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Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>The a2 Milk Company<br>FY21 Result&nbsp;— Complicated Formula&nbsp;</h2>
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<p><strong>NEUTRAL</strong></p>
<p>The a2 Milk Company's (ATM) FY21 result was at the lower-end of recent guidance and materially below the prior year given well-signalled challenges, while FY22E outlook disappointed against our expectations. Negatives (higher US and Mataura Valley Milk losses, cost lift, subdued industry growth with further downside near-term, slower English label recovery) outweighed the positives (higher net cash, improved disclosure/transparency, brand health, inventory issues almost behind it). ATM has a number of redeeming features (strong brand, net cash, attractive returns/free cashflow), however, a material deterioration in industry dynamics and accelerated investment will continue to weigh near-term. At this juncture there is too much uncertainty to have conviction in a directional call, with risk/reward broadly balanced and catalysts yet to show a turn in momentum. NEUTRAL​​​​​​​.</p>
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<h3>What's changed?&nbsp;</h3>
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<ul>
<li><strong>Earnings</strong>:&nbsp;Material downgrades&nbsp;(EBITDA -15% to -25%) reflecting slower English label recovery, higher impact from birth rates and&nbsp;Mataura&nbsp;Valley Milk, MVM (and its downgraded guidance). We expect consensus revisions to be more moderate.</li>
<li><strong>Target price</strong>:&nbsp;NZ$6.50 (-9%) with earnings revisions partially offset by a higher net cash position and rolling forward our valuation.</li>
</ul>
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<h3>Key areas of interest</h3>
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<ul>
<li><strong>Infant Formula outlook</strong>:&nbsp;ATM is targeting "sales stabilisation" in English label and "growth" in China label.&nbsp;A&nbsp;rollercoaster&nbsp;two years has seen an artificially boosted FY20 (stock-piling and excess sell-in) and subsequent&nbsp;rebase&nbsp;in FY21. Our channel checks and surveys indicate the brand continues to resonate well with consumers and there is runway for share gain off current levels, however, a deterioration in industry dynamics (particularly birth rates) will be a material headwind in the short to medium-term.&nbsp;&nbsp;</li>
<li><strong>Inventory challenges almost behind it</strong>: The issue of aged and excess stock is expected to be fully resolved by 1H22 (slightly longer than expected) after material corrective measures in 4Q21. We expect to see this through improved retail prices in due course.</li>
<li><strong>Balance sheet strong; capital management withdrawn</strong> (for now):&nbsp;ATM has net cash of ~NZ$607m (FY21 adjusted for MVM) or ~NZ$0.82/share —&nbsp;better than we expected. Prior suggestions of potential capital management were withdrawn&nbsp;as ATM prioritises investing behind the brand. We expect this may be revisited in the medium-term.</li>
<li><strong>MVM guidance lowered</strong> (again):&nbsp;ATM is now expecting an FY22E EBITDA loss of c. -NZ$20m (-NZ$10m previously) due to materially lower volumes&nbsp;(and low utilisation). ATM also revealed losses will not be tax deductible, with a sharp lift in its effective tax rate. Medium-term guidance remains for a "positive EBITDA contribution in FY25E", however, we are materially more bearish.&nbsp;​​​​​​​</li>
<li><strong>Valuation &amp;&nbsp;our view</strong>:&nbsp;Using our revised forecasts, ATM is trading on a cash-adjusted 12m forward PE of ~30x. This adjusts to ~24.5x if you adjusted for US losses, or ~22x also excluding MVM . The margin of error in&nbsp;forecasts remains high and we expect the stock to remain&nbsp;newsflow&nbsp;driven. The next key event is the Investor Day on 27 October. In the interim, we expect to see minimal change in our regular channel checks. Refer our note&nbsp;"Catalyst Check"&nbsp; (12 August) for detail of how we see the path for catalysts.</li>
</ul>
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The a2 Milk Company FY21 Result&nbsp;— Complicated Formula&nbsp;

NEUTRAL
The a2 Milk Company's (ATM) FY21 result was at the lower-end of recent guidance and materially below the prior year given well-signalled challenges, while FY22E outlook disappointed against our expectations. Negatives (higher US and Mataura Valley Milk losses, cost lift, subdued industry growth with further downside near-term, slower English label recovery) outweighed the positives (higher net cash, improved disclosure/transparency, brand health, inventory issues almost behind it). ATM has a number of redeeming features (strong brand, net cash, attractive returns/free cashflow), however, a material deterioration in industry dynamics and accelerated investment will continue to weigh near-term. At this juncture there is too much uncertainty to have conviction in a directional call, with risk/reward broadly balanced and catalysts yet to show a turn in momentum. NEUTRAL​​​​​​​.


What's changed?&nbsp;



Earnings:&nbsp;Material downgrades&nbsp;(EBITDA -15% to -25%) reflecting slower English label recovery, higher impact from birth rates and&nbsp;Mataura&nbsp;Valley Milk, MVM (and its downgraded guidance). We expect consensus revisions to be more moderate.
Target price:&nbsp;NZ$6.50 (-9%) with earnings revisions partially offset by a higher net cash position and rolling forward our valuation.



Key areas of interest



Infant Formula outlook:&nbsp;ATM is targeting "sales stabilisation" in English label and "growth" in China label.&nbsp;A&nbsp;rollercoaster&nbsp;two years has seen an artificially boosted FY20 (stock-piling and excess sell-in) and subsequent&nbsp;rebase&nbsp;in FY21. Our channel checks and surveys indicate the brand continues to resonate well with consumers and there is runway for share gain off current levels, however, a deterioration in industry dynamics (particularly birth rates) will be a material headwind in the short to medium-term.&nbsp;&nbsp;
Inventory challenges almost behind it: The issue of aged and excess stock is expected to be fully resolved by 1H22 (slightly longer than expected) after material corrective measures in 4Q21. We expect to see this through improved retail prices in due course.
Balance sheet strong; capital management withdrawn (for now):&nbsp;ATM has net cash of ~NZ$607m (FY21 adjusted for MVM) or ~NZ$0.82/share —&nbsp;better than we expected. Prior suggestions of potential capital management were withdrawn&nbsp;as ATM prioritises investing behind the brand. We expect this may be revisited in the medium-term.
MVM guidance lowered (again):&nbsp;ATM is now expecting an FY22E EBITDA loss of c. -NZ$20m (-NZ$10m previously) due to materially lower volumes&nbsp;(and low utilisation). ATM also revealed losses will not be tax deductible, with a sharp lift in its effective tax rate. Medium-term guidance remains for a "positive EBITDA contribution in FY25E", however, we are materially more bearish.&nbsp;​​​​​​​
Valuation &amp;&nbsp;our view:&nbsp;Using our revised forecasts, ATM is trading on a cash-adjusted 12m forward PE of ~30x. This adjusts to ~24.5x if you adjusted for US losses, or ~22x also excluding MVM . The margin of error in&nbsp;forecasts remains high and we expect the stock to remain&nbsp;newsflow&nbsp;driven. The next key event is the Investor Day on 27 October. In the interim, we expect to see minimal change in our regular channel checks. Refer our note&nbsp;"Catalyst Check"&nbsp; (12 August) for detail of how we see the path for catalysts.



The A2 Milk Company: FY21 Result — Complicated Formula

A2 Milk Co Ltd

The A2 Milk Company: FY21 Result — Complicated Formula