Australia | 10:00 AM
The market took fright at A2 Milk's earnings downgrade with supply challenges overriding what appears as ongoing strong demand.
- Prior to this week, a2 Milk's share price offered little room for disappointment
- Market had ignored indications of logistics bottlenecks and headwinds
- Profit warning caused by higher air transport costs pressuring margins
- Analysts' earnings downgrades largely consistent with management's downgraded guidance
- Current debate revolves around whether negative factors might impact for longer?
By Danielle Ecuyer
Why did the market ignore Synlait Milk's previously flagged supply challenges?
With high expectations for growth and a supportive macro backdrop for infant formula demand, a2 Milk's ((A2M)) trading update, which included an unwelcome earnings downgrade, has eroded investor confidence amid mounting supply chain challenges.
As the Citi analyst notes, when a stock is priced for perfection, there is little wriggle room for disappointment, particularly in a volatile market where investors sell first and ask questions later.
From a top-down perspective, a2 Milk has been hit from multiple angles in recent months, resulting in a mismatch between supply constraints and strong demand.
While some analysts view the issues driving earnings downgrades as temporary, others are more cautious, suggesting supply chain pressures and potential reputational damage from failing to meet demand could extend into FY27.
Profit warning reflects unwelcome margin pressures
a2 Milk downgraded FY26 sales growth by -2% to -3% at the midpoint, with Macquarie noting the decline in earnings (EBITDA) margin of -1.5 percentage points, or -150bps, translating into an earnings downgrade of around -12%.
The company highlighted strong demand “across all product categories and regions in 3Q26, with positive year-to-date offtake trends similar to or better than those seen in 1H26”.
Bell Potter emphasised the reduction in FY26 earnings (EBITDA) margin guidance to 14%–14.5% from 15.5%–16%, reflecting a -300bp cut in 2H26 expectations, with net profit after tax now expected to be flat or down on the prior year, versus earlier expectations for positive growth.
Cash conversion is also expected to decline to around 50% from 80%, due to delayed cash receipts into FY27 and higher year-end inventory levels.
The market reaction was swift, with the share price falling -12.99% on the day, making it the worst performer on the ASX.
The trouble spots
Morgans points to the relatively modest downgrade to revenue guidance, around -NZ$50m of infant formula sales, reinforcing management’s view that demand remains strong.
The broker highlights stronger sales in March, supported by peer product recalls, suggesting a2 Milk continues to gain market share.
Macquarie describes a “perfect storm” over the March quarter, where strong demand coincided with inventory rebuild efforts following Synlait Milk’s ((SM1)) Dunsandel production issues, which delayed product release, with an 8–10 week lag flagged at the 1H26 result.
Jarden notes production has now returned to required levels, but a backlog of unfilled orders remains, meaning output is still addressing past rather than current demand.
Compounding the issue are new Chinese “cereulide” regulations introduced following industry recalls, requiring more frequent and stringent product testing, further delaying product release and creating bottlenecks.
Jarden adds these requirements were initially focused on China label products but have since extended to English label imports.
Company management expects China label products to be most impacted through April and May, with increased testing and customs clearance times contributing to delays.
Analysts also note Genesis, a cross-border e-commerce (CBEC) sales channel in China, is experiencing elevated demand, while a2 Milk is managing planned production disruption as its Pokeno plant is prepared for the Platinum transition.
On margins, pressure is largely attributed to worsening sea freight disruptions linked to the Middle East conflict, prompting a shift to more expensive air freight.
Macquarie notes the reduction in infant formula sales guidance of circa -2.5% equates to roughly two weeks of sales, implying limited earnings impact from volume alone.
Instead, higher freight costs are seen as the primary driver of the downgrade, with air freight accelerating inventory rebuild but lifting cost of goods sold more quickly than traditional shipping.
Morgans expects elevated freight and logistics costs to persist into FY27 but anticipates profit growth will recover as supply chain investment moderates and sales accelerate, alongside (expected) continued market share gains.
Bell Potter raises concerns that FY26 margin guidance, now below August 2025 levels despite higher revenue, may signal a return of cost of goods sold inflation.
Across the market, brokers have lowered earnings forecasts by around -9% to -13% following the market update.
The full story is for FNArena subscribers only. To read the full story plus enjoy a free two-week trial to our service SIGN UP HERE
If you already had your free trial, why not join as a paying subscriber? CLICK HERE