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Against the Odds: A2 Milk Set to Defy Sluggish Chinese Economy

By Jamie Gray

Business Reporter, NZ Herald

18 Aug 2024 | 01:00 PM | 5 mins to read

A2 Milk looks set to defy the effects of a sluggish Chinese economy and a declining birth rate with a lift in its net profit at its full-year results announcement tomorrow.

The infant formula marketer took a big hit when the onset of Covid-19 almost destroyed the unofficial “daigou” trade in 2020. It has also battled a declining birth rate in China—easily the world’s biggest formula market—and an economy that has been slow to recover from the pandemic. The birth rate in A2's main market has halved over the last 10 years. Despite these headwinds, A2 Milk has rebounded to a point where it is now one of the top five brands in China.

Market expectations are for the company on August 19 to report a net profit of about $172 million for the June year, up from $155.6 million a year earlier. A post-pandemic boom in marriages in China is showing signs of running out of steam, but Craigs Investment Partners still expects A2 Milk to deliver a strong annual result.

In the March 2024 quarter, there were 1.97 million marriages in China, down 8.2% from the March 2023 quarter. “Given the high correlation between marriages and births in the following year, this suggests that the baby bounce we expected in 2024 [following a spike in Covid-delayed marriages in 2023] is more likely to be an aberration rather than the start of a new upward trend,” Craigs said in a research note. “We remain comfortable with our prior estimates for births to lift to 9.8 million in 2024 [up 9%], before easing back to 9.1 million in 2025 and slowly drifting down to 7 million longer term.”

Recent data suggests that A2 Milk gained share in key online channels over the second half, and Craigs expects A2 to deliver a result at the top end of the company’s guidance of low to mid single-digit revenue and EBITDA growth. Craigs also expects A2’s net profit to exceed consensus forecasts, estimating it at $183 million.

In the background is cash-strapped Synlait Milk—A2 Milk’s sole provider of infant formula, in which A2 holds a stake of just under 20%—which is making plans for a capital raise.

Oyvinn Rimer, senior research analyst at Harbour Asset Management, said, “Directionally, A2 Milk has done a good job of rebuilding after the Covid-driven earnings rout and managing the demise of daigou and falling birth rates.” He added, “We have gone through a period when there has been a consolidation of brands in China as well.”

There has been a tough re-regulation process in China, which has led many smaller brands to fall away, working in A2 Milk’s favor. “A2 seems to have not only taken market share but also grown volumes well above what the overall market would indicate,” Rimer told the Herald.

From here, A2 Milk faces some big issues, not least of which is what to do with an estimated $900 million it will have in the bank by the time it reports. Rimer notes that while China’s long-term demographic still looks challenging, A2 is well-placed to benefit from any slight uptick in the birth rate. “Even if there is only a short blip up in the birth rate, A2 will probably benefit from that for a number of years going forward.”

Rimer, who visited China in May, said it was easy to be negative about conditions there. “The structural challenges are well known, but there are some nuances that might actually benefit A2.”

A2 Milk has been a stellar performer on the sharemarket, with the stock gaining 32% over the last 12 months. Today, it trades well above last year’s low of $4.07.

Commenting on A2 Milk’s estimated $900 million war chest, Rimer said the company could buy Synlait, with a market cap of just $62 million, several times over. The big question facing Synlait and its other major shareholder, Bright Dairy (39%), is what form the capital raise will take. “Right now, [A2’s cash mountain] is an insurance policy for Synlait,” Rimer said. “Maybe they will be called on to provide capital, but who knows. Once we get through the issue with Synlait, they will be able to be clearer as to how that capital is managed.”

Synlait Milk has abandoned its earnings guidance for 2024. The company’s previously announced guidance was for earnings before interest, taxes, depreciation, and amortisation (EBITDA) at the lower end of a $45 million to $60 million range, excluding a non-cash adjustment for the product costing method change of about $17 million. Synlait now says its 2024 performance has been affected by unforeseen year-end timing differences between July and August for manufacturing and shipping, with additional costs incurred in relation to its strategic review and deleveraging plan.

Bright Dairy says Synlait has the potential to recover. In a recent interview with the Herald, Bright Dairy’s chairman, Huang Liming, stressed that Synlait had Bright’s support. Synlait was Bright Dairy’s first overseas investment when it took a controlling stake 14 years ago.

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*Jamie Gray is an Auckland-based journalist covering the financial markets and the primary sector. He joined the Herald in 2011.*