Company Overview: The A2 Milk Company Limited (ASX: A2M) is a premium branded dairy nutritional company, which is focused on products containing the A2 beta-casein protein type. The Group is organized into business units based on geographical location along with a corporate function, and has four reportable operating segments, namely the Australia and New Zealand segment, the China and Other Asia segment, the USA segment and the UK segment (discontinued operations).
A2M Details
Strong Base for Sustainable Growth: The A2 Milk Company Limited (ASX: A2M) is a premium branded dairy nutritional company, which is focused on products containing the A2 beta-casein protein type. As on 6 October 2020, the market capitalization of the company stood at ~$10.57 billion. During FY20, the company continued to strengthen its brand and business foundations and is building a strong base for sustainable growth for future years. The company has an increased focus on delivering its financial ambitions, and to further improve the impact on broader communities. During FY20, the company has achieved significant growth in China and is likely to witness additional opportunities in North America and other parts of Asia.
Despite the COVID-19 pandemic, A2M demonstrated resilience in the second-half and well-managed its business. During the year, it made significant gains in revenue and earnings, with strong performance in all key product segments and across all core markets. The overall result for FY20 reflects continued growth in its infant nutrition segment with sales of NZ$1.42 billion, reflecting an increase of 33.8% on Y-o-Y basis. The company also achieved growth of 21.2% in its English label infant nutrition products and reported a double-digit increase in liquid milk businesses in Australia and the USA. During the year, the company invested NZ$194.3 million in marketing, to drive brand awareness and conversion to trial in key growth markets and delivered an increase of 32.9% in EBITDA to NZ$549.7 million. The balance sheet of the company remains robust with a closing cash position of NZ$854.2 million.
The company remains focused on continued expansion into more physical stores in China and driving growth across all infant formula channels and expanding its distribution and presence in the USA. With an increasing scale of its infant nutrition business, the company’s manufacturing capacity and capability will complement its existing supply chain relationships. It broadened its product portfolio in core markets, built a market leading position in Australia and leveraged its strategic partnerships to provide meaningful benefits in the medium term.
FY20 Financial Highlights (Source: Company Reports)
Note: 1 All figures are in New Zealand Dollars (NZ$) unless otherwise stated. 2 All comparisons are with the 12 months ended 30 June 2019 (FY19), unless otherwise stated. 3 All figures are quoted based on all operations of the Group, including discontinued operations, unless otherwise stated. 4 Earnings before interest, tax, depreciation, and amortization (EBITDA) is a non-GAAP measure. However, the company believes that it assists in providing investors with a comprehensive understanding of the underlying performance of the business.
Details of Top 10 Shareholders: The following table provides an overview of the top 10 shareholders of The A2 Milk Company Limited. The Vanguard Group, Inc. is the largest shareholder in the company, with a percentage holding of 6.93%.
Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)
Key Margins: During FY20, gross margin of the company stood at 56%, higher than the industry median of 41.8%. In the same time span, net margin of the company was 22.4% as compared to the industry median of 8.3%. Higher gross and net margin show that the company is well-managing its costs and can convert its revenue into profits. In the same time span, EBITDA margin of the company was 31.9%, relative to the industry median of 17.1%, indicating increased profitability. During FY20, Return on Equity of the company was 40.4%, higher than the industry median of 18.5%. This shows that the company is well-managing the capital of its shareholders.
Looking into the balance sheet, current ratio of the company stood at 3.69x, higher than the industry median of 1.64x. This shows that the company retains a decent liquidity position and can pay off its current liabilities using its current assets. During FY20, assets-to-equity ratio of the company was 1.28x, lower than the industry median of 2.02x and debt-to-equity ratio was 0.01x, as compared to the industry median of 0.23x. This indicates that the business is financed with a significant proportion of investor funding and a small amount of debt, resulting in a financially stable balance sheet.
Key Margins (Source: Refinitiv, Thomson Reuters)
A2M Enters Exclusive DD on Mataura Valley Milk: The company is exploring options to participate in manufacturing at MVM’s facility in New Zealand and has extended a non-binding indicative offer to acquire a stake of 75.1% in MVM, for a total consideration of ~NZ$270 million. The potential investment in Matura Valley will complement and develop its strategic relationships with Synlait Milk and Fonterra Co-operative Group. However, the transaction is dependent on additional due diligence and is likely to be settled by the end of FY21 from its existing cash reserves.
Strong Growth Across Regions and Products: During FY20, the company launched new products, including a2 Smart NutritionTM in Australia and reported a growth in ANZ revenue to NZ$965.7 million with an EBITDA of NZ$465.6 million. The company has strengthened its nutrition position in China and retains a decent runway for growth. The China label infant formula accounts for 24% of the company’s infant formula business. For FY20, revenue of China went up to NZ$699.4 million and EBITDA stood at NZ$224.8 million. In the same time span, A2M built its brand awareness which drove towards meaningful scale in the US with revenue increasing to NZ$66.1 million, up from NZ$34.6 million.
Geographic Segment Revenue and EBITDA (Source: Company Reports)
Key Risks: The company is susceptible to risks related to changing climate, dynamic geopolitical and regulatory environments, competition and consumer laws, high reliance on strategic partnerships, counterfeiting or tampering of food quality disruption to business activities, and overall damage to brand and reputation. It may also be impacted by the ongoing disruptions from the COVID-19 pandemic.
Outlook: The company reported a strong performance in China IMF brand health metrics and is anticipating continued growth in its Mother & Baby Stores (MBS). It is also likely to witness constructive effect from brand building activities and the marketing investment in activation. Despite the significant uncertainty and instability in market conditions because of the COVID-19 pandemic, the company has provided guidance for FY21 and expects revenue in the range of NZ$1.80 billion to NZ$1.90 billion and group EBITDA margin of ~31%. The company may also experience some disruptions in its daigou channel in the first half of FY21 and is likely to report a lower ANZ revenue for 1H21.
Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)
Valuation Methodology: Price to Earnings Multiple Based Relative Valuation (Illustrative)
Price to Earnings Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)
Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months
Stock Recommendation: The company’s rapid growth and healthy balance sheet with significant cash reserves has created a wide range of options to fund its future growth. It is gaining momentum in key markets has increased its national footprint to over 20k stores. As per ASX, the stock of A2M is inclined towards its 52-weeks’ low level of ~$11.280, proffering a decent opportunity for the investors to enter the market. On a technical analysis front, the stock of A2M has a support level of ~$13.226 and a resistance level of ~$17.266. We have valued the stock using the P/E multiple based illustrative relative valuation and have arrived at a target price of lower double-digit upside (in percentage terms). Considering the current trading levels, increased momentum for growth, resilient financial performance despite the market uncertainty and positive long-term outlook, we recommend a ‘Buy’ rating on the sock at a current market price of $14.16, down by 0.492% on 6 October 2020.
A2M Daily Technical Chart (Source: Refinitiv, Thomson Reuters)
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