a2 Milk Starts Paying Dividends

This story features A2 MILK COMPANY LIMITED, and other companies. For more info SHARE ANALYSIS: A2M

After a tough couple of months of supply chain disruptions and weak Chinese economic data, a2 Milk has relieved the market with upgraded FY25 revenue guidance and a maiden dividend.

-a2 Milk upgrades FY25 revenue guidance
-Maiden dividend from next year
-Investment in supply chain still a priority
-Analysts remain mostly cautious

By Greg Peel

The a2 Milk Company ((A2M)) was enjoying a cracking 2024 with the shares up around 77% to September when the wheels fell off. August New Zealand port data showed a fall of -16% in NZ infant formula volumes to China year on year due to supply disruptions from Synlait Milk ((SM1)), of which a2 Milk owns 19.8%.

Adding to negative sentiment were data showing the Chinese marriage rate had fallen -17% year on year, implying a further fall in China’s birth rate, and thus less demand for infant milk formula (IMF).

There was a sharp bounce in the share price in late September when Beijing announced stimulus measures to improve the birth rate, but these were soon deemed to be of little impact and the share price fell once more.

By the time of a2 Milk’s AGM last week, the share price had fallen -35% from its mid-year peak. Shareholders were thus relieved when the trading update provided at the AGM proved better than feared.

We’ll Take It

a2 Milk raised FY25 revenue growth guidance to mid-to-high single digit from mid-single digit. Hardly mind-blowing, but a relief nonetheless.

Mataura Valley Milk’s (75% owned) external sales are significantly above plan and reflecting upward movements in commodity prices, forex impacts, greater volumes and changes in product mix. Global Dairy Trade average values are up 7% year to date and 12% year on year, although this is largely mitigated by the NZ farmgate price, which is up 21% year on year.

The impact on earnings is nevertheless immaterial, Morgans notes, given MVM ingredient sales are largely commodity milk powder sales which have a slightly dilutive impact on a2 Milk’s gross margins and earnings.

Otherwise, English label IMF sales are slightly ahead of plan, due to category growth and sales on China’s Singles Day (ironic?), as well as Liquid Milk sales, which saw growth in the core products of lactose-free in Australia and grass-fed in the US.

Chinese label sales are broadly in line with plan given Synlait Milk supply constraints. Chinese label production levels returned to normal during the September quarter and trade stock is returning to target levels ahead of the all-important Chinese New Year.

Year on year revenue growth in percentage terms is expected to be consistent between the first half FY25 and the second, while the FY25 earnings margin is expected to be consistent with FY24 (14%).

Maiden Capital Management

Given a2 Milk’s strong balance sheet, featuring net cash of close to NZ$970m in FY24, the board has announced a dividend policy for the first time, targeting a payout ratio of between 60-80% of underlying profit. The first interim dividend is expected to be declared in February and in line with the bottom end of the range.

The initiation of a dividend is a positive reward for shareholders, Wilsons notes, and signals improved visibility on the quantum of potential M&A or joint venture deal as part of management’s intended supply chain transformation

As the company executes its strategy, the board will continue to review capital management options which may result in further capital returns to shareholders, likely to be in the form of special dividends over time. The board nevertheless remains conscious of the company’s significant cash balance which is being prioritised for supply chain transformation, growth opportunities and risk mitigation.

The introduction of a dividend policy has come earlier than analysts had expected and was thus a positive surprise. Citi points out it potentially opens up the universe of potential investors, particularly retail, which could reduce share price volatility.

Mostly Cautious

Citi reiterates its Buy rating on a2 Milk following the AGM. Since mid-2023, the broker has been optimistic on the outlook for 2024 births due to Year of the Dragon and pent-up family formation post-covid.

Citi thinks a2 Milk could also see market share gains (currently 7.3%) due to the structural shift to English label (20.2% share) and from new product development, such as the new English label product which is “more premium than platinum” to launch later in FY25.

Citi sees other near team catalysts including the potential for further Chinese government stimulus aimed at increasing the birth rate beyond 2024 and a potential supply chain acquisition.

The world has been waiting for Beijing to announce a big-bang stimulus package to rescue its ailing post-covid economy but has been constantly disappointed by efforts to date. China’s falling birth rate, and thus rapidly ageing population, is of particular concern for the government.

Citi notes China will be holding its Central Economic Work Conference in mid-December, where it could outline further plans to boost the birth rate, an issue which it has acknowledged needs to be addressed in recent months. China’s Two Sessions meeting in March 2025 may also serve as another catalyst, with potential stimulus to be outlined.

Citi has increased its target price for a2 Milk to $7.15 from $7.04.

Ord Minnett has gone the other way, cutting its target to $5.90 from $6.50. This broker highlights the economic environment in the Chinese market, the primary destination for the company’s infant milk formula that makes up 68% of annual sales, has proven a long-running drag on its stock.

However, Ord Minnett upgrades its rating to Accumulate from Hold given valuation support and the strong start to FY25.

UBS has a Buy rating.

Thereafter, Hold or equivalent ratings prevail.

Given the share price has been weak in recent weeks on weak shipment data, weak macro data (falling marriage registrations etc) and concerns China’s stimulus measures aren’t enough to grow the birth rate, a relief rally following the stronger than expected trading update, slightly upgraded guidance and the announcement of a dividend policy, is not surprising to Morgans.

Management continues to execute well, the broker suggests, but trading on an FY25 PE of 23.7x Morgans thinks a2 Milk is fairly valued and maintains a Hold rating. The broker is also concerned the investment in the supply chain will initially be earnings per share dilutive. Morgans’ target has fallen to $5.95 from $6.25 previously.

There is no change to Bell Potter’s Hold rating, as a2 Milk continues to trade at a premium to other Dairy FMCG (fast-moving consumer goods) entities. The most recent update illustrates an evolution of the revenue mix towards that of a more traditional dairy entity, Bell Potter notes, that would likely step-change as investment in downstream processing is pursued.

Bell Potter’s target has fallen to $6.00 from $6.10.

At October peaks, a2 Milk’s share price implied around an 8% six-year sales compound annual growth rate, Macquarie calculates, while the recent sell-off appeared to price in downgrade risk and CAGR of more like 1-2% versus 6% consensus. The trading update bounce took the implied CAGR back to around 5%.

For Macquarie, the key catalyst, other than delivering on earnings amid structural challenges, is supply chain investment. This broker retains a Neutral rating and has cut its target to $5.70 from $5.90.

Morgan Stanley retains an Equal-Weight rating and $5.90 target.

The consensus target among the seven brokers monitored daily by FNArena covering a2 Milk has fallen to $6.14 from $6.28, noting this does not include UBS whose target is quoted in NZ dollars. But if we take out Citi’s stand-out target of $7.15, consensus falls to $5.89.

There are three Buy or equivalent ratings and four Hold ratings.

Wilsons suggests the marginally stronger result in the core branded business (IMF and liquid milk) is encouraging and reflects strong operational execution in a challenging market. The broker understands that supply chain disruptions during the period have been in line with expectations.

Wilsons welcomes the new dividend policy and openness to special dividends, rewarding shareholders while also implying improved visibility on supply chain transformation funding needs. Wilsons retains a Market Weight rating and a target of $5.75, down from $5.97.

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