The A2 Milk Company: Downgrades come in three?

About the author:

Belinda Moore
Author name:
By Belinda Moore
Job title:
Senior Analyst
Date posted:
25 February 2021, 1:00 PM
Sectors Covered:
Agriculture, Food & Beverage, Travel and Chemicals

  • The A2 Milk Company's (ASX:A2M) underlying 1H21 result was weak but was slightly ahead of guidance.
  • Disappointingly, A2M has issued another material earnings downgrade.
  • While uncertainty remains, A2M’s share price may remain subdued, however we believe the company is well placed over the medium to longer term once channels normalise and maintain an Add rating with a lower PT (login to view).

Weak 1H21 result but slightly better than guidance; CF was poor

1H21 sales fell 16%, underlying EBITDA declined 31% and NPAT was down 34%. As previously guided to, A2M was impacted by pantry destocking, weak sales to the daigou which then had a flow on impact to the CBEC channel and adverse FX.

On a positive note, A2M’s China brand metrics remain strong, with MBS market share rising to 2.4% vs 1.7% the pcp, sales increased 45.2% (now 31.5% of group revenue) and brand awareness and loyalty is increasing.

The liquid milk business in both Australia (revenue up 16.3% on pcp) and the US performed well (revenue +22.3% and the EBITDA loss reduced to NZ$11.6m from NZ$30.0m).

Cashflow generation was particularly poor and A2M reported an operating cash outflow. The running down of inventory has been slower than A2M expected.

As a consequence, a stock provision of NZ$23.3m was booked. The balance sheet remains strong with NZ$774.6m (104cps) of net cash.

FY21 guidance is downgraded for a 3rd time

FY21 revenue guidance has been downgraded to approx. NZ$1.40bn (-19% yoy), which was at the lower end of its previous range (NZ$1.40-1.55bn).

A2M noted that the pace of the recovery in the daigou/reseller and CBEC channels has been slower than previously anticipated. It said that the issue has been more about weaker than expected prices vs volume.

EBITDA margin guidance is now 24-26%, excluding MVM costs (vs. 26-29% previously) and implies EBITDA of NZ$336-364m, down 34-39% on the pcp.

A2M noted its FY21 outlook assumes its actions to re-activate the daigou/reseller channel delivers a significant improvement in the 4Q21 vs the 3Q21.

Corporate daigou sales are improving. Underpinning the improvement has been

  1. The corporate daigou support program
  2. Effective innovative promotional activity
  3. The OTO channel in China is seeing strong growth

2H21F revenue of NZ$723.4m is 6.9% higher than the 1H21 of NZ$676.5m and should be achievable, albeit there is a lack of transparency in some of its channels.

Mataura Valley Milk (MVM) investment is initially dilutive

Due to revised volume assumptions, A2M now expects MVM will generate EBITDA losses of NZ$10m pa over FY22-24 (compared to breakeven previously).

A2M reiterated its expectations for MVM to be EBITDA positive in FY25 as significant nutritional volumes are manufactured. Prior to blending and canning investment, D&A is expected to be NZ$15m pa.

While initially MVM will be EPS dilutive and it will increase the capital intensity of the company, we recognise the strategic benefits of diversification by supplier, geography and it will further cement A2M’s relationship with its Chinese partners.

We also think it will ultimately prove to be the correct move on the regulatory front as we expect that China regulations may eventually require brand owners to control the supply chain.

Additionally it will allow A2M to launch new products overtime.

We revise our forecasts; Add rating and new PT

We have reduced our FY21/22/23 NPAT forecasts by 13.7%/14.1%/13.9%.

We forecast solid earnings growth from FY22 driven by a recovery in the daigou as COVID-19 restrictions ease and there is ongoing growth in the China and North American businesses from increased distribution and higher sales velocities.

With only 2.4% market share in China’s MBS channel, there is plenty of growth to be had over coming years. Ex cash, the stock is trading on an FY22 PE of 22.8x.

We maintain an Add rating but note that short term uncertainty remains and patience is required. Credibility also needs to be rebuilt.

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