' Well, here we are."

Primark expects to take up to 12 months to sell on the stores it does not want (most likely to New Look and Philip Green's Arcadia), trade through old stock and rebrand the estate as its own. By 2008, Mr Lang estimates Primark will have almost doubled its sales and operating profits to more than £1.5bn and £200m respectively. ABF said its clothing arm would contribute more group profit than any of its other businesses, which include a grocery arm that is home to Twinings tea, by 2007. And all this while ensuring that the acquisition will cover its cost of capital by the end of the first full year of trading.

It is no surprise that ABF is happy to dip into its infamous cash pile - until last year the cash generative business had more than £1bn to play with - on Primark's behalf, given that the retailer is outshining almost all of its UK competitors. In the half year to 5 March, Primark's underlying sales soared 6 per cent. Contrast that with the 6.5 per cent fall in underlying sales reported by Matalan, the former star of the discount sector, last year. Or with the continued decline in clothing sales M&S will report tomorrow - anything up to 9 per cent on an underlying basis. How does Primark do it?

Mr Weston said it boils down to selling clothes that people want to buy and keeping footfall high by constantly restocking its shelves with new items. "Plus," he added, "our prices are gobsmackingly low."

For Mr Hyman, "Primark is probably the outstanding value retailer". "It has captured the mantel that was once the property of M&S, delivering basic clothing at a quality and price that no one else could match. It is in a virtuous circle that is difficult to ... beat," he said.

Primark shouts about its prices too, eschewing the 99p gimmick employed by most for single-digit price tags. Its £10 Marc Jacobs-esque military-style jackets may break that barrier, but they are none the less alluring for doing so. The pricing architecture, along with everything else, was dreamt up by Arthur Ryan, who founded the chain with ABF's backing 36 years ago in Ireland, where the estate trades as Penneys. Analysts believe Mr Ryan, 69, is critical to Primark's success, which raises the question of what happens when he retires next year, as he is tipped to do.

Primark's investment in the quality and fashion of its ranges means it is no longer appealing just to those on a budget, again helping it stretch the value-clothing market. Where the ambitious group and its peers could trip up depends on how far up the fashion stakes it pushes itself. The group is embroiled in litigation with Monsoon, which believes Primark copied six of its designs. Monsoon, which forced Primark to a settlement for a similar infringement this year, is seeking £200,000 in compensation.

Mr Whitefield said: "Value retailers don't employ huge creative design teams. Their buyers have to get their information from somewhere. Sometimes they take that a step too far and copy." He thinks the main threat to value retailers is that people could get bored with disposable fashion, reverting instead to investing in statement pieces.

But with the opening up of China as a sourcing destination and the ever-headier competition between retailers to persuade us to open our wallets, Primark's day in the sun could last for a long time yet.