Conflicting Views Abound For A2 Milk

Australia | Feb 28 2020

A2 Milk delivered a first half result that generated some conflicting views as brokers try to assess the outlook.

-Are foreign brands regaining ground in China?
-Market focus turns to margins from investment
-Second half performance outlook unclear

By Eva Brocklehurst

The first two months of the second half have revealed strong revenue growth and robust demand for a2 Milk ((A2M)). Or has it?

There was no specific earnings guidance at the first half results and the company refrained from quantifying any impact from coronavirus. Bell Potter suggests the indicators of infant milk formula activity are conflicting.

Negative export trends from Australia to China are in stark contrast to the company's report of revenue growth. Yet it appears to Citi that Chinese consumers have been stockpiling essential items such as infant formula ahead of the New Year while foreign brands are winning back share from domestic brands amid credibility issues, which may be attributed to coronavirus. Perhaps.

This development would, if it continues, signal a sudden shift in the trend where Chinese domestic brands were gaining ground at the expense of foreign brands. However, it also could be based on the fact foreign brands are over-represented in e-commerce channels.

An inability of China's domestic operators to restart production and source raw materials is considered by Citi to be a short-term inconvenience. Marketing is weighted to the second half and the broker acknowledges there is uncertainty around coronavirus impacts on the supply chain.

While the infant formula business appears resilient, Ord Minnett is one broker concerned about negative channel margin mix, and the shift in emphasis to mother and baby stores (MBS) and away from daigou (personal shoppers in Australia delivering to China).

Bell Potter points out the ongoing ability of the company to repatriate margin from daigou customers, via lifting Australian infant milk formula prices closer to China's shelf prices, is a key driver of profit.

However, Wilsons believes the near-term outlook is favourable and the pulling forward of demand is more than offsetting logistical challenges. Moreover, the quantum of disruptions in MBS and corporate daigou appears to be moderating. UBS finds little evidence of margin dilution and lifts forecasts materially to reflect the increased sales velocity in MBS.

Margin Focus

The market's focus has turned to short-term operating earnings (EBITDA) margin after a multi-year investment phase, Ord Minnett points out. This makes the ongoing strategy less clear, particularly as former CEO Jeff Babbage has returned as the interim CEO this year.

The broker suspects the multi-year investment phase proposed explicitly in August 2019 was not acceptable to some stakeholders and so the commentary has retreated towards margins. Yet there was no insight into other elements of operating earnings so the outcome is unclear.

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