Waiting for big reveal from a2 Milk
Full-year result — due next month — will show how company is faring in China
Now that a2 Milk has finished its financial year, what can investors expect when the former high-flier reveals its result?
Hong Kong-listed infant formula company Ausnutria — an a2 Milk peer — issued a profit warning early this month, saying there would be a “significant decrease in profits” for the six months to June.
“Due to lower birth rate in Mainland China and stringent anti-epidemic measures in some regions, the infant formula industry faced unprecedented challenge in the first half of 2022,” said Ausnutria.According to market data company AC Nielsen, the industry’s overall sales from January to April 2022 decreased by 4.4 per cent year-on-year, while sales volume fell by 6.2 per cent.
Overall demand in the industry is decreasing, Ausnutria said.Broker Jarden has reviewed its operating forecasts for China infant formula, for both second-half performance and the longer-run issues of declining birth rates and increased competition.
Adrian Allbon, director, equity research at Jarden, said the second-half performance of a2 Milk — whose success has been closely tied to its popularity in China — was “probably” on track.
“Against the backdrop of challenging market issues including Covid-related lockdowns and lower birth rates, which impacted Ausnutria with its July profit warning, it looks as though a2 Milk is on track broadly to deliver second-half expectations, based on our analysis of port data and recent 618 [June 18] sales festival performance.
“If our analysis proves accurate, then this is a strong execution performance and further proof that the a2 Milk brand remains healthy from a demand perspective,” Allbon said in a research note.Longer term, birth rates in China remained a key headwind, he added.
Jarden’s modelling suggested that in 2021 and 2022, birth rates were at the low end of a2 Milk’s scenario range as described at the company’s investor day last October — implicit in its hopes of returning to $2 billion of sales by the 2026 full-year.
“The longer dated issue is also the demographic pressure from the single child policy of the past,” he said.
Opportunity or distraction?
Both Fonterra and a2 Milk have been left in the dust by French food group Danone and Australia’s Bubs in terms of winning regulatory approval to land much-needed infant formula in the US, where there is a chronic shortage.
The US Government has responded with temporary Food and Drug Administration approvals for new players, creating a short-term opportunity to test the market entry using what are known as Women, Infants and Children (WIC) waivers.But while the infant formula shortage has hit the headlines, market participants are unsure whether there is any real advantage in sending product to the US at this stage.
Oyvinn Rimer, senior research analyst at Harbour Asset Management, doubted FDA approval would benefit a2 Milk in the short run.
“Even if they got it, I think it would be totally immaterial,” he said. “The nature of the whole WIC facility is temporary only, so if you have a couple of shipments of product it would be one-off in nature.”
The US market’s structure is very different from China’s.“It’s highly regulated with largely a central buyer. Eighty to 85 per cent of infant formula is subject to some form of price control, and there are four big players that dominate.“The market could get very excited from an announcement but it would almost be a distraction — and immaterial from a profit and loss perspective,” Rimer said. “It’s not going to move the dial.”
He expects the second-half result to June 30 to reflect a rebalancing of inventory and a $60 million to $65m revenue contribution from a2 Milk’s majority-owned manufacturing facility, Mataura Valley Milk.
FDA approval
Jarden’s Allbon said preliminary analysis suggested that if a2 Milk could gain FDA approval for an order size of about 1-2 million tins, it could generate one-off Ebitda of $20-$30 per tin for the 2023 full-year, assuming the company gains a WIC waiver.
“While this could result in its US operations moving towards profitability, future profitability at this level seems unlikely if the WIC structure reverts.
“Based on the limited information to date, we see the US opportunity as a useful experiment for a2 Milk to test the market but, ultimately, further commitment or sustainable value uplift requires more clarity on how the US industry structure will settle and whether new entrants will be encouraged to stay.”
Shares in a2 Milk peaked at $21.51 two years ago but have since slumped to around $5.A2 Milk’s result is due out in late August.
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