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).

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>The a2 Milk Company<br>Baby Steps Forward&nbsp;</h2>
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<p><strong>OUTPERFORM</strong></p>
<p>The a2 Milk Company's (ATM) Annual Meeting provided little in the way of new information, reiterating its FY21 guidance. A positive takeaway was indications of "early green shoots" in the under-pressure daigou channel. ATM's channel mix is shifting rapidly, with strong performance in direct channels being overshadowed by daigou pressure. We view this as temporary and expect a return to growth from 2H21. Current investor focus appears firmly centered on FY21 earnings downgrade risk, which is unlikely to be resolved until the timeline of daigou re-ordering and realignment of channels is clearer. Looking through short-term earnings volatility, we see an attractive medium-term growth runway, with our confidence boosted by recent proprietary channel checks in the key offline market. Valuation metrics remain attractive (PE of ~25x, or ~21x adjusted for cash and US losses), particularly given ATM's strong free cashflow generation and high returns. OUTPERFORM.</p>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/172/584/original/image_98255878551605744938402.png?1605744940" class="editor-image img-responsive" data-smartkarma-image-id="172584"></figure>
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<h3>What's changed?&nbsp;</h3>
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<div id="m_-6625314858639885095iwrmo3">
<ul>
<li><strong>Earnings &amp; target price</strong>:&nbsp; Small revisions, EBITDA -2% in FY21/22E, -1% in FY23E (mix changes, FX). No change to target price.</li>
</ul>
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<h3>What did we&nbsp;learn from the Annual Meeting?</h3>
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<div id="m_-6625314858639885095i2j7y">
<ul>
<li><strong>"Early green shoots" in the&nbsp;Daigou&nbsp;channel:</strong>&nbsp;The pressure&nbsp;in the&nbsp;daigou&nbsp;channel is now well known, from a suite of compounding issues including COVID-19 border restrictions, surplus channel inventory, pantry de-stocking, high freight costs, low reseller margins, packaging concerns (due to COVID-19). We expect the disruption to moderate gradually over time, with early positive signals of turning a corner (channel inventory lower, pricing stabilised), however, do not factor a full recovery in the channel.</li>
<li><strong>No change to Mother &amp; Baby Store trajectory; the key growth engine</strong>:&nbsp; ATM reiterated growth is "strong", albeit without specifics. Rolling 12m market share of 2.2% to September&nbsp;(vs 2.0% to June and 1.7% to Dec 2019) highlights the ample runway still remaining. Our recent offline channel checks saw strong performance for ATM &amp; high quality perception for&nbsp;NZ sourced product.&nbsp;</li>
<li><strong>Encouraging performance in key Singles Day Shopping Festival</strong>:&nbsp;+24% English label growth "consistent with plan". Discounting was moderate, implying&nbsp;value growth was also strong.&nbsp;IF category growth was&nbsp;lacklustre, suggesting ATM outperformed.</li>
<li><strong>Other areas of the business delivering growth</strong>:&nbsp;Including other nutritional products, liquid milk in Australia, and gross revenue in the US (albeit offset by the planned reallocation of marketing spend to in-trade spend which nets off against revenue).&nbsp;</li>
</ul>
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<h3>Key issue creating debate — when will growth return and is there a downgrade still to come?</h3>
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<div id="m_-6625314858639885095iprtk">
<p>Market attention appears centered on one over-arching question — will ATM downgrade its FY21 (particularly 2H21) guidance? Despite the reiteration of guidance and channel commentary, which if anything was incrementally more positive than the last update, this question will likely remain an overhang until the 2H21 outlook is clearer. ATM is going through a dramatic, rapid shift in channel mix which makes forecasting more challenging than usual. The issues are well known, however, the timeline (particularly of daigou re-ordering) is less clear. Our analysis suggests the share price is already factoring in some of the risk (c. 70%). Even under our downgrade scenario we see attractive value (valuation multiples lift by c. 2x).</p>
</div>
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<div><strong>Chelsea Leadbetter CFA</strong></div>
<div><a href="mailto:chelsea.leadbetter@forsythbarr.co.nz" target="_blank" rel="noopener">chelsea.leadbetter@<wbr>forsythbarr.co.nz</a></div>
<div>+64 4 495 5262</div>
<div></div>
</div>
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<div><strong>Matt Montgomerie</strong></div>
<div><a href="mailto:matt.montgomerie@forsythbarr.co.nz" target="_blank" rel="noopener">matt.montgomerie@forsythbarr.<wbr>co.nz</a></div>
<div>+64 9 368 0124</div>
</div>
</div>

