Industry background: a2’s advantage is that its milk and baby-formula products contain only the A2 beta casein protein type, which is reported to have greater digestive benefits. It is the market leader in the category, but others have caught on and also launched in this space.
The Kiwi company’s premium products command a premium price and it now sells products in Australia/NZ, China/Asia and the US (fresh milk only). It recently exited the milk category in Britain. It also has a 17.4 per cent stake in Synlait, its contract manufacturer, and has a strategic relationship with Fonterra.
In China, the biggest formula market in the world, the Chinese government is seeking to support local players as the country looks to become more self-sufficient. China is encouraging more domestic investment in infant formula as it seeks to bolster the image of home-grown products.
Result: a2 was heavily punished for falling short of analysts’ lofty expectations for the operating margin outlook, despite meeting its 2019 full-year guidance.
Full-year sales were up 41 per cent to a record $NZ1.3 billion ($1.2 billion) and net profit surged 47 per cent to $NZ287.7 million.
The balance sheet is strong with no debt, and a substantial cash balance of $NZ465 million at year’s end.
The company said its infant nutrition market share strengthened to 6.4 per cent in China over the fiscal year, and doubled its distribution to 16,400 mother and baby stores in China. It also managed to navigate changing cross-border e-commerce laws.
In the US, sales of fresh milk doubled and distribution expanded to 13,100 stores including Walmart, Costco and Kroger.
Australian fresh milk revenue grew 10.7 per cent to a record market share of 11.2 per cent. a2 Platinum formula revenue grew 35.3 per cent and remains the top brand in local grocery and pharmacy channels.
The outlook: a2 expects sales growth in fiscal 2020 and is tipping a flat earnings before interest, tax, depreciation and amortisation margin of the 28.2 per cent achieved in the June half. This was below consensus and worried analysts, and led to downgrades. Marketing spend will increase to 12 per cent of sales in 2020, up from 10.4 per cent in 2019.
Citi analyst Sam Teeger has a “neutral” call, and said it makes strategic sense for the company to invest heavily to build its top-line growth but increasing competition in China could mean it’s required just to maintain market share.
“To further market gains may require new product development or acquisitions, which the company would be well placed to fund with $465 million of cash,” he said. “We expect the US to be an increasingly important growth driver for the company.”
UBS analyst Ben Gilbert has a “buy” on a2 and believes the long-term opportunity remains intact. He noted the next catalyst for the stock is September 17-18 at the China investor tour.