2024 Annual Results Q & A - 19 August 2024

I thought I would clip the Results Presentation down to the Q&A for convenience and reference as needed.
I have put together the dialogue as best I can; I have not proofread it.
Interpret as necessary.


**Tom Kier (Baron Joey):** "Good morning, guys. Could I just check whether the MVM and U.S. losses are expected to reduce in FY25, and if that's included in your outlook statement?"
**Speaker:** "Yes, Tom, they are expected to reduce, and that is included in our outlook statement."
**Tom Kier:** "Great. And secondly, can you elaborate on the supply constraints in the first half of FY25? I noticed you're flagging a potentially weaker performance in the first half. When do you expect this to be resolved, and what are the moving parts in that issue?"
**Speaker:** "Sure, Tom. I'll answer that. It's a combination of a few factors. Firstly, we finished FY24 with slightly lower stock than planned, primarily due to strong fourth-quarter sales and distributor shipments in China, particularly for early-stage products like our trial packs and 400g tins. Secondly, after year-end, we've experienced supply constraints in the infant category. These issues are being addressed, and we expect them to be resolved in the first half, but they are likely to constrain our sales during this period. We're also likely to incur significant air freight costs in the first half to catch up ahead of sea freight shipments. Lastly, the harder impact to quantify would be related to the New Year acquisition. It's always difficult to assess the rolling impact of that going forward, but I hope this gives you some insight into the challenges we're currently facing. It's not unusual in our industry; we've experienced similar issues before. Last year it was more related to the English label, while this year it's more about the China label."

**Tom Kier:** "Got it. Great, thanks.

**David:** "Thank you. Your next question comes from Matt Montgomery from For Bar. Please go ahead."
**Matt Montgomery:** "Hi, David, good morning. Just following up on Tom's second question, I was wondering if you could attempt to quantify the net drag of the supply constraints and what gross margins might look like excluding the air freight headwinds. I'm trying to get a sense of the materiality of what you're calling out."
**David:** "Matt, we’re not providing specific guidance on the sales drag. It’s hard to be too detailed on that. It will have a significant impact on growth margins, but what I can tell you is that the air freight costs are likely to be quite significant—potentially $10 million or more over what we’d ordinarily experience. We do have air freight from time to time, but nothing of this magnitude."
**Matt Montgomery:** "Okay, maybe we can take that offline. Just on your supply chain, after Friday, my view was that investors probably had more foresight on the CapEx profile of the business over the next few years. You’re sort of putting your eggs in the MVM and SLE basket, but you’re also implying that you’re still looking for potential site acquisitions. Apart from speed to market for new products, are there any other compelling reasons why you wouldn’t look to gain brand slots at Mata Valley? And secondly, is it more of an opportunistic exploration of a new site, or would you say it’s more likely that you would partner with someone else or acquire a site yourself?"
**David:** "In terms of MVM and our ability to utilize that for China label slots, MVM is capable of achieving China label registration in time. The issue is that we would need to invest in blending and canning, which we have plans to do, but that would take some time—possibly around five years—to install, develop new products, submit dossiers, and achieve semi-registration. That’s why we are looking at other opportunities. MVM will continue to be part of our supply base, and we’ve potentially got access to another China label registration there. We’re also partnering with our U.S. opportunity, subject to FDA approval. Over time, there’s an opportunity to innovate and in-source English label products to MVM in partnership with other supply partners in New Zealand. Currently, we partner with New Zealand New Milk, a subsidiary of Black Talis, and Yili, a subsidiary of Mengniu. In terms of new investment opportunities, we’re actively looking at M&A and JV opportunities to expand our footprint. There are two main reasons for this: firstly, to accelerate our nutritional manufacturing capability, and secondly, to gain quicker access to additional China label registrations. Our focus is primarily on New Zealand and China, although we’ve looked at other markets as well. To answer your question, it’s not just a high-level exploratory effort; it’s a very deliberate strategy. We hope this will lead to tangible action in the future, though I can’t provide specific guidance on what that may look like or the timing."
**Matt Montgomery:** "Okay, thank you very much."
**David:** "Alright, we’ll leave it there. Thanks.---

**David Arrington (Bank of America):**Thank you. Your next question comes from David Arrington from Bank of America. Please go ahead.
**David Arrington:**Morning. Look, I've had a couple of emails, incoming emails, with people confused about the supply chain issue. So, I don't want to burn a question on this, but I think we need to clear it up. The consensus forecast, and I know you don't want to comment on consensus, I accept that, but the market was expecting you to grow sales by about 9% next year, with margins expected to grow to around 14.5% to 15%. However, there seems to be a miss in terms of what was expected in FY25 compared to what you're guiding. You mentioned to Tom that this is even factoring in reduced losses at the U.S. and Matura Valley. So, the supply chain constraint is an issue that we need to clear up. I don't fully understand what it is, why it's happening, and if it’s the key reason for this. Could you clear this up, please? This is causing quite a bit of angst in the market, and your previous answer didn’t fully explain the supply chain constraint. If you could clarify this, it would be great for all investors and people on the call.
**Company Representative:**Hi David, it’s hard to be very specific about this. In terms of growth, we are targeting mid-single digits, and in the absence of this issue, we might have been in the mid to higher single digits. It’s difficult to be precise. Regarding margin improvement, yes, we would have liked to deliver more substantial EBITDA margin improvement. We're still focused on that and hope to improve EBITDA margins, but the potential loss in sales, plus the air freight cost, is likely to temper any growth in EBITDA margins. At the moment, our best estimate is that EBITDA margins will be broadly flat. They could go up or down, but that’s where we are now. So, it’s quite a significant impact.
**David Arrington:**What’s the cause? I still don’t understand what’s causing this. You gave a partial answer, but is it a one-off issue? Is it sustained? What exactly is it?
**Company Representative:**David, it’s not appropriate for me to comment on our supply chain in detail. It's more operational and temporary, and it will be corrected. We’ve had these problems in the past, and it’s not unusual for the industry. I’m not blaming Synlait directly for this, but it does happen from time to time. It’s probably more appropriate for Synlait to explain; I don’t want to speak on their behalf.
**David Arrington:**Okay, I think that's enough on that, David. And look, we have a continuous supply chain, so if there’s any disruption, it does impact us. We finished the year slightly lower at the end of FY24, which doesn’t help. If there’s an interruption, it takes time to catch up, and we’re currently ramping up production. It’s unfortunate, but temporary. The longer-term impact I mentioned could be on new user acquisition, but it’s difficult to quantify at the moment. We should be back on track by the end of the half, hopefully earlier.
**David Arrington:**No, I understand the sensitivity of the issue, and I appreciate the answer. I have plenty of questions about the details, but you're sitting on a billion dollars in cash, and your operating execution is going great. To meet your $2 billion sales target and mid-teen margin, how much CapEx do you need? How much excess cash do you have right now to achieve your medium-term target?
**Company Representative:**Firstly, let me clarify that our target is not 16%. That’s not what we’re aiming for. In terms of CapEx, if we were to fully develop MVM and install blending and canning, you're talking about $100 to $200 million of CapEx. Additionally, we may consider some China market investment, but that’s likely further down the track. The M&A/JV opportunities we’re looking at in New Zealand and potentially China could cost hundreds of millions of dollars, depending on whether it’s an outright acquisition or a joint venture.We’re also preserving our balance sheet to mitigate supply chain risks and invest in developing our own capabilities and market access for the future. We’re not sitting on close to a billion dollars for any other reason. Once we have more clarity, we’ll assess how to return capital to shareholders in the most effective way.
**David Arrington:**How long do you need for clarity, David? A year or two? Because what you're discussing seems like a longer-term issue.**Company Representative:**No, it's more like a year or two, and I hope it’s less than that. The key determinant is the Synlait recapitalization process, which should be clarified shortly. As for our M&A/JV opportunities, we're always looking, but we can’t be certain. I hope this will be within the timeframe you mentioned. We're not sitting on a billion dollars for the next five years, if that’s what you're thinking.
**David Arrington:**Okay, well, thank you for answering the questions, David. They needed to be clarified, so thank you very much.---

**Adrien Alurn (Jarden):**Thank you. Your next question comes from Adrien Alurn from Jarden. Please go ahead.
**Adrien Alurn:**Good morning, team. Can you hear me okay?
**Company Representative:**Yes, we can, Adrian.
**Adrien Alurn:**Thank you. Just staying on the supply chain, you mentioned you might give more clarity on the settlement with Synlait. You used the term "higher manufacturing and flexibility costs." Can you give us more depth on what that means? I understand it's all contained within your targets, but can you give us an indication of the changes there?
**Company Representative:**Just to clarify, I think Synlait said "moderately higher manufacturing costs," and we mentioned that our conversion cost would increase incrementally. There’s potentially a difference between those two statements. From our point of view, we have an incremental increase in the conversion costs for certain products, both China label and English label. It’s not all products, and it’s relatively incremental. It’s nothing to do with ingredient costs since it’s a tolling relationship we have with Synlait. The ingredients cost is different, and we work together to optimize quality, service, and cost. So, the impact on our product costs and margins associated with the settlement agreement is relatively small.
**Adrien Alurn:**Understood. Maybe a second question for yourself or Johan: In terms of the English label category, you noted it has gone to about 17% from 15%. Where do you see that settling in the next couple of years? Do you think the trend is towards 20%, or could you give us more depth on that?
**Company Representative:**Adrian, just to clarify, you’re referring to the English label share of the total China IMF market, which has improved. If you look back to pre-pandemic levels, that rate was a lot higher. English label was impacted by COVID-19, which caused the ratio to drop. The improvement now is driven by the absence of the pandemic, making English label products more attractive, especially in terms of value for money. Additionally, some new products from Hong Kong and Europe contain ingredients like HMO, which are particularly attractive. So, it’s a combination of factors driving the English label share. It’s hard to say exactly where it will end up, but it’s good to see momentum returning to the English label.**Adrien Alurn:**Was it around 23% pre-pandemic? Do you think it might increase a couple of points toward 20%, or are you expecting it to go higher?
**Company Representative:**Yes, it was around 23% pre-pandemic. It might increase slightly towards 20%, but I wouldn’t expect it to go much higher.
**Adrien Alurn:**Thank you. One last question: When you launch products like Immune+ or Move, how long does it take for them to be net positive at the contribution margin? How much marketing support is required upfront for those kinds of products?
**Company Representative:**There is some upfront marketing support, but products like Immune+ and Move build on an existing portfolio, so they leverage the marketing support already in place. We invest ahead, probably about six months before seeing a positive contribution. Ultimately, once it hits a steady state, we ensure that the marketing investment aligns with the revenue generated. These are faster-growing, high-margin products.
**Adrien Alurn:**So, in the second half, there would be some drag from these new products on the actual margin contribution due to marketing costs?
**Company Representative:**Yes, some of the marketing costs occurred in FY24, and a little will continue into FY25. We will continue to expand the portfolio, and there should be a positive contribution in FY25.
**Adrien Alurn:**Thank you for the answers.---

