A2 Milk Running At Full Strength

Array
(
    [0] => Array
        (
            [0] => ((A2M))
        )

    [1] => Array
        (
            [0] => A2M
        )

)

This story features A2 MILK COMPANY LIMITED.
For more info SHARE ANALYSIS: A2M
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

The a2 Milk Co has impressed brokers with its substantial revenue and profit growth at the start of FY18, although projections are considered largely factored in to the stock.

-Management prepared for competitive responses in A1 protein-free category
-Frequent running out of stock a key risk to monitor
-Potential for the launch of the nutritional product in Southeast Asia
 

By Eva Brocklehurst

The a2 Milk Co ((A2M)) is running strongly, supported by significant growth in its specialised milk products in Australasia and China. The company's market share of infant formula in China finished the September quarter at 4.1% versus 2.1% in the prior corresponding quarter. Marketing expenditure is expected to lift by $30m in the second half of FY18, to support an expanded distribution chain in the US and the timing of the Chinese campaigns.

The company has highlighted revenue growth of 69% year-on-year, operating earnings (EBITDA) growth of 121% and net profit growth of 138%, over the first four months of FY18. There were 600 new distribution points added, taking the total to around 3600.

Management has also signalled a preparedness for competitive responses that are expected in the A1 protein-free category over time, but remains confident in its first-mover advantage, trademarks and patents.

Credit Suisse raises its estimates for operating earnings for FY18-20 by 8-12% and concedes it possible that the company could over-achieve on investor expectations. Yet, given the current infant formula revenue base, the magnitude of the company's ability to surprise in this way should begin to taper. The broker believes growth projections are now substantially reflected in the share price and downgrades to Neutral from Outperform.

Macquarie expects momentum should underpin continued growth over FY18 and into FY19. There is upside to the long-term market share for the company, and that should provide further valuation upside, as would new products and market launches.

The company has launched an English label infant formula in Hong Kong, with initial distribution through pharmacies from November. Potential is also being explored regarding a launch of nutritional product in Southeast Asia. Macquarie believes this could leverage off the company's growing brand and product awareness and scale that is building in the infant formula business.

While Bell Potter upwardly revises sales and gross margin forecasts, this is tempered by higher levels of marketing expenditure. Going forward, scope for further success in the US and UK fresh dairy markets is envisaged along with a more aggressive launch of infant formula products in the UK.

Nevertheless, Bell Potter joins those brokers downgrading in the light of recent share price appreciation. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, lowers its rating to Hold from Buy. Target is $8.15. FNArena's database has two Buy and three Hold ratings.

Citi expects earnings upgrades to continue, despite a degree of caution in the company's outlook around the seasonality of sales and its plans to increase marketing expenditure. The broker sticks with its Buy rating, removing the High Risk annotation now CFDA approval has been received, also noting the Lion court case is delayed until next year, which removes a short-term uncertainty.

Sales momentum is unlikely to slow over the remainder of FY18, in Citi's view, as further market share gains in A2 Platinum market are expected.

Inventory Issue

The broker acknowledges the company's frequent running out of stock is a key risk to monitor, as it could lead to consumers and daigous switching to competitor brands. On this subject, a2 Milk has expressed a desire to build inventory to more sustainable levels, targeting greater flexibility and lower costs via better procurement arrangements through its supply chain.

Infant formula supply and canning capacity is the only tangible constraint, in Deutsche Bank's view. The broker upgrades growth estimates while maintaining a Hold rating on valuation grounds.

Capital Management

The company continues to review its surplus cash and will update investors at the interim result in February about how this will be deployed or returned. Deutsche Bank includes an NZ$40m buyback within its estimates. The broker lifts US revenue growth and operating expenditure assumptions, although concedes these are less material to valuation.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms