The rise of dairy company A2 Milk has stagnated in recent months, with the business providing a trading update last week, guiding in line with market expectations for FY18.
For FY19 A2M did not provided explicit revenue guidance; but guided to flat EBITDA margins of ~30 per cent.
The margin guidance is below market expectations of ~32pc, implying ~2pc to ~5pc downgrades to FY19 EPS.
This is due to extra investment in marketing, overheads (China expansion) and one-off new-CEO costs.
I am interested to see the full details are provided at the upcoming FY18 results in August, including an understanding of the new incoming CEO’s strategy/outlook.
The trading update provided some mixed signals.
The positive is the business is clearly growing strongly with revenue ahead despite disruptions with new products and China labelling.
Anecdotally, pricing has begun to improve and old-label stock largely cleared, setting A2M up for a clean start to FY19.
On the negative side is the business appears to be undergoing “growing pains“.
As a result, cost associated with setting up the business for long term growth is increasing.
Anecdotally, pricing has begun to improve and old-label stock largely cleared, setting A2M up for a clean start to FY19. On the negative side is the business appears to be undergoing "growing pains". As a result, cost associated with setting up the business for long term growth is increasing.
I believe to date, management appear to be navigating this balance between short term margins dilution and long term profit growth.
Overall the medium term outlook for A2M remains positive.
It is mostly driven by increasing penetration into new channels in China and the potential to grow the North American business, which has yet to provide an adequate return on capital employed.
I believe the long term dynamics of the business are still solid with the strong brand presence in ANZ and the Chinese market.
This stems from its intellectual property around A2 milk and digestive benefit claims.
Its patents and trademarks (IP protected until 2023) provide the company with a platform for premium differentiated diary and nutritional products.
To date management have successfully executed the balance between growing earnings, controlling inventory/supply chain and investment in sales and marketing for ANZ and China.
This remains a key area of risk and opportunity.
A2M currently has ~5pc market share of the Chinese infant formula market with the potential for >10pc share.
A2M is also at the early stages of penetration of the offline channel in China (physical store channels).
The ANZ fresh milk market is relatively mature with A2M estimated to have a ~9pc of the Australian Fresh Milk market growing at ~3pc p.a.
The opportunity lies in the USA market for fresh milk.
I would like to see more detail post the August result before investing and expect short term volatility.
- This article does not take into account the investment objectives, financial situation or particular needs of any particular person. Accordingly, before acting on any advice contained in this article, you should assess whether it is appropriate in light of your own financial circumstances or contact your financial adviser.
- Christopher Hindmarsh is an adviser at JBWere Limited. JBWere Limited is owned by National Australia Bank Limited.
