As I look for blue-chips left behind in the latest profit-reporting season, three themes stand out.
The first is China. Australian agricultural companies exposed to China have had a hellish time thanks to tariffs and fears of escalating trade tensions between the countries. The a2 Milk Company, Treasury Wines and other China-focused stars have been smashed in the past year.
Renewables is the second theme. Stocks that still rely heavily on fossil fuels are down on their share-price highs. I covered some of them last week in this column, notably Origin Energy and Ampol. You could add AGL to that list.
The third theme is technology. Granted, it’s a stretch to say big tech was sold off due to disappointing profit growth. Rising bond yields, which are bad for valuations of high-growth stocks, have much more to do with the tech sector’s recent pullback.
After heavy falls at the start of this week, the Nasdaq Composite Index in the US had a technical correction (a fall of at least 10% from the previous high), then bounced on Tuesday night our time. In Australia, the BetaShares S&P/ASX Australian Technology ETF (ATEC) is off 7% over one month.
Tech stars Altium and Appen (two of the so-called WAAAX stocks in Australia) are well off their highs. Appen in particular looks interesting at these levels. Buying global tech on market sell-offs (via Exchange Traded Funds) has been a key idea of this column in the past 18 months.
It’s a little too early to buy tech because rising bond yields are likely to persist. I don’t expect an inflation breakout, but the bond market rout has further to play out and US shares are pricey.
Better value in tech will emerge. It won’t last long because investors will snap up tech stocks if they fall too far. Be ready to pounce on tech in the next few weeks through ASX-quoted ETFs.
For now, I’m more interested in agricultural companies that have been oversold. The ag sector has rising costs and further trade retaliation from China is a threat. Everything I’m hearing in agriculture suggests the Chinese trade threat is escalating.
As always, it’s a question of price. The market has factored too much bad news into The a2 Milk Company (A2M), Treasury Wine Estates (TWE) and United Malt Group (UMG) (covered in a recent Switzer column) at current prices.
Treasury Wines is an obvious takeover target. Also, it wouldn’t surprise if a global dairy giant or private-equity firm pounced on a2 Milk given its depressed share price.
Never buy stocks on the basis of takeover alone. Treat any takeover as the cream rather than the cake. Focus on buying high-quality companies when they trade below their fair value and offer a sufficient margin of safety. Look for stocks that have been oversold due to short-term events.
Having covered takeovers for years, I have watched stocks that are perennially touted as “takeover targets”. Often, takeover bids seemingly take forever to arrive and the stock halves. Or an indicative proposal to acquire a company goes nowhere.
a2 Milk and Treasury Wines suit experienced portfolio investors who can withstand short-term price volatility. Here is a snapshot of both companies and their prospects:
1. The a2 Milk Company (A2M)
The market couldn’t get enough of a2 Milk in 2019-20. Its shares spiked to a $20 high in mid-2020; even the early stages of the pandemic could not sour a2’s rally.
The market belatedly realised that a key distribution channel for a2 products – the “daigou” – was affected by COVID-19. The daigou is mostly mini entrepreneurs who buy popular wellness products in Australia and sell them to customers in China via online platforms or stores.
You might have seen a few stores in your suburb boxing up infant formula and vitamins, to sell in China. That’s the daigou in action. These Chinese entrepreneurs, often students or budding business owners, were a big force behind the rise of Blackmores and a2.
COVID-19 hurt daigou activity in Australia. Fewer international students and less Chinese tourism meant less daigou trade of a2’s infant formula. Weaker prices for infant formula in Asia also affected the daigou’s interest in exporting it from Australia to mainland China.
a2 Milk’s revenue for the first half of FY21 fell 16% to $677 million. Underlying earnings (EBITDA) slumped 32% to $178.5 million and earnings guidance was downgraded. The disappointing result was worse than the market feared.
a2 management cited challenges in the daigou/reseller market as the main reason for its revenue fall. Profit margins also shrunk as a2 sold a higher proportion of liquid milk (and slightly less infant formula) and more of its China-label milk.
That’s the bad news. The good news is a2 is doing plenty to help key daigou resellers – a strategically important sales channel – through promotions and customer support.
a2’s China-label milk is growing strongly (off a low base) and increasing market share. In Australia and New Zealand, a2’s liquid milk sales rose 16% over the half.
The reopening of economies as the COVID-19 vaccine rolls out is another plus for a2. International students will take a while to return to Australia in large numbers and daigou activity here could be subdued this year and next. But that’s already priced into a2.
At $8.99, a2 is trading on a forecast FY22 Price Earnings (PE) multiple of about 20 times, on Morningstar numbers. The PE has averaged above 30 in the past three years.
a2’s glory days (on the share market, at least) are behind it for now. Much hard work is needed to steer it through volatile markets. Yet for all the challenges, a2 has an innovative product in a boom market (China) – not that you’d know it by the current price.
From a charting perspective, a2 needs to hold around $9 – a point of previous price support.
Chart 1: a2 Milk
Source: ASX
2. Treasury Wine Estates (TWE)
I last covered TWE in this Report in January 2020 at $8.98 a share. It now trades at $11.42 – a 27% gain in just over two months.
I wrote at the time: “TWE is bombed out due to all the negativity around China’s tariffs. That is an opportunity for contrarian, long-term investors to buy into Australia’s wine star at a depressed price.” That view stands.
Like a2, TWE has had a tough time on the market. Its stock soared through $19 in September 2019, then halved when China slapped massive tariffs on Australian wine imports.
TWE is transitioning its China-bound exports to other markets – a strategy that will take time – and expediating the sale of its lower-end wine brands in the United States.
If Chinese trade retaliation was not enough, TWE faced global disruption to sales channels for luxury wine due to the pandemic.
Net sales revenue fell 8% to $1.4 billion for the first half of FY21. Statutory net profit fell 43% to $120.9 million. The market expected a weak result and TWE delivered.
In spite of this bad news, TWE shares spiked 6.5% on Monday. Rumours swirled that a European beverage giant was considering acquiring TWE. A few weeks ago, there was talk of a global private-equity group pouncing on TWE and restructuring it.
There was also confirmation this week of TWE’s planned sale of its lower-end US wine brands.
Some fund managers I know have a bearish view on TWE and a few big investment banks have sell recommendations on it. Chinese trade hostilities with Australia are not moderating; it’s hard to see TWE’s prospects in that market improving anytime soon.
Back home, the agricultural sector faces rising land, labour and raw-material costs. A higher Australian dollar is another handbrake for agriculture exporters. With so many micro and macro challenges, it’s easy to see why some fund managers are avoiding TWE.
TWE should have no shortage of suitors. Multinational beverage companies are on the acquisition trail, snapping up smaller players with strong brands, such as TWE’s Penfolds. If ever a global giant is going to buy TWE, it is now when the share price is beset by bad news.
If a takeover does not eventuate, TWE offers a sufficient margin of safety at the current price. I’m backing its management to transition the company’s Chinese exports into other markets, and streamline its brand portfolio towards high/mid-level wines with fatter profit margins.
At $11.42, TWE is on a forecast PE multiple of about 21 times FY22 earnings. It’s not a screaming buy, but one suspects more value will be unlocked in TWE in the next two years – either organically or through acquisition.
Chart 2: Treasury Wine Estates
Source: ASX
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 9 March 2021.
