A2 Milks It

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

The a2 Milk Company posted a solid first half, gaining market share, and the second half is set to enjoy a number of tailwinds.

-a2 Milk’s first half exceeds expectations
-Market share gains overcome Chinese brand dominance
-First half headwinds to subside
-New product launches offer potential

By Greg Peel

Infant milk formula distributor The a2 Milk Company ((A2M)) reported a solid first half result, with sales up 10% year on year, earnings up 5% and profit up 6.9%. Cash flow was materially stronger than expected, albeit benefiting from timing issues.

The balance sheet remains in a strong net cash position of $1.0bn, and the board declared its first dividend with an interim of 8.5cps.

While the company’s top-line growth was solid, as was previously guided to, its margins were down year on year, Morgans points out. Gross profit margin fell -190 basis points and the earnings margin was down -65bps to 13.3% following Synlait Milk’s ((SM1)) operational issues which constrained infant formula supply, and resulted in a2 Milk airfreighting product to China to try and catch up sales.

Yesterday’s release marks another creditable performance, Jarden suggests, given the China infant formula end-market remains in structural decline (first half value down -6% year on year), albeit the A2 protein segment continues to grow (up 14%) and now represents some 20% of total value, up 18% from FY24.

At the profit level, the interim result also absorbed aforementioned additional airfreight costs associated with China Label products, as well as temporary supply constraints.

Market Share

The a2 brand has maintained its number five player market position and was the third largest share gainer in the period. English Label (EL) sales were up 13% year on year compared to market value growth of 7%, Jarden notes, driven by strength in the China cross-border e-commerce (CBEC) and offline-to-online (O2O) channels.

On the flipside, Daigou trade continues its declining trend and now represents less than 5% of total formula sales.

Jarden reports new EL product launches include a2 Platinum into Vietnam and a2 Gentle Gold into Australia, with Vietnam planned for the second half, and a2 Genesis, which is an ultra-premium, probiotic human milk oligosaccharide (HMO) product, tested in the Hong Kong CBEC market and to be launched in March.

China Label sales were up 2% year on year compared to a market value decline of -8%, but was constrained by temporary supply shortages in the first quarter. China Label formula share is now 5.3%, up 0.4 percentage points half on half and benefiting from a continued shift to online channels and offline retailer consolidation.

The result demonstrated to Citi that gone are the days in which market share gains were dominated by domestic Chinese brands, with a2 Milk the third highest market share gainer behind Yili and Nestle, with the latter recently flagging science-based innovation through HMOs. Distribution improvements are driving Nestle’s growth.

In the top five brands, two are domestic and three are international, including a2 Milk, suggesting Chinese nationalism is having less of an impact on purchase decisions.

Guidance

FY25 revenue guidance has been upgraded from mid-to-high single digit growth to low-to-mid double digit growth. Earnings margin guidance has also now been upgraded to be slightly up year on year as opposed to flat previously.

Management informed the upgrade reflects stronger than expected demand for EL formula in the CBEC and O2O channels, increased Liquid Milk sales, particularly in the USA Club channel, forex benefits and higher global dairy trade pricing increasing Mataura Valley Milk external ingredients sales.

One for Mum, one for Dad, and one for Xi

Citi believes a2 Milk is gearing up for a strong FY26 due to increased second half marketing –at least 10% higher than the first half– with guidance for FY25 marketing and sales to be up, despite the first half being down and the second half having a higher sales base.

An important driver, as President Xi moves to address China’s declining population, is the number of babies born in the Year of the Dragon (Chinese lunar year 2024). Citi notes birth rates were up 5.8%, and babies are now moving to the higher-volume stage three (toddler) formula, which is the largest segment of the market.

Children born in a Year of the Dragon (the only mythical creature in the Chinese zodiac) are said to be destined for good fortune and greatness, which is why, in many Asian nations, more babies are born during Dragon years than any other.

Chinese marriage data nevertheless suggest weaker 2025 births, Macquarie notes, but management highlights a multi-period covid bump (no pun intended I’m sure), government stimulus focused on second babies, and better support for births outside marriage.

a2 Milk highlighted strong demand for early-stage and trial products, which could support growth into FY26, Macquarie suggests, even in a tougher backdrop.