**Moderator:** Thank you. Our next question comes from Richard Barwick from CLSA. Please go ahead.
**Richard Barwick:** Good morning, everyone. I have a question about the $2 billion revenue target and how MVM (Matura Valley Milk) fits into that. Am I correct in assuming that by FY27, MVM's revenue contribution would be close to zero? And, as part of that, how should we be thinking about MVM's progress, especially in the context of the dispute resolution with Synlait and the potential shifting of English label production to MVM?
**David:** Richard, it's David here. MVM will eventually help us develop our nutritional manufacturing supply capability. Over time, it will assist with innovation, particularly in our English label products. However, in the timeframe through to FY27, MVM won't significantly contribute to market access or growth for our China label. While MVM might offer incremental growth, its primary financial role will be to reduce losses, with a target to achieve this by FY27. So, while the internalization of sales for A2 will reduce MVM's external reported sales revenue, it's unlikely that this will bring it down to zero. Even if we were to fully in-source our English label portfolio over time, that would only account for about half of MVM's capacity. MVM might still produce other powdered and fortified products, or even some commodity ingredients, particularly during peak milk production periods. So, while internalization and innovation may reduce external sales, it's unlikely to eliminate them completely.
**Richard Barwick:** I think it's important to understand that in the context of the group’s $2 billion revenue target and rising margins, MVM could have quite an impact. Lower revenue from MVM could affect margins positively, correct?
**David:** Yes, that’s correct. MVM might strain the top line but offers opportunities for bottom-line improvements.
**Richard Barwick:** Okay, thanks. My second question is about the birth rate. You mentioned you're still expecting positive numbers for this calendar year, but then possibly a decline after that. Is there anything you can add regarding what you're seeing or hearing in the market about the birth rate for calendar 2024?
**David:** It’s difficult to be specific, but we look at a lot of different data points. Most suggest that the birth rate for calendar year 2024 will be higher than the reported 9 million in the prior year, possibly somewhere between 9 and 10 million, ideally towards the higher end. However, we anticipate downward pressure on the birth rate over the longer term due to socio-demographic trends, absent significant policy changes. But, despite these challenges, the market remains large, and we see significant growth opportunities, especially outside of infant formula, like in other nutritionals, which are up 37% and now represent a $110 million business.

**Moderator:** Thank you, David. Your next question comes from Phil Kimber from & Capital. Please go ahead.
**Phil Kimber:** My first question is about your early-stage infant milk formula. In one of your slides—slide 41—you showed significant market share improvements in early-stage products, much better than the other stages. I think you mentioned that lower early-stage inventory was due to strong sales in the fourth quarter. Could you provide more details on what's driving such strong numbers in the early-stage products?
**David:** Yes, Phil, your summary is correct. As I mentioned earlier, we ended the year with lower early-stage inventory, particularly for China label products. This was partially due to the strong sales in the fourth quarter, and also because of the lower stock of starter packs and trial packs we had available. While we had some inventory, it was lower than usual, which, combined with supply constraints, has created challenges that we’re currently managing. Shao, would you like to add anything about the drivers of early-stage growth in China?**Shao:** Yes, sure. Early-stage products are always a focus for the China business because they set the stage for future growth. We've been very disciplined and balanced in allocating our budget to drive growth in this area. This fiscal year, in particular, we’ve seen a deliberate effort to leverage the "Dragon Baby Boom" year. We’ve focused on new user recruitment across online and offline channels, including the medical channel. We’ve launched initiatives like the baby swimming center and maternity classes, and we've increased our presence in medical platforms with doctor endorsements. Online, we've introduced maternity packs for pregnant women and smaller trial packs for baby usage, all aimed at driving early-stage growth and ensuring a strong pipeline for future growth.
**Phil Kimber:** Thanks, that's really insightful. My next question is about corporate costs. I noticed they were up significantly in the second half, about $10 million at the EBITDA level, compared to being down in the first half. I couldn't find any commentary on this. What specifically drove this increase? Was it just timing, or was there something unusual in the second half that won’t continue next year?
**David:** Hey, Phil, it's Dave. We did mention at the half-year that our corporate costs would be weighted towards the second half. It's mainly due to the timing of certain project costs, particularly those related to science, research, and sustainability. These costs aren’t necessarily one-off and are likely to recur annually, but they were more concentrated in the second half this year. Additionally, our FX losses, which sit in corporate, were also skewed towards the second half. So, it’s a combination of FX and the timing of certain corporate costs.
**Phil Kimber:** So, the full-year growth rate in corporate costs is sensible, but don’t fixate on the half-year timing, right?**David:** Exactly. Think about the full-year perspective. We're increasing capabilities during the year, so some of that run rate might continue into next year. You might need to consider the FX impact as well, or just take it out completely.
**Phil Kimber:** Perfect, thanks, David.---

