The A2 Milk Company: Lack of transparency in key channel

About the author:

Belinda Moore
Author name:
By Belinda Moore
Job title:
Senior Analyst
Date posted:
21 December 2020, 9:00 AM
Sectors Covered:
Agriculture, Food & Beverage, Travel and Chemicals

  • While 2Q21 infant formula sales improved on the 1Q21, they have been below budget and consequently, A2M has materially downgraded its FY21 guidance.
  • While guidance always looked too optimistic, the extent of the downgrade is disappointing and highlights how important the daigou is to A2M’s growth and the lack of transparency in this channel.
  • We have made material revisions to our forecasts.
  • While uncertainty remains, A2M’s share price may remain subdued, however we continue to believe the company is well placed over the medium to longer term once channels normalise and maintain an Add rating with a new price target (login to view).

Downgrades both 1H21 and FY21 guidance

Only one month since guidance was reiterated, A2M has downgraded its 1H21 revenue guidance by 8-14% (NZ$55-105m). While 2Q21 revenue will be higher than the 1Q21, December trading has been materially weaker than expected.

The 1H21 EBITDA margin is now expected to be 27% (~31% before), implying EBITDA of NZ$180.9m (-32% on 1H20) which was 22% below our previous forecast. Additionally, FY21 revenue guidance has been downgraded by 18-22% and with lower margin expectations, EBITDA has been revised by 24-35%.

A2M now forecasts a weak 2H21 (revenue down 5-21% on 2H20) compared to previous expectations of solid double-digit growth.

Rate of recovery slower than anticipated

A2M continues to be impacted by pantry destocking following its strong 3Q20 result and lower than anticipated sales to the Australian retail daigou channel due to reduced tourism from China and international students.

Additionally, sales to the corporate daigou channel, have been slower than expected (reseller margins have been under pressure). Furthermore, sales through the CBEC channel have weakened since China’s Singles Day driven by the disruption to the daigou channel, which typically helps to stimulate consumer demand.

A strengthening NZDUSD has been a further earnings headwind. A2M does not believe China/Australia trade tensions have impacted its business and instead, the issues facing the company are more a consequence of COVID-19.

We revise our forecasts

Given A2M’s weaker-than-expected guidance, we have reduced our FY21/22/23 NPAT forecasts by 27.8%/28.4%/28.9% respectively. Our new forecast is at the lower end of A2M’s sales guidance.

In FY21, we forecast NPAT to fall by 30%. We forecast solid earnings growth from FY22 onwards driven by a recovery in the corporate and retail daigou as COVID-19 restrictions ease and ongoing growth in the China and North American businesses from increased distribution and higher sales velocities.

We note our FY22-23 NPAT forecasts are well below A2M’s FY20 result. Over the medium term, A2M continues to target an EBITDA margin in the order of 30% (was 31.9% in FY20A). Our forecasts are now more conservative than this assumption with an EBITDA margin of 27.3% and 27.6% in FY23 and FY24.

Investment view – Add and updated price target

Given the extent/timing of the FY21 earnings downgrades, it will take time for A2M to rebuild investor confidence. On a positive note, A2M’s China brand metrics remain strong, with MBS market share rising to 2.3% in October (vs. 2.0% in Jun-20), 1H21 sales are expected to rise >40% and brand awareness and loyalty is increasing.

Given the size of the MBS market, we expect A2M to deliver strong growth in this channel over coming years as further share is gained. Its balance sheet also remains in a strong net cash position (+NZ$1.0bn) and it was revealed that the Board is considering a share buy-back given severe share price weakness and its belief that the company is well positioned over the medium to longer term.

As we have seen with other infant formula companies, the weakness could be a catalyst for corporate activity. Ex cash, A2M is now trading on an FY22 PE of 22x. The key risk is if trading conditions don’t improve and/or A2M gets caught up in geopolitical tensions with China.

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