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
Growing Presence in the US Markets and Healthy Balance Sheet: 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 24 November 2020, the market capitalization of the company stood at ~$10.13 billion. Despite the challenges posed by the global health pandemic, the company exhibited decent performance in FY20 on the back of expanding footprint in China and the US. It remained focused on delivering its financial objectives and hence made significant gains in revenue and earnings, with strong performances in all key product segments across core markets. Over the past 20 years, the company has grown to one of the largest listed companies in New Zealand.
Against the backdrop of the uncertainty and complexities caused by COVID-19, the products of the company were classified essential in nature and thus are attractive to consumers. Over the past several years, the company has developed a robust balance sheet with significant cash reserves of NZ$854.2 million, allowing the company to create a wide range of options to fund growth. The company also reported a net operating cash inflow of NZ$427.4 million, representing a high cash conversion rate.
Consolidated Statement of Financial Position (Source: Company Reports)
During FY20, the company reported an increase of 32.8% in its total revenue to NZ$1.73 billion and a rise of 32.9% in EBITDA to NZ$549.7 million. In the same time span, net profit after tax went up to NZ$385.8 million, reflecting an increase of 34.1% on FY19. The company reported decent performance in China label infant nutrition with more than twice its sales, and revenue in the US growing by over 90%.
FY20 Financial Highlights (Source: Company Reports)
The company remains optimistic of its strong base to navigate the present crisis and but may witness short-term softness in markets due to reduced tourism from China. The company retains healthy fundamentals, and a strong, unique A2 brand to witness rapid growth. The company remains focused on uplifting marketing investment in China and driving growth across all infant formula channels.
Details of Top 10 Shareholders: The following table provides an overview of the top 10 shareholders of The A2 Milk Company Limited. Mitsubishi UFJ Financial Group Inc is the largest shareholder in the company, with a percentage holding of 7.45%.
Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)
Decent Liquidity Position and Higher Profitability: On the balance sheet front, the company reported a decent liquidity position with a current ratio of 3.69x in FY20, higher than the industry median of 1.64x. In the same time span, cash cycle days of the company stood at 24.5 days as compared to the industry median of 32.8 days. During FY20, assets/equity ratio of the company was 1.28x, lower than the industry median of 2.02x and debt/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.
Looking at the profitability, gross margin of the company stood at 56% during FY20, relative to the industry median of 41.8% and a net margin of the company was 22.4%, higher than the industry median of 8.3%. In the same time span, the company reported decent profitability with EBITDA margin of 31.9%, higher than the industry median of 17.1%. The company also well-managed the capital of its shareholders and reported Return on Equity of 40.4%, as compared to the industry median of 18.5%.
Key Margins (Source: Refinitiv, Thomson Reuters)
Strong Strategic Partnerships: The company have strong strategic partners, which have been a key contributor to its performance, supporting its growth and adaptability. These include Synlait, Fonterra, and CSFA Holdings Shanghai Co., Ltd. Synlait has a foundational partnership for infant nutrition and defined supply rights for infant nutrition products into China, New Zealand, and Australia, whereas partnership with Fonterra exposes the company to multiple products and emerging markets. The company’s long term logistics and distribution and partner, CSFA Holdings Shanghai Co., Ltd is an exclusive import agent for A2M’s China label infant nutrition products.
USA Business Towards Meaningful Scale: The US markets have a significant growth opportunity for the company and remains the largest chilled milk market in the world at nearly $13 billion in retail sales. It has a sizeable and growing premium milk segment. Whilst the store numbers of the company have increased by 51% in FY20, sales of the company nearly doubled, indicating a strengthening of sales rate within existing stores. During FY20, the company reported an increase of 91% in revenue to $66.1 million. However, rising investment in marketing and distribution resulted in EBITDA losses of $50.5 million.
Key Risks: The company is susceptible to risks related to changing climate, dynamic geopolitical and regulatory environments due to its business in international markets, including in Australia, China and the US, stiff 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 global pandemic and rapid change in information technology.
Outlook and Guidance: The company is witnessing decent underlying brand health metrics in China, including market share expansion, and growth of brand awareness and loyalty measures. Despite the current headwinds, the fundamentals of the business remain sound over the medium term. The company has provided guidance for FY21 and expects group revenue to be in the range of $725 million to $775 million for 1H21 and in between $1.80 billion to $1.90 billion in FY21. The company also anticipates EBITDA margin of ~31% for FY21. With an increasing scale of its infant nutrition business, the manufacturing capacity and capability of the company will add to its existing supply chain relationships. A2M is focused on building a market leading position in core markets and leverage its strategic partnerships to provide meaningful benefits in the medium term.
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: A2M is expanding into more physical stores and is driving growth across all infant formula channels with expansion in its distribution network and presence in the US markets. As per ASX, the stock of A2M is inclined towards its 52-weeks’ low level of ~$13.04, proffering a decent opportunity for accumulation. The stock of A2M gave a negative return of 24.47% in the past three months and a negative return of 4.98% in the last one month. On a technical front, the stock of A2M has a support level of ~$13.073 and a resistance level of ~$15.901. We have valued the stock using the P/E multiple based illustrative relative valuation and have arrived at a target upside of lower double-digit (in percentage terms). On the backdrop of attractive trading levels, continued expansion, strong base for sustainable growth, and modest long term outlook, we recommend a ‘Buy’ rating on the sock at a current market price of ~$13.73, up by 0.586% on 24 November 2020.
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A2M Daily Technical Chart (Source: Refinitiv, Thomson Reuters)
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