Article from NBR this afternoon. Noted that Sam Teeger of Citi congratulating the A2 Team on the turnaround

A2 Milk shares gain on brand confidence

Analysts praise turnaround progress.

By Tim Hunter

Mon, 21 Feb 2022

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A2 Milk chief executive David Bortolussi.

Shares in infant formula specialist A2 Milk climbed 11% after the company posted better than expected halfyear results and expressed confidence in the strength of its brand in China.

By early afternoon, the stock was trading at $6.17, up 9.8% on its opening price and just off its day high of $6.23.

Net profit for the six months to December was $56.1 million, down 53% from $120m in the same period a year earlier.

Revenue was $658.8m, down from $676.5m.

In line with company expectations

On a conference call with analysts, chief executive David Bortolussi said the first-half result was in line with the company’s own expectations.

“Market conditions in China remain challenging but we’ve made good progress stabilising the business and executing against our growth strategy during the half.”

The presentation drew positive comment from analysts.

“You seem to have done a terrific job stabilising the group in the last 12 months,” said David Errington of Bank of America.

“Congratulations on the turnaround so far,” said Sam Teeger of Citi. “It’s nice to see things headed in the right direction.”

The latest result follows successive sharp declines since June 2020 after disastrous over-stocking early in the Covid pandemic triggered a collapse in sales.

Discussion on the call was focused on A2’s infant formula business in China, which dominates its revenue and profitability.

China sales
The company distinguishes between sales in China of its Chinese label product and sales of English label, which are bought by intermediaries in Australia for on-sale.

While sales of China label infant formula were $188.7m in the half, down from $213m in the previous corresponding period, the decline was caused by a deliberate effort to correct previous excess inventory levels by constraining sales to distributors in the first quarter, the company said.

A2 Milk China label sales. Source: A2 Milk presentation

“The China label picture is very clear,” Bortolussi said.

“Despite the challenging market and the decline in the market overall, we have performed well and gained share in-store in [mother and baby stores] and also online.”

Meanwhile, the company was gaining confidence in its ability to manage sales of English label product through cross-border e-commerce and daigou channels, he said.

“We expect our English label to be up in the second half and for the full year overall.”

A2 Milk English label sales. Source: A2 Milk presentation

While higher raw material and freight costs had reduced the gross margin in the half, the ebitda margin was affected by higher marketing and administration costs.

Marketing costs
Marketing expenses in the half were up 37% to $92.5m and are expected to be significantly higher in the second half, with the company forecasting full-year marketing spend of $220m – higher than the previous peak level of marketing activity in 2020.

Speaking to NBR after the results announcement, Bortolussi said the company was confident of maintaining its premium positioning despite increasing competition.

“Even though the number of newborns is down and the total market value was down marginally for the period, it’s important to note that the segments we play in were in growth.

“So the ultra-premium segment was in growth and the A2 protein segment within that. And the market is still a $45 billion market – the largest market in the world in the IMF category.”

The company declined to provide earnings guidance for the full year because of continuing uncertainty but said the outlook for second-half revenue had improved.

“However, this expected improvement in revenue is not expected to translate to higher earnings, as we have decided to continue to increase our brand and other reinvestment to drive growth consistent with our strategy.”

Reinvestment rate
Asked whether the higher marketing spend would represent the new normal, Bortolussi said the company was reviewing its brand positioning in the fourth quarter.

“We’re planning a big campaign in the fourth quarter so there will be significant investment associated with that.

“I see us maintaining and/or increasing this level of investment over time. In terms of the reinvestment rate as a percentage of revenue, it’s hard to be specific about that. I suspect it may still increase a bit more over time.

“Eventually we get to the stage where, hopefully, we’ll get a little bit of leverage out of that and the reinvestment rate may come off but I think, in the medium term, we might see the reinvestment rate increase.”

Milk processor Mataura Valley Milk.

Bortolussi also remarked on the progress of A2’s 75%-owned milk processor Mataura Valley Milk.

“Our goal is for MVM to become an internal integrated manufacturing facility for A2 branded product, with market leading quality, efficiency, innovation capability, and sustainability for English and China label IMF and other nutritional products and, in doing so, to achieve profitability by FY26 or earlier.”

The company was also investing in a new high-pressure electrode boiler at the plant, replacing its coal-fired boiler by October next year.

Bortolussi said sustainability was “a passion for me personally and a key component