Target NZD2.07 (AUD1.94). They reckon A2M has factored in the risks and is cheap here:
The a2 Milk Company Limited
Apparent reduction in China regulatory risks
New competition unlikely to materially impact medium-term growth
Following the recent expiration of A2M's first major patent (May 2016), the company
may face the prospect of competing products (with some new products already flagged
for launch). However, potential new products may still breach A2M's patent portfolio
and legal challenges from A2M are likely, in our view. We expect increased consumer
focus on A2 beta-casein protein to benefit the 'a2 Milk' brand over the medium-term,
and the company still has patent protection on marketing the benefits of A1-free or
A2-only milk products until October 2023. That said, over the long-term we have taken
a more cautious view A2M's Australian drinking milk share (cut from 4.5% to around
today's level of 3.5%).
China regulatory risk remains but more gradual impact now expected
During our recent trip to China (refer report), numerous industry participants referred
to delays to infant formula imports from 8 April until the Certificate rules were relaxed
in late May. We believe A2M has enough buffer in its FY16E guidance (EBITDA NZD45-
49m) to withstand this negative impact to sales. More importantly, in our view, was the
potential for cross-border eCommerce Chinese labelling law changes to be enforced
from 1 January 2018, significantly later than our expectations at early 2016. Assuming
A2M successfully registers with the China FDA over the next c.12 months, we believe
the a2 Platinum brand could benefit from likely brand consolidation in China.
Upgrade to Buy rating
The a2 Platinum brand is gaining traction in China, and there are positive early signs in
the UK (now runrate profitable) and US markets. Given the more gradual expected
phase-in of China regulatory changes, we have increased confidence of FY17E earnings
growth and upgrade our rating on A2M to Buy (from Neutral).
Valuation: NZD1.88ps (DCF by geography), down 6.5%
We have increased FY17-19E earnings by 3-6% as a result of higher medium-term
infant formula sales and adding China milk sales to our base forecasts, but cut long-
term forecasts by 3-9% as a result of lower long-term forecast Australian drinking milk
market share. Our valuation is now NZD1.88ps (down 6.5%). Our price target remains
a roll-forward of our valuation and is now NZD2.07ps (down 6.8%).
(20min delay)