The a2 Milk Company Baby Steps Forward&nbsp;

OUTPERFORM
The a2 Milk Company's (ATM) Annual Meeting provided little in the way of new information, reiterating its FY21 guidance. A positive takeaway was indications of "early green shoots" in the under-pressure daigou channel. ATM's channel mix is shifting rapidly, with strong performance in direct channels being overshadowed by daigou pressure. We view this as temporary and expect a return to growth from 2H21. Current investor focus appears firmly centered on FY21 earnings downgrade risk, which is unlikely to be resolved until the timeline of daigou re-ordering and realignment of channels is clearer. Looking through short-term earnings volatility, we see an attractive medium-term growth runway, with our confidence boosted by recent proprietary channel checks in the key offline market. Valuation metrics remain attractive (PE of ~25x, or ~21x adjusted for cash and US losses), particularly given ATM's strong free cashflow generation and high returns. OUTPERFORM.


What's changed?&nbsp;



Earnings &amp; target price:&nbsp; Small revisions, EBITDA -2% in FY21/22E, -1% in FY23E (mix changes, FX). No change to target price.



What did we&nbsp;learn from the Annual Meeting?



"Early green shoots" in the&nbsp;Daigou&nbsp;channel:&nbsp;The pressure&nbsp;in the&nbsp;daigou&nbsp;channel is now well known, from a suite of compounding issues including COVID-19 border restrictions, surplus channel inventory, pantry de-stocking, high freight costs, low reseller margins, packaging concerns (due to COVID-19). We expect the disruption to moderate gradually over time, with early positive signals of turning a corner (channel inventory lower, pricing stabilised), however, do not factor a full recovery in the channel.
No change to Mother &amp; Baby Store trajectory; the key growth engine:&nbsp; ATM reiterated growth is "strong", albeit without specifics. Rolling 12m market share of 2.2% to September&nbsp;(vs 2.0% to June and 1.7% to Dec 2019) highlights the ample runway still remaining. Our recent offline channel checks saw strong performance for ATM &amp; high quality perception for&nbsp;NZ sourced product.&nbsp;
Encouraging performance in key Singles Day Shopping Festival:&nbsp;+24% English label growth "consistent with plan". Discounting was moderate, implying&nbsp;value growth was also strong.&nbsp;IF category growth was&nbsp;lacklustre, suggesting ATM outperformed.
Other areas of the business delivering growth:&nbsp;Including other nutritional products, liquid milk in Australia, and gross revenue in the US (albeit offset by the planned reallocation of marketing spend to in-trade spend which nets off against revenue).&nbsp;



Key issue creating debate — when will growth return and is there a downgrade still to come?


Market attention appears centered on one over-arching question — will ATM downgrade its FY21 (particularly 2H21) guidance? Despite the reiteration of guidance and channel commentary, which if anything was incrementally more positive than the last update, this question will likely remain an overhang until the 2H21 outlook is clearer. ATM is going through a dramatic, rapid shift in channel mix which makes forecasting more challenging than usual. The issues are well known, however, the timeline (particularly of daigou re-ordering) is less clear. Our analysis suggests the share price is already factoring in some of the risk (c. 70%). Even under our downgrade scenario we see attractive value (valuation multiples lift by c. 2x).



Chelsea Leadbetter CFA
chelsea.leadbetter@forsythbarr.co.nz
+64 4 495 5262





Matt Montgomerie
matt.montgomerie@forsythbarr.co.nz
+64 9 368 0124



A2 Milk Co Ltd

The A2 Milk Company: Baby Steps Forward