he A2 Milk Company (A2M)
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Premium brand, premium rating
ADD (initiation) | current price:
A$12.72 | target price:
A$14.40 (previous: NA)
- We initiate coverage of A2M with an Add rating and A$14.40 price target.
- A2M's 1H18 result (+150% NPAT growth) demonstrates the strong global demand for its a2 dairy products, which have digestive and health benefits.
- We forecast strong growth over coming years as we expect A2M to continue to win market share across its product range in some big markets such as China. We therefore think consensus estimates in outer years will prove conservative and the upgrade cycle should continue.
- A2M's premium products generate high margins and therefore it deserves a premium rating, in our view. The company's FCF generation is extremely strong and provides it with both growth and capital management opportunities.
Strong
1H18 led by a2 Platinum market share wins
A2M reported a strong
1H18 result with sales up 70% on the pcp, EBITDA up 123% and NPAT up 150%. Margins continued to rise with the gross profit margin up to .8% vs 46.5% in the pcp and the EBITDA margin increased 790bps to 32.9% due to product mix (infant formula was 78% of revenue) and scale benefits. a2 Platinum remains the fastest growing infant formula brand with a market share of ~30% by value in Australian supermarkets. a2 Platinum's market share by value is also rapidly rising in China and it is one of the fastest growing brands in this market (worth about US$20bn pa). It currently stands at 5.4% according to Kantar. Despite starting to rebuild its inventory, operating cashflow rose 205% and A2M ended the half with net cash of NZ$240.2m.
Well placed to continue to deliver strong earnings growth
A2M is on a strong earnings trajectory as it builds a global branded dairy nutritionals business across ANZ, China and other Asia, UK and USA. We believe its strategic relationship with Fonterra should fast track A2M's entry to its other priority markets (South East Asia and Middle East) where Fonterra has strong distribution. It will also see A2M expand its product range. The strong growth in a2 Platinum has transformed A2M's earnings in recent years and we expect this to continue given there is plenty of market share to be won in existing and new markets. FY19 should benefit from the additional marketing spend in
2H18, a full year of CFDA approval and strong growth in Mother and Baby stores in China. In FY20, we forecast the US business to reach monthly break even and the Fonterra strategic relationship to make a positive contribution.
Initiate coverage with an Add rating and A$14.40 price target
A2M's point of differentiation (products only contain the A2 beta casein type rather than both A1 and A2 types found in conventional cows' milk) with health and digestive benefits has allowed it to win market share across product lines and geographies. It has also allowed it to price products at a premium to peers. The company generates strong EBITDA margins, considerable free cashflow (capital light business model) and a high ROE. Its balance sheet should allow it to fund a blending and canning facility, its new products and global expansion plans whilst rewarding shareholding through dividends and other capital management initiatives. With low market shares in some very large markets (China, USA, UK), we believe A2M should generate strong earnings growth over the medium term. Importantly, A2M is led by an impressive management team that has successfully managed China regulatory changes at a time when others have failed.
Belinda Moore
+61 7 3334 4532 [email protected]
