Article from NBR this afternoon. Analyst Earnings call will be available tomorrow at https://thea2milkcompany.com/results

A2 Milk shares jump on positive results

Analysts welcome strong performance from infant formula company’s marketing in China.

A2 Milk chief executive David Bortolussi.

Tim HunterMon, 29 Aug 2022

Shares in infant formula specialist A2 Milk jumped as much as 10% and analysts showered the company with praise as the market digested its full-year results announced this morning.

“It’s a terrific set of results,” said Bank of America’s David Errington on a conference call after the announcement.

“Well done on the result guys,” said Stephen Ridgewell of Craigs Investment Partners.

In a first reaction note to clients, Jarden analyst Adrian Allbon described it as a “strong execution result in a difficult macro environment …We expect the result to be well received on a management execution/turnaround basis”.

At 2pm, A2 Milk shares had eased to $5.98 from a day’s high of $6.02 but were still up 9% on yesterday’s close.

A key feature of the result was an improved performance in A2 Milk’s China label infant formula business, which increased sales by 12% to $438 million despite the overall market shrinking as the country’s birth rate declined.

Meanwhile e-commerce sales of A2 Milk’s English label product boosted sales into China by 53% to $256m, while sale through Covid-hit ‘daigou’ distributors fell 8% to $329m – a far cry from the $745m of sales in 2020.

Premium segment

A2 Milk chief executive David Bortolussi said the stabilisation of the business and the execution of its strategy in China were highlights of the result.

“Obviously our infant formula business is the most important and we’ve delivered double-digit growth not only in our China label business but also in our English label business, which has experienced significant volatility over the last couple of years,” he said.

“Yes the rolling impact of the lower birth rate in China has the total market in decline in value by 3% in the last year, but … it’s important to note we play in the ultra-premium segment, which was in growth – 9% for the full year. Within that, the A2 protein category is growing rapidly and almost doubled during the period.”

Bortolussi said A2 Milk’s “relatively low” overall market share of 4-5% meant there was still a significant opportunity to grow.

Supporting its China strategy the company invested $230m in marketing, 36% up on the previous year.

Metrics for brand health reached a record high during the year, said Bortolussi.

Buyback option

Net cash at balance date was $816.5m, allowing the company to announce an on-market share buyback of up to $150m.

Asked by analyst Tom Kierath of Barrenjoey whether the board had considered other mechanisms for a distribution, given its tax credits of more than $500m, chief financial officer Mark Sherwin said it had.

“The board has reviewed a number of mechanisms including dividends, special dividends, on-market and off-market, and all of those may play a part in time,” he said.

“For this particular return, we’ve chosen the on-market for a couple of key reasons.

“First of all, it’s really familiar in the New Zealand and Australian context. It’s relatively simple and it’s EPS accretive.

“Also we feel it demonstrates the improved confidence the board has in the strategy, the execution and the outlook.”

Sherwin said although off-market buybacks were more familiar in Australia, they were complex in New Zealand.

“Of course you’re absolutely right from a dividend perspective, there are substantial franking credits sitting with the business,” he said.

“We’ve chosen this way forward for this point in time. It doesn’t mean those returns may not be available in that mechanism in the future.”

Growth company

Asked the same question by NBR, Bortolussi said ordinary dividends were not currently being considered, “because we’re still a growth company in its development phase and believe the best opportunities are to invest in the company’s growth.

“We’ve still got a lot of investment to do in our business to develop it in terms of our supply chain and market access and development.”

Bortolussi said the choice of an on-market buyback, which mechanically increases earnings per share, was not influenced by his own EPS-driven long-term incentive scheme.

“In fact our board has the opportunity to, and probably will, adjust the earnings accretion associated with the on-market buyback. It’s not a factor at all in our consideration of the most appropriate means of returning capital to shareholders.”

A2 Milk products.

M&A activity

The CEO told analysts cash was also being retained to allow flexibility for merger and acquisition activity.

While the company was committed to expanding the capabilities of its majority-owned Mataura Valley Milk processing plant, “we are looking at other opportunities in New Zealand and China to accelerate our supply chain capabilities, whether that be blending and canning or otherwise,” he said.

“Part of our strategy was also greater access to China label registration. One avenue for that, which is our base line plan, is to continue the MVN capability build and apply for China label registration ... That’s going to take some time ...

“The other opportunity to do that is through M&A. We could potentially acquire a facility with China label registration and over time reformulate rebrand etcetera. There are opportunities for that in New Zealand and in China.”

China regulation

Bortolussi told NBR A2 Milk would have no difficulty complying with new registration standards being introduced by China’s State Administration for Market Regulation in February next year.

However, “the next important step in that process will be site audits. We understand [the Ministry for Primary Industries] will be able to undertake those on behalf of SAMR.

“The timing of it is inherently uncertain.”

Asked if A2 Milk’s New Zealand identity would be an advantage given China’s heightened tension with Australia, Bortolussi said: “New Zealand is definitely well-positioned as a country and an industry in relation to the registration process.

“I’d also point out there is a significant amount of Chinese direct investment.

"We don’t take that for granted. It is a complex registration process and we need to meet SAMR’s requirements going forward.”

In liquid milk, sales in Australia rose 1.8% to $172m and the company launched a lactose-free product after balance date.

US market

Liquid milk sales in the US gained 30% to $82.7m, but higher freight and raw milk costs widened the ebitda loss to $36.7m.

A2 Milk does not sell infant formula to the US, but did seek special discretion to export formula under emergency measures introduced in May by President Joe Biden to counter a short-term supply shortage.

After applying on May 27, the company said in August its application to the US Food & Drug Administration had been deferred.

Bortolussi said the company was ready to help the US if circumstances changed, but while the US market was on the long-term agenda, the arrangement was never likely to have material benefits for A2 Milk in the short term.

“It’s one thing to have the opportunity to supply the US market under the enforcement discretion, which primarily related to a humanitarian effort to ensure mothers and infants get access to products in that period. It’s different to think about longer-term market access, which the US market, unless the situation changes, is a very concentrated market where you have two players that dominate the market.

“Other companies that have entered the market over time have struggled to get market share.”