Goldman Sachs Recommendation - Buy

A2 Milk Co. (A2M.AX): FY16: Infant formula in good shape; retain CL-Buy
24 Aug 2016 at 4:51pm AEST
What's changed
A2M reported FY16 EBITDA of NZ$54.6mn, 1.5% above GSe. NPAT was 7% below GSe on tax given the higher US/UK losses which are not tax deductible. The company provided limited guidance for FY17.
Implications
Key takeaways: (1) Excluding US/UK, EBITDA was 15% ahead of GSe. Similar to the BAL result, infant formula growth boosted profit in ANZ and China and was above us on higher margins – which we view as sustainable into FY17E; (2) The US however was below our expectations. A2M flagged a cumulative US$20-25mn of investment in next 2-3 years, US$10mn greater than GSe; (3) Read-throughs from BKL’s weak outlook commentary? Based on industry contacts and data, we believe that changes to Chinese regulations in April/May caused some disruption to cross-border trade for both vitamins/supplements and infant formula. However, as we have highlighted previously, the regulatory framework for infant formula is more evolved and is at this stage clearer than the regulatory framework for vits/supps. Our contacts suggest that inventory issues for vits/supps are not as concerning as for infant formula, although we will continue to monitor this closely, particularly ahead of required labelling changes. Retain CL-Buy: Excluding US/UK, A2M is trading on 19x/16x FY17E/FY18E P/E, a 10%/18% discount to the ASX 200 Industrials ex-Financials, an attractive multiple given its growth prospects vs. risk profile in our view.
Valuation
We increase our 12-month target price (85% weight for equal blend of DCF and EV/GCI, 15% weight for M&A valuation) to A$2.35/NZ$2.45 from A$2.15/NZ$2.25 (in-line with our upgrades to ANZ and China), on FY17E/FY18E EPS changes of -7%/3%.
Key risks
(-) Safety and quality risks; intense competition from other foreign brands; adverse regulatory outcomes in China.