**Lisa Deng (Goldman Sachs):** Hi, I have two questions. The first one is around the starter packs that were quite strong in the fourth quarter. On page 41, we see a 26% increase for DO and a 14% increase for MBS. I'm surprised that this doesn’t translate into higher potential sales in FY25. Are we saying that the 5% revenue growth is mainly due to a supply gap rather than conversion issues? And on 400g tins, I noticed a lot of "gift with purchase" promotions, especially when signing up new members. Is that part of the reason for the margin drag in the second half as well?**Response:** Regarding the starter packs, the numbers on page 41 are share numbers. The total China market declined by over 10% during the year. While acquiring new users in stages one and two usually leads to brand loyalty in stage three, the growth isn’t solely driven by this. It does temper our opportunity in FY25. We would have liked to guide to a higher sales result, but mid-single digits seem fair at this point, especially considering the expected market decline in China. Regarding the 400g tins, yes, they are lower margin.
**Lisa Deng:** About the margin drag in the second half, if I reverse back that $10 million depreciation in the second half, the GP margin for the group is actually up year on year. We've spent more on starter packs, which are lower margin, but the margin excluding that $10 million is up. And regarding the 400g starter pack, did we stock out in the first half and couldn't catch up?**Response:** We don’t spend a huge amount on the starter packs. The 400g packs are lower margin and used in "gift with purchase" offers. This wasn’t a key driver of the gross margin movements; I was just providing context around inventory levels and constraints.
**Lisa Deng:** Got it. My second question is about the extra three sets of China label registration. There seems to be a big overlap in price points, especially with the English label moving into super premium. What would be the differentiation in capability or formula?
**Response:** The chart we shared was conceptual. We aim to expand our China label range over time with different price points and benefit propositions, but we won’t discuss specifics due to commercial sensitivity. If you look at the top 10 brands in China, they have multiple registrations allowing them to appeal to more consumer needs and manage trade effectively. We’re not aiming for 20 registrations, but a handful would help us meet trade needs more effectively.**Lisa Deng:** Understood. And regarding the $1 billion potentially looking for M&A, would we consider a sizable acquisition outside of IMF, such as in nutritionals or vitamins?**Response:** That's not currently a priority. Our main focus is on building nutritional manufacturing capability and market access to China. We’re open to acquisitions in adjacent areas to develop our business, but our primary focus is on organic growth opportunities, such as expanding our product portfolio and market penetration.
**Steven Ridwell (Craigs IP):** Good morning. My first question is about competition. A2 has continued to gain share in the overall market in FY24 but seems to have lost some share in the A2-only category. Which other brands gained share in the A2-only category, and does the guidance reflect these market share trends continuing into FY25?
**Response:** We’ve seen many top competitors launch or upgrade their A2 products, including organic and A2-plus versions. This segment is growing significantly in both volume and value. While there’s more competition, our brand remains a leader in this space, with strong brand equity. Although we might see a slight share decrease, we’re still growing as the category expands.
**Steven Ridwell:** That’s great. And switching to the US, what’s your view on the early consumer reception to the US label formula launch this year? Is it encouraging enough to warrant a broader market launch? And what revenue does the US label formula need to achieve for the US business to break even in line with the revised targets for FY27?**Response:** The market reception has been modest so far, partly because we haven’t pushed it hard during this period of having enforcement discretion approval but not long-term FDA market access. Our focus has been on securing long-term access, and we hope to submit our long-term application shortly. While we’ve been experimenting with different propositions, our main goal has been securing long-term FDA approval. The success of international brands entering the US market in the last two years is encouraging, and we have ambitions to achieve similar success. The profitability of our liquid milk business has improved, and we expect to break even in FY26. The key question for us is how much marketing investment is needed to realize the infant formula opportunity. We’re waiting for FDA approval, and while we’re optimistic, we’re cautious about large investments in the short term. Our intention is to invest prudently while exploring opportunities as they arise.

