Analyst Research
1 March 2020
The a2 Milk Co (A2M) reported another solid result which came in above market expectations.
COMPANY DATA
| Date of Report | ASX | Price | Price Target | Analyst Recommendation |
| 23/08/18 | A2M | A$10.69 | A$11.00 | NEUTRAL |
| Date of Report 23/08/18 | ASX A2M |
| Price A$10.69 | Price Target A$11.00 |
| Analyst Recommendation NEUTRAL | |
| Sector : Consumer Staples | 52-Week Range: A$4.47 – 13.78 |
| Industry: Food Products | Market Cap: A$7,843.7m |
Source: Bloomberg
INVESTMENT SUMMARY
We rate A2M as a Neutral for the following reasons:
- Targeted and distinctive product portfolio, with A2M’s a2 Platinum product gaining market share over competitors.
- Wining market share in Australia and China.
- Growing consumer demand for health and well-being globally.
- Strong demand growth in China for infant formula product.
- Expansion into new priority markets, aided by the capabilities of Fonterra.
- US expansion provides new markets + opportunities.
- Key patents provide barrier to entry.
- Takeover target – the Company was the subject of a takeover bid in 2015.
We see the following key risks to our investment thesis:
- Chinese demand underperforming market expectations.
- Disruption to A2 milk supply.
- Increased competition, including private labels & competitors developing products or branding that erode the differentiation of A2M branded products from other dairy products.
- Expiration of A2M’s intellectual property rights may weaken or be infringed by competitors.
- Withdrawal of A2M product from international markets due to market share loss or lack of market penetration.
Figure 1: A2M Revenue by Region
Source: Company
Figure 2: A2M Revenue by Key Product 
Source: Company
ANALYST’S NOTE
The a2 Milk Co (A2M) reported another solid result which came in above market expectations.
For FY18, revenue of NZ$922.7m was in line with estimates, EBITDA of NZ$283m was ahead of estimates of NZ$277m and NPAT of NZ$195.7m versus NZ$191m. Driving top line growth was +83.8% year on year growth in infant formula products, with A2M’s infant share in China growing from 2.8% to 5.1%.
Relative to previous corresponding period (pcp), group revenue was +68% higher, operating earnings (EBITDA) up +101% and NPAT was up +116% to NZ$195.7m. The only disappointment in the results release was the date for the U.S. business to deliver positive growth has been pushed out.
Continued successful execution of sales and marketing strategies that increase brand awareness, as well as new growth opportunities through the Fonterra, Synlait and Yuhan partnership render A2M a high-quality company which appears to be well and truly positioning itself to be a global dairy company.
We maintain our Neutral recommendation on valuation grounds, but the stock is likely to exceed our expectations.
- By regions: 1. ANZ continued with strong revenue and earnings performance. ANZ revenue was up +49% and EBITDA up +69% to NZ$262.2m, driven by growing infant formula market share (up to 32%), steady growth in fresh milk (revenue up +4% on pcp) and a pickup in revenue of milk powder products alongside new product launches; 2. Exceptional growth in China & other Asia continues. The China and other Asia business recorded an increase in revenue of +163%, and EBITDA up +148% to $81.3m, with increased investment in brand awareness through sales and marketing driving growth. The Company continues to support the strong growth of the China business, with the on-going focus on distribution channel strategy and marketing contributing significantly to overall expenses; 3. Positive EBITDA goals shift forward for the UK & U.S. business. Revenue for the two increased +54.3% on pcp, including the $15m revenue contribution in FY18 from infant formula sold to UK exporters, while EBITDA was down -$27.6m. For the U.S., the Company assumes approximately US$22m forward investment over FY19 before positive monthly EBITDA will be achieved in the next three years. The UK continues to experience strong volume growth (+50% on pcp) and will transition between suppliers in early FY19 which management anticipates will not create disruption to stock availability. However, the Company notes challenges in delivering scale to the market.
- Growth strategy continues with launch of new products and entry into new regions. A2M has continued its growth strategy with the launch of three new products in milk powder and pregnancy formula. The Company continues to investigate key markets to enter in the South East Asia region, with the strategic relationship with Fonterra Cooperative Group providing leverage to increase supply capacity and an exclusive distribution agreement with Yuhan Corporation for the South Korea market. To support the growth strategy, the Company’s investment in brand building and marketing grew by $31.6m to $73.6m.
- Management awaits impact of evolving Chinese regulatory environment. The CBEC grace period is scheduled to expire in December 2018 and the Company expects further announcements closer to the date regarding regulation surrounding online B2C tariffs.
FY18 RESULTS SUMMARY…
Figure 3: FY18 A2M Geographic and Product Segment Performance 
Source: Company; Numbers may not correctly add up due Corporate
By Region: 1. ANZ continued with strong revenue and earnings performance. ANZ revenue was up +49% and EBITDA up +69% to NZ$262.2m, driven by growing infant formula market share, steady growth in fresh milk (revenue up +4% on pcp) and a pickup in revenue of milk powder products alongside new product launches. 2. Exceptional growth in China & Other Asia continues. The China and other Asia business recorded an increase in revenue of +163%, and EBITDA up +148% to $81.3m, with increased investment in brand awareness through sales and marketing driving growth. The Company continues to support the strong growth of the China business, with the on-going focus on distribution channel strategy and marketing contributing significantly to overall expenses. 3. Positive EBITDA goals shift forward for the UK & US business. Revenue for the two increased +54.3% on pcp, including the $15m revenue contribution in FY18 from infant formula sold to UK exporters, while EBITDA declined to -$27.6m. For the U.S., the Company assumes approximately US$22m forward investment over FY19 before positive monthly EBITDA will be achieved in the next three years. The UK continues to experience strong volume growth (+50% on pcp) and will transition between suppliers in early FY19 which Management anticipates will not create disruption to stock availability. However, the Company notes challenges in delivering scale to the market.
Outlook. Marketing expenditure is expected to be higher than FY18 given stronger focus on growth initiatives in emerging markets as well as continued investment in the Australian market. Management expects EBITDA to sales ratio to be broadly consistent with FY18 and anticipates further growth in revenue particularly in respect of nutritional products in ANZ and China.
Figure 4: A2M Financial Summary
Source: BTIG, Company, Bloomberg
COMPANY DESCRIPTION
The a2 Milk Company Limited (A2M) sells a2 brand milk and related products. The company owns intellectual property that enables the identification of cattle for the production of A1 protein free milk products. It also sources and supplies a2 brand milk in Australia, the UK and the US, exports a2 brand milk to China, and distributes and markets a2 brand milk and a2 Platinum brand infant nutrition products in Australia, New Zealand, and China.
This Week’s News
Analyst Research
7 August 2019