Is the A2 Milk share price still a good buy after strong full year results?

Regan Pearson | August 22, 2020 8:30am | More on: A2M FPH SM1

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It’s been a funny week for the A2 Milk Company Ltd (ASX: A2M) share price.

After opening the week at a near record high of $19.52, the A2 Milk share price dropped almost 7% in the following days. This was after the company announced a record profit of NZ$385.8 million, a 34% increase.

So, what happened?

There is no doubt that A2 Milk has had an absolute stellar 2020 financial year. The company received a positive bump in earnings from the COVID-19 pandemic as people rushed to buy groceries and milk powder. At the same time, A2 Milk seized the opportunity to boost its shareholding in supplier Synlait Milk Ltd (ASX: SM1) to 19.8%.

And to cap it all off A2 Milk Company was included as a member of the S&P/ASX50Index (ASX: XFL).

However the outlook provided by A2 Milk for FY21, and expectations of slower revenue growth going forward, has caused at least one broker to turn sour on the company and suggest shares are a ‘sell’. I disagree.

There’s still a lot to like about A2 Milk

Firstly, although growth may slow in the coming year, it certainly won’t stop. The company’s guidance for the 2021 financial year said it expected “continued strong revenue growth support by our regions”. This will be driven by investing more into marketing and continuing to increase market share.

Secondly, I think the A2 Milk brand is building a valuable intangible asset moatthat adds significant long-term value for investors. Having a trusted, health focused brand differentiates A2 Milk and lets the product command a premium price for what would otherwise be a commodity product.

Finally, if the company can continue to grow revenue and maintain strong margins, it stands to become a cash-generating monster in the coming years.

For the 2020 financial year, A2 Milk reported a huge return on equity (ROE) of 34%. To put this into context, data compiled by valuation guru and New York University professor Aswath Damodaran suggested the average ROE for the food processing industry was 7.9% in 2019. With no debt and minimal capital expenditure requirements, this cash can be ploughed back into growth or returned to investors.

Should you buy A2 Milk shares?

I think it’s one of the best quality companies to own today, and the A2 Milk share price is reasonable relative to its prospects for growth over the next 5 to 10 years.

I’ve made the mistake before of thinking shares in quality, growing companies looked expensive, only to watch them flourish – hello Fisher & Paykel Healthcare Corp Ltd! (ASX: FPH).

I see the A2 Milk share price in that light today. A high margin, growing business with significant potential to continue compounding returns over the coming years.