**Host:** Thank you. We only have 5 minutes remaining on this call. Your next question comes from Samer from Citi. Please go ahead.
**Samer:** Hi David and team, good morning. Regarding the mid-single-digit revenue guidance for FY25, could you talk us through what's assumed in there, particularly with the two new infant formula products and new markets like Vietnam? Are there any upside scenarios? Also, on the downside, how confident are you that the supply disruption will be resolved and won't worsen?
**David:** Hi Samer. We're not in a position to provide specific guidance on the new products, but I can give you some insight into where we're expecting growth. Overall, the mid-single-digit revenue guidance assumes that our total IMF sales will be broadly consistent with that. English label sales are expected to be ahead of China label this year, with China label being more constrained by supply. Our milk businesses in the US and Australia are expected to see low single-digit growth on average, though it may vary by region. Other nutritionals should grow well, but not at the same rate as last year. MVM is more challenging to predict, so it might remain flat or increase slightly, depending on milk supplies. Regarding the supply constraints, we expect them to be resolved during this half, with the US ramping up production. We don't anticipate any worsening of the situation, but if it does, we'll inform the market if it's material.
**Samer:** That's helpful, David, thank you. Just to clarify, have you factored in any revenue from the new innovations, or could that be potential upside if they are successful?
**David:** The revenue guidance includes these new innovations. For example, J2 is ramping up, and we have a new product planned for the English label portfolio in the second half. These are all part of the guidance, along with other products already in the market.
**Samer:** Great, thank you. It's exciting to see all this new development. Is there any way to understand the potential margin impact in FY25 as you launch these new products, given that early commercial batches might be more expensive?
**David:** That's a great point, especially for infant formula. The cost of producing in smaller batches is significantly higher. For products like Gentle Gold and the next one we introduce, margins will be lower until they reach scale. Typically, margins normalize when we hit around one to two million tins. However, the overall impact on the business should be minimal due to the relative size of these new products.
**Host:** Thank you, David. The final question comes from Marcus Curley from UBS. Please go ahead.
**Marcus:** Good afternoon, David. Could you quantify the market headwinds you're expecting in FY25, particularly concerning China label and your aspirations to grow store count?
**David:** The total market is likely to decline mid-single digits in value. The China label category, especially in the NBS channel and tier 1 & 2 cities where we over-index, is underperforming, which is a headwind for us. However, we have a significant opportunity to expand our distribution in tier 3 & 4 cities, where our share is much lower at around 3%. We’ve grown our store count to 29,000, up by about 3,000 from the half, primarily due to expansion in these cities. There's also opportunity in the online channel, which is growing faster than offline.
**Marcus:** Are you anticipating any share losses within the English label segment, considering your guidance of around 5% growth?
**David:** We hope to maintain, if not increase, our share in the English label segment over time. Although SmartPath data shows a slight decline, that's just for the four major platforms plus some smaller stores. We're working on more direct engagement with C2C and pop stores, and we're seeing improvement there. We also see great opportunities in platforms like Douyin, which are outside our reported numbers. Our O2O partnership with UO is also showing positive results. So, there are many opportunities to continue growing in English label, and our guidance reflects a measured view on that.

**Host:** Thank you. There are no further questions at this time. I'll now hand back to Mr. Borty for closing remarks.

**David:** Thank you very much for joining the call today. I look forward to continuing our discussions with analysts and investors over the next couple of weeks. Thank you.