New Zealand Professional Investment Services Firm

Forsyth Barr

We are proud to be a New Zealand owned firm, with 21 offices throughout the country and over 300 employees. We assist personal, institutional and corporate clients providing a full range of investment services.

Forsyth Barr is a foundation New Zealand Exchange firm (NZX) and accredited market participant. We have been confirmed by the Financial Markets Authority as a Qualifying Financial Entity (QFE).

Research is the cornerstone of our advice. We have one of New Zealand's leading teams of analysts. Our global affiliations ensure comprehensive research coverage of all major investment markets.

New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>The a2 Milk Company<br>1H22 Result&nbsp;— Baby Steps</h2>
<div></div>
<p><strong>NEUTRAL</strong></p>
<p>The a2 Milk Company (ATM) reported a 1H22 result ahead of our and consensus expectations, with the hangover of elevated English Label (EL) and China Label (CL) inventory levels proving less significant than expected. Qualitative outlook commentary for higher revenue (both EL and CL driven) but greater costs (primarily marketing) implied a broadly unchanged FY22 earnings outlook relative to our previous expectations. The positives outweighed the negatives in 1H22 and despite early signs of execution there is still a long road to recovery&nbsp;—&nbsp;at 30x 12m forward PE (cash adjusted) we view the risk/reward as broadly balanced given the uncertain backdrop.&nbsp;Retain NEUTRAL.</p>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/258/627/original/image_79537135151645491932787.png?1645491933" class="editor-image img-responsive" data-smartkarma-image-id="258627"></figure>
<div>
<h3>What's changed?&nbsp;</h3>
</div>
<div id="m_2180761297944473663iwrmo3">
<ul>
<li><strong>Earnings</strong>:&nbsp;FY22/FY23/FY24 EPS +3%/+2%/+6%.</li>
<li><strong>Target price</strong>:&nbsp;Increased to NZ$6.45 (from NZ$6.10) reflecting higher earnings estimates.</li>
</ul>
</div>
<div>
<h3>Key takeaways from ATM's 1H22 result</h3>
</div>
<div id="m_2180761297944473663icft5">
<ul>
<li><strong>We perceive the outlook commentary positively</strong>:&nbsp;Outlook commentary lacked quantitative detail but higher revenue and&nbsp;costs (primarily marketing) implied a broadly unchanged FY22 earnings outlook. Looking beneath the hood,&nbsp;we view this positively and think that&nbsp;ATM's&nbsp;confidence in its ability to drive growth from its increased marketing spend is improving. This should help drive&nbsp;incremental revenue growth&nbsp;but&nbsp;highlights the fundamental change in&nbsp;ATM's&nbsp;margin profile.</li>
<li><strong>China Label —&nbsp;the key medium term driver remains intact</strong>:&nbsp;In light of the continued shift towards local brands in China, the key positives out of the result were (1) moderate CL market share gains, and (2) retained FY22 guidance for CL growth.&nbsp;Despite the challenging industry backdrop, ATM is one of few international brands taking market share and the runway for growth remains significant (reflected in its Mother &amp; Baby store [MBS]&nbsp;market share of ~2.6%).</li>
<li><strong>English Label&nbsp;recovery ongoing but baby steps</strong>:&nbsp;ATM now expects EL revenue growth in FY22 versus its previous expectation of stable&nbsp;revenue. CBEC and&nbsp;daigou&nbsp;market shares modestly declined again in 1H22 but early signs in the recovery are positive, with&nbsp;ATM's&nbsp;inventory issues now behind it (reflected in improved and stable product pricing) and positive momentum returning in what has been an extremely challenging&nbsp;18 months.&nbsp;We expect the recovery to take time but believe the worst has likely passed.</li>
<li><strong>Looking beyond FY22</strong>:&nbsp;Despite early signs of execution there is nothing to change our view that the&nbsp;backdrop will remain challenging&nbsp;for the foreseeable future. Our base case is&nbsp;the size of the infant population in 2025 will still be below 2021 levels, and well below pre COVID&nbsp;levels — refer our report&nbsp;"Times are Changing"&nbsp;published 11 February 2022 for more detail. Growing market share against this backdrop&nbsp;requires&nbsp;a material step up in costs which&nbsp;was again reiterated&nbsp;by management (with a significant step up in marketing in FY22 expected). Our forecasts assume a continued increase in marketing as a percentage of revenue from FY22.&nbsp;</li>
<li><strong>Brand health metrics continue to be supportive</strong>:&nbsp;Brand health remains strong with modest improvements in the latest print (January 2022),&nbsp;with brand awareness amongst consumers continuing to improve.</li>
</ul>
</div>

