The A2 Milk Company: A year to forget

About the author:

Belinda Moore
Author name:
By Belinda Moore
Job title:
Senior Analyst
Date posted:
27 August 2021, 7:00 AM
Sectors Covered:
Agriculture, Food & Beverage, Travel and Chemicals

  • FY21 was a tough year for The A2 Milk Company (ASX:A2M). Following four earnings downgrades, the result came in at the lower end of guidance.
  • While an improved performance is targeted in FY22, A2M’s outlook comments underwhelmed. We have made material downgrades to our forecasts.
  • A2M is likely through the worst of it. However, given earnings uncertainty remains and it is trading on a full valuation (FY22/23 PE of 36.3/28.1x and a material premium to peers), we maintain a Hold rating. Our new price target is (login to view target price).
  • Potential corporate activity is the key upside risk.

Event: weak FY21 result; at the lower end of guidance; misses consensus

FY21 sales fell 30%, underlying EBITDA declined 76% and NPAT was down 77%.

The decline in earnings reflected NZ$108.6m of stock provisions given excess and aging inventory issues, one-off costs (NZ$9.7m) associated with its new ERP system, consumer pantry destocking post COVID, purposely holding back sales to rebalance channels, weak daigou sales given travel restrictions/structural changes and COGS/FX pressures. In the 2H21, A2M reported a loss. The US result disappointed, losing NZ$33.5m in FY22.

A2M’s balance sheet remains strong with NZ$875.1m (118cps) of net cash. It will be reduced in July by NZ$268.5m for its investment in Mataura Valley Milk (MVM).

Outlook: falling birth rate is concerning

FY22 is expected to continue to be a challenging and volatile year. Management said that it will take time to recover. A2M highlighted the lower birth rate in China, increased competition from domestic brands and increased promotional activity.

The declining birth rate has been further impacted by COVID and vaccination programs. In fact, women are receiving advice from health care professionals to delay getting pregnant for at least six months post vaccination. The declining birth rate is particularly impacting A2M’s Stage 1 sales which is concerning.

In FY22, A2M expects the value of the overall China IF market to decrease. However, the ultra-premium segment (A2M plays in) is expected to grow at or above market and the premium segment is expected to perform at or below market.

Thankfully, the actions A2M has been taking to address excess inventory are proving effective with English label now at targeted levels and pricing has improved. However, China label will continue to be rebalanced through 1Q22.

A2M’s 1H22 revenue (including MVM) is forecast to be marginally lower than the pcp. However, 2H22 revenue is forecast to be materially higher than the pcp given the 2H21 was depressed following channel inventory rebalancing actions.

MVM earnings guidance has been downgraded for a second time due to lower third party assumptions given the tough operating environment.

Unsurprisingly, the Board said that it has decided not to return capital to shareholders at this point in time. A2M is looking at further investment to strengthen its business and is reviewing potential acquisition opportunities. It also noted the importance of preserving cash in uncertain times.

At an Investor Day on 27 October, a new management team will present the company’s growth strategy. In our view, A2M needs to upgrade its formulation, innovate and have more SKU’s/products to drive sales growth in the future.

Forecast implications: We have made material downgrades

Reflecting more subdued sales given the challenging operating environment and higher costs, D&A and tax guidance, we have reduced our FY22/23/24 NPAT forecasts by -30.4%/-21.2%/-12.1% respectively.

In FY22, we forecast 42.6% NPAT growth however we stress that a large component of this growth reflects a lack of provisions and one-off items which impacted FY21. How the high margin English label IF performs, will be a key determinant of A2M’s FY22 performance.

Investment view: Hold rating 

Our valuation has fallen (login to view target price). While A2M has a strong brand and we are impressed with new management, given earnings uncertainty prevails and it is trading on steep multiples, we retain a Hold rating.

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Disclaimer: Analyst may own shares. 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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