Is it time to buy A2 Milk shares now that China is re-opening?

Nick Sundich Nick Sundich, April 5, 2023

A2 Milk shares have been listed on the ASX for roughly 8 years, listing in late March 2015 at $2.30 per share. After hitting an all-time high of $20.05 per share, it has been (mostly) downhill ever since.


A2 Milk (ASX:A2M) share price chart, log scale (Source: TradingView)


In this article, we ask why did A2 Milk shares go so high in the first place, why did they go so low and what does the future hold?

To answer the latter question, that will come down to whether or not it can it regain the foothold in China it once had and whether or not it could gain a foothold in the USA enough to make up for it?


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How did A2 Milk shares go so high?

A2 Milk rose in the first place because it had significant success in selling its dairy products (milk and infant formula), particularly in China.

China was not just an opportunity because of the population size and its consumption of dairy products (roughly 30 kilograms per year), but because consumers preferred foreign brands. There are local brands, but they have been tainted since a contamination scandal in the 2000s.

In the 12 months to June 2019 (FY19), it recorded NZ$1.3bn in revenue. Although China and the rest of Asia was by no means its largest market (accounting for roughly 31% of revenues), it was growing fast. The company’s sales in Australia and New Zealand only grew by 28% but sales in China and the Asia-Pacific grew by over 74%.

During the Corona Crash, when the ASX 200 fell by >30%, A2 Milk shares actually gained 4% and ultimately reached its all time high in July of 2020.

We think there were 4 reasons. First, because it provided essential products so its operations (and therefore revenues) were unaffected by lockdowns. Second, ‘panic buying’ by consumers in all markets. Third, a depreciation of the NZD against the USD which artificially inflated revenues.


Why did A2 Milk shares fall after mid-2020?

A2 Milk shares have never reached their mid-2020 levels again.

Issues bubbling under the service during the early days of the pandemic started to bite the company including supply chain disruptions, diplomatic spats between China and the West and the drying up of the daigou trade (which was a major source of revenue).

Daigous are exporters who buy in Australia or New Zealand on order from contracts in China and despatch the goods back to China themselves.

Some investors were also concerned about the company’s high marketing budget and perceived low return on it.

Ultimately, the China opportunity was shrinking but there was one factor more important than any other. Namely: China’s falling birth rate.

The abolishment of China’s one child policy had done little to encourage couples to have more children. And women were delaying their pregnancies to get vaccinated against COVID-19.

In FY21, the company’s revenue fell 30% to NZ$1.2bn and its net profit fell 79% to NZ$80.7m. This after four guidance downgrades in the preceding 4 months. Ouch for A2 Milk shareholders.

This led to shareholder launching multiple class actions against the company.




What about the USA?

Prior to COVID-19, A2 Milk had a presence in the US market but it was just 2.6% of sales in FY19. Obviously, the US has a high population and a big market (at US$4.3bn) but it is a competitive market with local brands dominating.

However, a severe shortage in April 2022 led to the Biden administration launching ‘Operation Fly Formula’ – flying infant formula into the country from overseas.

A2 Milk was a little late to the party compared to its peers, thanks to the FDA taking its time to review its application. It first applied in May and heard nothing until August, only hearing then that the FDA was deferring a further review.

And keep in mind that there were 160 companies around the world trying to crack this market too, some of which were getting approval faster.

Eventually, it got market access last November. But this was only on a temporary basis and it now expected gross margins to be lower due to higher air freight and rework costs in the near term.


So will FY23 and FY24 be better for A2 Milk?

This will come down to whether or not two things can happen. First, if can it regain the foothold in China it once had. Second, whether or not it could gain a foothold in the USA?

A2 Milk is optimistic – (but then again, which companies are not optimistic about the future). CEO David Bortolussi expects China’s birth rate to bottom out this year and to rise in the next couple of years as couples marry after postponements due to COVID-19.

But it still has not sold any tins in the USA yet.

Its 1HY23 net profit was NZ$68.5m, 22% higher than the year before.

For the full FY23, consensus estimates expect NZ$1.6bn in revenue (up 11%), $222.5m in EBITDA (up 13%) and $0.21 EPS (up 31%). For FY24, $1.78bn in revenue (up 10%), $272.4m in EBITDA (up 22%) and $0.26 EPS (up 24%).

Briefly jumping forward to FY27, estimates call for $2.4bn in revenue, $538m in EBITDA and $0.48 EPS. These represent CAGR (Compound Annual Growth Rates) of 10.9%, 22.4% and 24.6% respectively.

The company’s multiples for FY24 look reasonable at 14.1x EV/EBITDA, 23.1x P/E and 1.06x PEG.

Nonetheless, the 11 analysts covering the stock only have a target price of $6.76 (up 16% from the current share price). The highest is $8.47 (up 45%) and the lowest is $5.03 (down 14%).


So is it time to buy A2 Milk shares?

We are not so sure at the moment. On one hand, its multiple are more reasonable, its growth prospects are strong. The other, investors need to realise that the company is different to what it was in 2019 and never will be again.

We think investors should wait until the company’s FY23 results where it will provide an update on its US endeavours and China sales.



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