Long-suffering shareholders in a2 Milk (A2M) finally had something to cheer about last week when the company announced a surprise $150 million on-market share buyback. Although this is unlikely to move the dial, it does signal the Directors’ increasing confidence in the company’s ability to generate profitable growth.
A former “darling” of the sharemarket, A2M hit almost $20.00 midway through 2020. That was before the impacts of Covid-19 were understood, including the ban on international visitors which killed the daigou trade in A2M’s infant formula milk products. (Students, visitors and entrepreneurs buying the product in Australia and re-selling it in China). It was also before the Chinese authorities made it harder to sell foreign products directly into the Chinese market. And also before a couple of missteps by the Company including inventory management. By May, the shares had tumbled to a low of $3.90.
a2 Milk Company Limited (A2M) – 5-year chart
Source: nabtrade
But the announcement of the buyback, and a profit result that was better than expected, saw the shares close on Friday at $5.83 for a net gain of 18.7% for the week. So how should investors think about A2M? Let’s start with last week’s profit result, and then see what the major brokers have to say.
Full-year results
A2 Milk delivered revenue growth of 11.2% to NZ$1,446 million (after adjusting for the purchase of Matura Valley Milk). Revenue growth accelerated in the second half, rising by an adjusted 15.7% on the first half.
EBITDA rose 59% to NZ$196.2 million, with the sales margin increasing to an adjusted 16.1% in FY22 compared to 10.2% in FY21. NPAT rose 42.3% to NZ$114.7 million.
Highlights included the growth in China label infant milk formula, where sales rose by 12.2% to NZ$438 million driven by market share increases in mother & baby stores and the Chinese domestic online channel. A2M said its shares went up from 2.2% to 3.0% and from 2.0% to 2.5% respectively.
In the higher margin but smaller English label infant milk formula, sales into China rose by 53% to NZ$256 but were still below FY20’s result of NZ$341 million. Sales in Australia/New Zealand fell by 7.8% to NZ$329 million, although A2M said the trajectory was improving.
In the infant milk formula market, A2M is facing two headwinds. Firstly, China’s birth rate is falling, and secondly, the shift to the (lower margin) China label product continues (now 85% of the overall market). Against this is the increasing penetration of the product as the middle class expands, plus a “premiumisation” of the China label product (which suits A2 Milk).
Looking ahead, the company said that it expects revenue growth in both the China label and English label products in FY23.
In the liquid milk market in Australia and New Zealand, sales increased marginally by 1.8% to NZ$172.0 million. North America posted an increase in sales of 30.0% to NZ$82.7 million, but the loss widened to NZ$36.7 million. A2M said this was mainly due to higher costs (freight, fuel, raw milk). Accelerating the path to profitability for the US market remains a key strategic focus.
The recently acquired Matura Valley Milk (a NZ dairy that manufactures nutritional products) lost NZ$18.8 million, although the second half saw stronger sales and a narrower loss. This facility provides A2M with independent manufacturing capability.
For FY23, the Company says that the outlook is “positive with continued growth expected”. It expects “high single-digit revenue growth”. “EBITDA growth is expected, with modest improvement in EBIDA margin”.
At 30 June, A2M had net cash of NZ$816 million, which it considers to be more than sufficient to fund investment opportunities and working capital needs, hence the return to shareholders through an on-market buyback of up to $150 million.
What do the brokers say?
Although the major brokers agreed that the result was better than expected, it didn’t lead to any material change in target prices. According to FNArena, sentiment remains negative. Of the four major brokers that cover the stock, two have “Sell” recommendations and two have “Neutral” recommendations. Target prices vary from a low of $4.25 with Macquarie through to a high of $5.87 from Morgans. The consensus is $4.96, 14.9% lower than Friday’s ASX close of $5.83.
Citi downgraded to “Sell” from “Neutral”, noting that the chance of getting access to the US market for infant formula products (where there is a current shortage) had faded. Further, it saw downside risk with current Chinese regulatory events, which will require A2M to obtain a new registration in order to sell China label products after 21 February 2023.
My view
If you have worn the pain on A2M, my inclination would be to hang on. While there is regulatory risk, A2M is a great brand, and a great marketing company and management seems to have got the company firing. Guidance on revenue growth and EBITDA is positive, as is the confidence demonstrated by the buyback.
But for other investors, there are lower-risk investment options.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
