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Sales Slowdown Hits a2 Milk Guidance

Australia | Dec 21 2020

This story features A2 MILK COMPANY LIMITED. For more info SHARE ANALYSIS: A2M

As was widely feared, a sharp slowdown in sales to China has materialised for a2 Milk, which has significantly downgraded guidance for FY21

-Retail disruption should ease as pandemic subsides
-Highlights the importance of daigou to growth
-Trade tensions not considered the underlying issue


By Eva Brocklehurst

A trading halt heralded the warning, and fears were soon realised as a2 Milk ((A2M)) flagged a materially weak December. Guidance has been downgraded, substantially.

No tourism/international students from China has affected the Australian retail daigou (local purchase for sale in China) channel, while sales into the corporate daigou market have also been slower.

A protracted slowdown in the daigou channel has also spread to the CBEC (cross border e-commerce) channel, with shipments to Hong Kong over the year to date down -27%, which Bell Potter notes has historically been a close proxy for CBEC revenues.

First half revenue guidance is downgraded by -8-14%, having been reiterated just one month earlier at the AGM. First half margin expectations have been revised down to 27% from 31%.

FY21 revenue guidance has been revised to NZ$1.4-1.55bn while operating earnings (EBITDA) margins have been downgraded to 26-29% from 31%. This implies FY21 EBITDA of NZ$364-450m, -24-35% below prior guidance.

A stronger New Zealand dollar has also affected margins. With events now playing out in line with expectations and following the material drop in the share price, Bell Potter's rating is upgraded to Hold from Sell with a target of $10.40.

Morgan Stanley follows the same theme, upgrading to Equal-weight from Underweight with an $11.00 target, as the risks to guidance become reality. The broker points out, since the August result, FY21 guidance has declined -37% and the stock is down -45%. Moreover, management selling of shares hasn't helped.

Morgan Stanley believes a broader change is now required to restore growth settings for the respective channels, and lacks conviction regarding the company's mitigation strategies and/or whether the latest update signals the end of the downgrade cycle, given a new CEO will start in January.

Still, on the positive side, the downgrade risk appears priced in and headwinds are inter-related, with retail constrained by travel disruptions that should cease as the pandemic ebbs. The company had expected CBEC would pick up some of the slack from daigou but this has not eventuated.

Morgan Stanley acknowledges this is what usually would be expected from a strong brand where one route to market has been disrupted. Citi is also conscious of the larger-than-expected connection between daigou and CBEC that has exacerbated the problem.

A2 Milk intends to direct incentives to corporate daigou and restrict supply of English-labelled product to drive scarcity. All up, this just highlights how important the daigou is to growth… and also the lack of transparency in the channel, Morgans asserts.

Despite the impact on daigou, the company does not believe trade tensions between China and Australia have affected its business, and the issues are more simply a result of the pandemic.

Morgans expects net profit will fall by -30% in FY21 while a recovery in FY22 will be driven by corporate and retail daigou as restrictions ease. Higher sales velocity is anticipated in both China and North America, subsequently.

Moreover, given the size of the mother & baby market in China, Morgans still expects strong growth will be provided to a2 Milk as further market share is obtained. The company is also in a strong net cash position and the board has signalled it is considering a share buyback, given the weak share price.

Morgans suspects, as has been the case with other infant formula companies, weakness could also be a catalyst for corporate activity. While sales forecast for both daigou and CBEC channels have been revised, the broker notes the liquid milk business in Australia and the US is still performing well.

See also, Daigou Drought Sours a2 Milk Outlook on September 29, 2020.

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