The a2 Milk Company 1H22 Result&nbsp;— Baby Steps

NEUTRAL
The a2 Milk Company (ATM) reported a 1H22 result ahead of our and consensus expectations, with the hangover of elevated English Label (EL) and China Label (CL) inventory levels proving less significant than expected. Qualitative outlook commentary for higher revenue (both EL and CL driven) but greater costs (primarily marketing) implied a broadly unchanged FY22 earnings outlook relative to our previous expectations. The positives outweighed the negatives in 1H22 and despite early signs of execution there is still a long road to recovery&nbsp;—&nbsp;at 30x 12m forward PE (cash adjusted) we view the risk/reward as broadly balanced given the uncertain backdrop.&nbsp;Retain NEUTRAL.


What's changed?&nbsp;



Earnings:&nbsp;FY22/FY23/FY24 EPS +3%/+2%/+6%.
Target price:&nbsp;Increased to NZ$6.45 (from NZ$6.10) reflecting higher earnings estimates.



Key takeaways from ATM's 1H22 result



We perceive the outlook commentary positively:&nbsp;Outlook commentary lacked quantitative detail but higher revenue and&nbsp;costs (primarily marketing) implied a broadly unchanged FY22 earnings outlook. Looking beneath the hood,&nbsp;we view this positively and think that&nbsp;ATM's&nbsp;confidence in its ability to drive growth from its increased marketing spend is improving. This should help drive&nbsp;incremental revenue growth&nbsp;but&nbsp;highlights the fundamental change in&nbsp;ATM's&nbsp;margin profile.
China Label —&nbsp;the key medium term driver remains intact:&nbsp;In light of the continued shift towards local brands in China, the key positives out of the result were (1) moderate CL market share gains, and (2) retained FY22 guidance for CL growth.&nbsp;Despite the challenging industry backdrop, ATM is one of few international brands taking market share and the runway for growth remains significant (reflected in its Mother &amp; Baby store [MBS]&nbsp;market share of ~2.6%).
English Label&nbsp;recovery ongoing but baby steps:&nbsp;ATM now expects EL revenue growth in FY22 versus its previous expectation of stable&nbsp;revenue. CBEC and&nbsp;daigou&nbsp;market shares modestly declined again in 1H22 but early signs in the recovery are positive, with&nbsp;ATM's&nbsp;inventory issues now behind it (reflected in improved and stable product pricing) and positive momentum returning in what has been an extremely challenging&nbsp;18 months.&nbsp;We expect the recovery to take time but believe the worst has likely passed.
Looking beyond FY22:&nbsp;Despite early signs of execution there is nothing to change our view that the&nbsp;backdrop will remain challenging&nbsp;for the foreseeable future. Our base case is&nbsp;the size of the infant population in 2025 will still be below 2021 levels, and well below pre COVID&nbsp;levels — refer our report&nbsp;"Times are Changing"&nbsp;published 11 February 2022 for more detail. Growing market share against this backdrop&nbsp;requires&nbsp;a material step up in costs which&nbsp;was again reiterated&nbsp;by management (with a significant step up in marketing in FY22 expected). Our forecasts assume a continued increase in marketing as a percentage of revenue from FY22.&nbsp;
Brand health metrics continue to be supportive:&nbsp;Brand health remains strong with modest improvements in the latest print (January 2022),&nbsp;with brand awareness amongst consumers continuing to improve.



The A2 Milk Company: 1H22 Result — Baby Steps

A2 Milk Co Ltd

The A2 Milk Company: 1H22 Result — Baby Steps