New Zealand Professional Investment Services Firm

Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

The a2 Milk Company FY20 Result — Cash is King

OUTPERFORM
The a2 Milk Company (ATM) reported strong FY20 growth, in line with our expectations, while FY21 outlook (unsurprisingly) allows reasonable artistic licence when forecasting EBITDA although nothing to meaningfully change our prior assumption or thought process. Key highlights were (1) a substantial sales acceleration in China channels, (2) further proof of strong execution through a fast-moving backdrop, and (3) solid cash conversion (even when adjusting for some timing benefits). ATM ticks a lot of boxes, with an attractive growth outlook, defensive product, high returns and large (and growing) net cash position. We see attractive value at current levels (EV/EBIT ~19x, PE ~28x adjusted for US losses/cash; or ~21x and ~32x respectively unadjusted) on both an absolute and relative basis.


FY20 result and first-time FY21 outlook insights; minor forecast changes (aside from mix differences)


ATM delivered FY20 profit growth of +34%, in line with our expectations or marginally ahead when adjusted for a small inventory impairment (c. NZ$5–10m). FY21 outlook is for "strong revenue growth" and EBITDA margin of 30–31%. There was nothing in the result to change our thought process. If anything, we came away slightly more positive on the runway, and ATM's ability to capitalise on that, in the large China offline channel. We make minor changes to our earnings expectations (aside from mix differences) — we forecast a three year EPS CAGR of +15%.


Key near-term focus areas



Revenue trajectory: Channel checking has become increasingly difficult as ATM has expanded its channels to market. Little detail was provided on recent trading, although ATM does believe COVID-19 related pantry stocking (which boosted 3Q20) has now unwound. Strength in more direct channels to market in China was encouraging in FY20, with ample opportunity still remaining, particularly in Mother &amp; Baby Stores. China is a complex market, and we expect this channel to require continued investment in both trade spend and marketing.
Margin —&nbsp;is guidance conservative?&nbsp;A common question for&nbsp;ATM. It is early into FY21 but based on what is observable, and&nbsp;ATM's&nbsp;signalled cost intentions, we are more than comfortable with forecasts slightly above the top of the range.
Market share:&nbsp;ATM&nbsp;has (once again) revised market share metrics it provides —&nbsp;with a shift to more channel-specific metrics. These show positive momentum, aligning with revenue growth. Meanwhile,&nbsp;Kantar&nbsp;(a survey of 2,000 consumers) has been surprisingly flat. This is another reminder of the challenges associated with relying on any one data point in China.&nbsp;
What to do with the cash:&nbsp;Retaining some cash is prudent, and we expect&nbsp;ATM&nbsp;to do so;&nbsp;however, with NZ$850m (+84% in FY20) on its balance sheet questions will continue to be asked until the pathway is clearer. We learnt nothing new around&nbsp;ATM&nbsp;exploring "participation in manufacturing", with the company leaving all options on the table.
New&nbsp;CEO&nbsp;due to start in early 2021:&nbsp;At face value he seems a reasonable hire and we are not expecting any material shift in strategy. However, key will be getting confidence in the cultural fit with, what we consider, a strong senior management team.




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





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



The A2 Milk Company: FY20 Result — Cash Is King

A2 Milk Co Ltd

The A2 Milk Company: FY20 Result — Cash Is King