Nzx full year results, page-229

A2 Milk: Don’t throw the baby out with the bath water

ANDREW MITCHELL

Ophir Asset Management

FOLLOW

Surprise around a lower margin outlook in FY20 has well and truly captured the market’s attention and seen a significant sell-off in A2 shares today. It is clear that one year into her tenure as CEO, Jane Hrdlicka is exerting her influence on the company as she tries to create a sustainable business over the long-term. Our read is that Jane has shifted the focus of the business from the short-term to the longer-term land grab at play.

In the past year marketing costs have nearly doubled to ~NZ$135m and will likely approach NZ$200m in FY20. We have also seen the company “unashamedly lean” on consultants including an increase of ~NZ$20m to build capability and capacity as it obtains an intimate knowledge of its customers and what they want in the two largest consumer markets in the world - China and the USA.

Maybe the money spent on consultants could be better spent internally, nevertheless, Jane’s intent to invest for the future is clear. Given the share market’s reaction today some investors have taken a dimmer view as to whether these investments will drive an uptick in top-line growth. We believe that this has been further exacerbated by management giving scant details on its strategy justifying this is necessary to protect its competitive position.

Top-line growth is impressive

We believe judging the performance of the company on the FY20 margin outlook in isolation is premature. Not only because it includes significant losses from its emerging fresh milk business in the US, but more importantly it fails to capture the impressive quality and momentum in the top line.

Market share continues to grow with the latest disclosure in June at 6.4% on a rolling year basis vs 6% in March. Offline sales in China have increased 100% with A2 now available in ~17,000 stores up from ~12,000 at the end of H1. There have also been some recent price rises put through in both fresh milk and infant formula. A2 clearly has some very strong momentum heading into FY20 even before the full benefits of these investments have had time to kick in.

A2 is a very cash generative high growth company. We believe by focussing on just the margins outlook, the market is missing the quality, momentum and potential upside in top line growth. The market appears to be ignoring that A2 has signaled that it sees significant opportunity to accelerate growth and will invest accordingly. We see this growth potential as a big positive for the share price longer-term.

This reporting season has been a curious one so far. Whilst the share prices of some growth companies have been well rewarded for re-investing in future growth (ie Seek ASX:SEK) others such as A2 have been in our view unfairly punished