The A2 Milk Company: When there are high expectations

About the author:

Belinda Moore
Author name:
By Belinda Moore
Job title:
Senior Analyst
Date posted:
20 August 2020, 2:53 PM
Sectors Covered:
Agriculture, Food & Beverage, Travel and Chemicals

  • While The A2 Milk Company (ASX:A2M) reported a very strong result, it fell slightly short of high expectations.
  • Growth is targeted in FY21, however the quantum wasn't specified at this time. While we expect solid earnings growth over the forecast period, we note FY20 benefited from some favourable tailwinds which won't be repeated. We have made minor revisions to our forecasts.
  • We continue to rate A2M highly, however we maintain a Hold rating with the stock trading in line with our revised price target (Morgans clients can login to view detailed reports and price targets here).

Strong result, but slightly short of high expectations

The A2 Milk Company (ASX:A2M) delivered a strong result, however it was slightly below our forecasts and consensus.

Revenue +32.8% to NZ$1.73bn (guidance NZ$1.7-1.75bn; MorgansF NZ$1.75bn); and EBITDA +31.4% to NZ$552.0m (implied guidance NZ$527-560m; MorgansF NZ$560m).

While a potentially conservative inventory provision (cNZ$5-10m) was recognised at year end (included in COGS) and took some of the shine off the result, we note marketing spend (NZ$194.3m) was also slightly short of guidance of NZ$200m.

Operating cashflow was stronger than expected at NZ$427.4m (vs. MorgansF NZ$390.0m) and positively benefited from the timing of supplier payments (cNZ$50m benefit).

The balance sheet finished in a very strong NZ$854.2m net cash position.

Continued China IF market share gains

Total IF sales rose 33.8% to NZ$1.42bn (82% of group revenue), with strong growth in China label sales (+101% to NZ$337.7m) and CBEC sales (+40.3% to NZ$341.1m) increasing the group's direct China IF revenue mix to 48% (vs. 39% the pcp).

While A2M's MBS distribution footprint rose 16% to 19,100 stores (rollout slowed by COVID-19), sales velocity per store increased strongly with management highlighting further capacity to improve following its investment in organisational capability.

While the source of market share data presented has changed, continued share gains were achieved.

Strong growth is expected in FY21

Despite the uncertainties of COVID-19, A2M expects continued strong revenue growth and an EBITDA margin of 30-31% in FY21 (31.9% in FY20).

Following a shift in marketing strategy, the US business is expected to deliver a reduced EBITDA loss (was NZ$50.5m in FY20A) but largely flat net revenue, with volume growth to be offset by greater promotional activity.

FY21 capex is expected to increase to NZ$50m from NZ$7.2m largely due to its ERP project (NZ$15m) and the acquisition and capital works upgrade of the Kyabram milk processing facilities (>NZ$20m), before normalising in FY22.

A2M continues to evaluate opportunities to invest/participate in manufacturing capacity.

We revise our forecasts

Given the slightly softer than expected FY20 result, higher D&A and lower net interest income, we have reduced our FY21/22/23 NPAT forecasts by 2.1%/2.2%/2.4%. In FY21, we forecast 17.5% NPAT growth.

While we expect that A2M can report solid growth in FY21, we are cognisant that FY20 benefited from some favourable COVID-19 tailwinds which won't be repeated (particularly 3Q20 pantry stockpiling and FX benefits).

In FY21, we expect sales growth will be driven by the benefit of A2M's 4Q20 marketing spend and price rises.

Reduced US losses will also support earnings growth.

Investment view – Hold rating 

In light of softer peer updates, its result was impressive and illustrates that the company continues to win market share, flex its pricing and supplier bargaining power and effectively manage its channels to market.

A2M has the balance sheet capability to continue to invest in the long-term profitability of its business by accelerating its marketing spend, expanding into new geographies, developing new products and retaining the flexibility to diversify its supply chain.

However, with stock trading in line with our revised valuation (Morgans clients can login to view detailed reports and price targets here) we maintain a Hold rating.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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