Company Overview: The A2 Milk Company Limited (ASX: A2M) is engaged in the sale of branded products made with milk from cows, containing the A2 protein type. The company has operations in the following geographic regions – Australia and New Zealand, China and other parts of Asia and the USA. The Australia and New Zealand segment reports revenue from the sale of infant formula, milk and other dairy products along with royalty and licence fee income, while China and other parts of Asia report revenue from infant formula and dairy product sales. The USA segment receives revenue only from milk sales.
A2M Details
Resilient Performance with a Strong Cash Position to Aid Growth: The A2 Milk Company Limited (ASX: A2M) is engaged in the sale of branded milk products. The market capitalisation of the company as on 2nd February 2021, stood at ~$8.01 billion. As per a recent update, the company has entered into binding agreements for the acquisition of 75% stake in Mataura Valley Milk, a diary-based business located in Southland, New Zealand. The proposed acquisition will provide A2M manufacturing capability for nutritional products and also aid in geographic diversification. The transaction will be funded from A2M’s existing cash reserves for a total consideration of NZ$268.5 million, based on the enterprise value of ~NZ$385 million.
The company delivered a decent performance in FY20, with a revenue of NZ$1.73 billion, an increase of 32.8% from the previous corresponding period. The rise in revenue was supported by the growth in the infant nutrition segment with total sales of NZ$1.42 billion, during FY20. It experienced a surge in demand for its products during the third quarter, as there was a shift in consumer preferences due to the outbreak of the COVID-19 pandemic. The company has also witnessed a growth of 91.2% in USA milk revenue segment. A2M reported an EBITDA of NZ$549.7 million and a net profit of NZ$385.8 million, during the period. There was an improvement in the cash position of A2M to NZ$854.17 million in FY20, compared to NZ$464.80 million in FY19.
Financial Performance Over the Past Few Years (Source: Company Reports)
Resilient Business Performance Despite the Short-Term Headwinds: Notwithstanding the near-term headwinds due to the outbreak of the COVID-19 pandemic, few business segments of the company have been performing well in H1FY21. The performance of the China label in Mother & Baby Stores (MBS) has been decent and the company expects revenue growth of 40% in the first half, when compared to the previous corresponding period. There has been an improvement in the liquid milk businesses in Australia and the USA, and both the units delivered decent first-half growth in H1FY21, when compared to H1FY20.
Revenue Performance Segment Wise: Infant nutrition contributed to the majority of sales in FY20, with a percentage of ~82% of the total sales. Geography-wise Australia & New Zealand contributed around ~56% of the total sales, followed by China & Other Asia regions at ~40% of revenue. There was a growth of 91% in revenue to NZ$66.1 million in the USA market in FY20, when compared to FY19. Brand awareness has more than doubled and conversion rates were up significantly in the USA market during the period.
FY20 Segment Performance (Source: Company Reports)
Top 10 Shareholders: The top 10 shareholders together form around 37.74% of the total shareholding while the top 4 constitutes the maximum holding. Mitsubishi UFJ Financial Group Inc and The Vanguard Group, Inc are holding a maximum stake in the company at 8.53% and 6.93%, respectively, as also highlighted in the chart below:
Data Source: Refinitiv, Thomson Reuters, Chart Created by Kalkine Group
Key Metrics: During FY20, there was an improvement in the gross margins of the company to 56%, from 54.8% in FY19. Net margin stood at 22.4% during the same period. The quick ratio of the company improved to 3.21x in FY20, from 2.65x in FY19 and current ratio to 3.69x from 3.15x, reflecting an improvement in the liquidity profile of the company. The cash cycle days stood at 24.5 days.
Profitability and Liquidity Profile (Source: Refinitiv, Thomson Reuters)
Key Risks: The company is exposed to credit risk and it is dependent on the individual characteristics of each client. In this regard, the majority of sales are made to reputed retailers with high creditworthiness. A2M analyses new customers’ historic credit profile before entering into any sort of business agreements. The Group is also exposed to foreign currency fluctuations as it reports revenue from a diversified geographic base. The company has witnessed disruption to the corporate daigou channel, due to the stage 4 lockdown in Victoria, owing to the spread of COVID-19 pandemic. The daigou channel forms a strategic part of A2M’s business mix, and is responsible for demand creation across multiple sales channels, including CBEC. As such, the disruption has impacted the profitability of the company in the short term.
Outlook: Despite the economic uncertainties due to the impact of the COVID-19 pandemic, the company continues to invest in its marketing and organisational capabilities. It expects FY21 revenues to be around ~$1.4 billion to $1.55 billion, and EBITDA margin to be between 26% and 29%. A2M anticipates EBITDA margin to be around 30% in the medium-term and considers the business to be fundamentally sound, despite the disruption induced by the pandemic.
Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)
P/E Multiple Based Relative Valuation, (Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group)
*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks.
Stock Recommendation: The company’s one brand, two labels strategy has engaged strongly with the consumers, where the China label range delivers A2M's premium positioning and the English label is premium priced within the reseller and online channels. As per ASX, the stock of A2M is trading above its average 52-weeks’ levels of $9.820-$20.050, respectively. The stock of A2M has corrected 9.08% and 22.31% in the last one and three months, respectively. On a technical analysis front, the stock has a support level of ~$9.785 and a resistance level of ~$15.042. We have valued the stock using a P/E multiple-based illustrative relative valuation and have arrived at a target price of low double-digit upside (in % terms). We presume that the company might trade at a discount to its peer average P/E (NTM Trading multiple), considering the impact of the COVID-19 pandemic on its key channels and uncertainty in the near term. For the purpose, we have taken peers such as Synlait Milk Ltd (ASX: SM1), Bega Cheese Ltd (ASX: BGA), Fonterra Shareholders' Fund (ASX: FSF), to name a few. Considering the current trading levels, decent financial performance in FY20, rise in sales in the infant nutrition segment, comfortable cash position and the expected synergy from acquisition, we recommend a ‘Buy’ rating on the stock at the current market price of $10.450 per share, down by 3.152% as on 2nd February 2021.
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A2M Daily Technical Chart (Source: Refinitiv, Thomson Reuters)
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