Citi notes the potential for further Chinese government stimulus aimed at increasing the birth rate beyond the 2024 level to be announced at China’s Two Sessions meeting next month.

Further Tailwinds

The airfreight cost drag worth some -$8m in the first half is unlikely to repeat, Citi declares, and distribution growth is set to accelerate following first half supply constraints.

In terms of planned new product launches, key highlights for Jarden include a2 Genesis targeting the ultra-premium EL segment with its HMO ingredient. Management noted on the earnings call that HMO has been the fastest growing sub-segment of EL over the last three years and now comprises some 30% of total EL market value. Key competitors experiencing HMO success have been Danone and Nestle.

In China Label, a new fortified seniors’ powder range (three distinctive products) was launched late in the first half and a new fortified kids’ powder is targeted to launch in the March quarter, albeit this segment is seen cannibalising some share from stage four (three years and older) formula.

In the US, securing a longer-term market access option for infant formula remains with the FDA for final approval.

While a2 Milk is launching new products across EL formula, kids and seniors, its priority remains to invest in the supply chain, Morgans notes, likely in 2025, to gain access to more China Label registrations and increase its addressable market.

Given the company is likely to acquire an underutilised facility, in the near term, this investment is likely to be earnings per share dilutive, although Morgans recognises there is a possibility the loss-making Matura Valley Milk facility is shut down.

It will all come down to management’s strategy decisions, Morgan Stanley determines. Supply chain investment cost is dependent on the progression of the strategy. Outright acquisitions (in the hundreds of millions), a possible Matura upgrade (costing -$150-200m), and other capital requirements are dependent on strategy.

Management nonetheless hopes significant excess capital to be returned to shareholders over time.

Priced In?

a2 Milk has a great brand, Morgans believes, which is taking market share. The management team continues to execute well. The company generates strong cashflow and has a very strong balance sheet.

However, trading on an FY26 PE of 25.1x, Morgans thinks the shares are fairly valued, and maintains a Hold rating, with a target increase to $6.87 from $5.95.

Of a similar opinion is Bell Potter.

The first half saw a good result and the upgrade to guidance a little stronger than this broker would have expected when forex movements were allowed for. Forward growth is “reasonable”, but at 17.6x FY25 earnings the shares are trading at a big premium to the sector, Bell Potter notes, with dairy peers at 12.2x and infant formula peers at 8.2x, notwithstanding a2 Milk’s own three-year average PE of 14.5x.

Bell Potter sticks with Hold, while lifting its target to $7.25 from $6.00.

Management continues to execute well, suggests Wilsons, noting further market share gains, new product launches and continued progress on its strategic roadmap. However, supply chain transformation and a challenging formula market remain front of mind for the broker.

The current share price, in Wilsons’ view, is fairly priced and as such this broker remains Market Weight, with a target increase to $7.06 from $5.75.

A “first glance” report from Morgan Stanley makes no change to its Equal-weight rating or $5.90 target.

Despite a2 Milk’s share price re-rate, Macquarie believes momentum remains, and the EL market outlook is a key positive. Given ongoing market share gains, performance of new product launches, the Chinese birth rate, and balance sheet deployment into M&A/further capital management, Macquarie sees limited downside catalysts near term.

Macquarie points out the PE is around the median post-covid, and upgrades to Outperform from Neutral, with a target increase to $7.85 from $5.70.

a2 Milk is benefiting from the turnaround in the Chinese birth rate in 2025, Citi agrees, along with the structural shift towards EL, in which the company outperforms with a 20% share, ongoing market consolidation and its own “excellent” execution.

Citi reiterates Buy, lifting its target to $8.20 from $7.33.

Jarden maintains an Overweight rating, notwithstanding the more limited valuation support. The company has returned to strong momentum and has a number of defined catalysts over the next twelve months which could provide upside risk to Jarden’s existing growth estimates and/or provide additional capital returns to shareholders via special dividends.

Jarden lifts its target to NZ$7.75 from NZ$7.15.

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