(Asx: A2M) | A2 Milk Company

Oct 27, 2021

Sentiment: Sideways

Type of Trade: Conservative

Industry: Farm Products | Milk, Infant Formula & Diary

Sector: Consumer Staples

The A2M Company is a New Zealand licensor and marketer of fresh milk, infant formula, and other dairy products that lack the A1 beta-casein protein. The firm was founded in 2000 by Corran Mclachlan, who develop genetic test to determine which proteins a cow produces in its milk, and business partner Howard Patterson. Challenges in English label channels put pressure on market share.

The share price had been performing extremely well between 2016 and 2020 rising by 3,267% from 60c to as high as $20. Since August 2020, the stock has taken a heavy toll due COVID-19 pandemic and it is currently trading 69% below its all times high (ATH).

Many investors have been trying to pick the bottom between $10-$5, and since May it appears the SP has broke out its bearish trend and bounced back from $5 couple times making what technique analysts call double bottom formation.

A double bottom pattern is a technical analysis charting pattern that describes a change in trend and a momentum reversal from prior leading price action. It describes the drop of a stock or index, a rebound, another drop to the same or similar level as the original drop, and finally another rebound.

See the example below:

Even Though, we have recently spotted a double bottom formation, it appears that today’s investor presentation and potential further expected downgrade in the HFY22 has triggered a sell off.. Need to see what will be the next bottom to ensure SP will still moving within the channel.

FY21 Full year results were poorly received by investors as the company has been downgraded its earning several times with Revenue and EBITDA margin down as following:

  • Revenue down 30.3% to $1.21b
  • EBITDA down 77.6% to $123m including stock write-down and MVM acquisition costs.
  • EBITDA margin of 10.2% or 11.1% excluding MVM acquisition costs.
  • Chinese Local players continued to gain share against the traditional multinational brands, but so A2M chinese brand,nevertheless still rising red flag.
  • Performance: Australian daigou/resellers and retailers with Sales of a2 Platinum® English label infant nutrition of $357.0 million, down 52.1% and Significant decrease was due mainly to prolonged impacts emanating from COVID-19 volatility.

✅ Interesting enough the company continue to be profitable with net profit after tax down 79% to $80.8 million. Think about what are the listed companies making NPAT of $80m per year?

The problems generated by COVID, the relationship with china, has caused a massive disruption of digoel channel, hence making the firm to change its strategy and start looking for different ways to growth the business.

✅ A2M has recently completes strategic acquisition of 75% interest in Mataura Valley Milk. The acquisition is strategically important as it provides the opportunity for a2MC to participate in nutritional products manufacturing, in addition to offering supplier and geographic diversification, as well as strengthening relationships with key partners in China. We believe it was a smart move by the firm.

✅ The company is also reviewing its growth strategy to respond to rapidly changing China market dynamics.

✅ The fact the Board has carefully considered capital management initiatives and has decided not to return capital to shareholders in the last financial year has already been priced into the SP and equally straight the company balance sheet.

✅ Although the key financial metrics were poor than FY20, we believe that such as downgrade has finally been priced in offering fundamental value for the stock at $5-$6 level.

✅ ANZ liquid milk growth and still set to growth further.

✅ Company is still set to invest further in USA despite the poor performance in FY21, mostly due to what the firm calls “unfavourable foreign exchange” is an important market. Some of the plans of the company to so called change in execution approach are described as following, and is belief to be helpful to increase sales in USA.

  • Leveraged trade investment to bring price to an affordable premium
  • Objective to increase conversion and household penetration
  • Increasing range, facings and improving overall shelf positioning
  • Improvements in brand health metrics

A2M acknowledges USA the largest global milk market with significant and growing premium segment and growth in awareness to create a platform for future product innovation. A2M also launched in Canada via a licensing agreement with Agrifoods.

Growth Prospect

The Company is confident in the underlying fundamentals of the business and the growth opportunity remains strong with a positive long-term outlook. However, given the continuing uncertainty and volatility in a2MC’s consumer markets resulting from issues related to COVID-19 and the rapidly changing market dynamics in China, the Company has determined not to provide specific guidance, hence putting various investors in selling mode by overacting. No guidance means not certainty and the stock will purely trade on market sentiment.

Our view is that absence of guidance means potential further downgrade that the firm has chosen no to disclose.

  • The key drivers and important issues that may impact FY22 results is provided as following:
  • China infant nutrition market
  • Category and business divisions
  • Marketing and capability investment
  • Key financials

(New) Company Investor Presentation Day 2021

Disruptive 2021 – Key Action the A2M has taken

  • Recognised stock write-downs and deliberately slowed down sales in 4Q21. This plan was implemented to reduce inventory levels and rebalance English Label IMF (infant formula) pricing across channel.
  • Swapped Older distributor inventory with more recent stock to improve on-shelf product freshness.
  • Increased Brand Investment with a significant campaign in 4Q21 to drive customer demand.
  • Reorganised the Asian-Pacific Division for enhance focus in new opportunities, not clear impact in the business
  • Refreshed growth strategy, not very clear yet.

Growth Plan

  • The Company continuing to focus on China Market Opportunity in particular (not so sure if a wanted to see this, whereas other markets could be the key for growth).
  • Brand Review (not immediate effect, but building and sustaining a strong brand equity is always a win in the long term, see other industry examples that can charge premium price such as Apple, Tesla, to name a few).
  • Assessing the Channel route-to-market for English Label IMF and capturing the full potential of China label IMF distribution in key channels (again, it appears the A2M still very much focused on Chinese market, I would like to see more discussion about opening new channels in different markets, perhaps using English label IMF.
  • Re-Imagining the infant formula product portfolio in English label and China Label to appeal to a broader set of consumers. (I think it is very basic and the critical growth compound is to find and develop more channels and source distributors in different markets).
  • A2M is also considering opportunities for adjacent category growth in China (again the focus is China), ANZ and USA (I like that), as well as assessing opportunities in new emerging markets. (New Emerging Markets could be the key to unlock further growth for A2M, furthermore North America still appears to be a minority focus on A2M growth strategy). Furthermore, a lots of investment will need to be taken, which will have immediate impact on FY22 and FY23 EBITDA. The question is, will investor embrace the growth phase of A2M over the next 12-24 months?
  • Non Financial key measures were also debated, regarding Sustainability GHG emission reductions.
  • Ambition to grow sales to over NZD$2 Billion in the next 5 years which is well above the currently NZD$1.2 Billion. (Ideally, we want to see some growth back in the company).
  • A2M Distribution is approaching an optimal level productive level of ~30K Stores in North America and it has been increasing its recognition as high quality brand among consumers.

Key Problems with Chinese Market

The A2 Milk Company is today

Last time, we have once again reached the target of $6.95 as the previous entry. Since the Stock has taken a deep fall after the investor presentation day, A2M will re-test the lower range of the channel. An entry could be effective once SP confirms to be bouncing back from the bottom of the channel.

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