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>Market Intolerant to Lower Margins</h2>
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<p><strong>NEUTRAL</strong></p>
<p>The a2 Milk Company's (ATM) 2021 investor day had something for everyone but reinforced; (1) the continued uncertainty in the current environment, (2) the magnitude of investment required to drive revenue growth, (3) brand health appears strong, and (4) the significant runway of growth remaining for ATM, particularly in China label where it under-indexes. There is no change to our view that ATM offers a number of quality features (strong brand, net cash position, attractive return profile), however, the ongoing&nbsp;uncertainty means we continue to view the risk/reward as broadly balanced until clarity on the near-term outlook and longer-term market opportunity improves. Retain NEUTRAL.</p>
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<h3>What's changed?&nbsp;</h3>
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<ul>
<li><strong>Earnings</strong>:&nbsp;Material near-term downgrades;&nbsp; FY22E/FY23E/FY24E EBITDA down -18%/-15%/-15% in light of&nbsp;significantly increased cost assumptions (primarily marketing)</li>
<li><strong>Target price</strong>:&nbsp;No change; near-term earnings downgrades offset by higher medium to longer-term revenue assumptions</li>
</ul>
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<h3>Key takeaways from the 2021 investor day</h3>
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<ul>
<li><strong>Revenue growth pathway well articulated but magnitude of cost investment is significant</strong>:&nbsp;ATM provided a high level road-map outlining its expected revenue and EBITDA margin pathway over the medium-term (&gt;5 years). While significant uncertainties&nbsp;exist (with variability likely between each driver) we do not view&nbsp;ATM's&nbsp;revenue target (~NZ$2bn over the medium-term) as stretched. However,&nbsp;against this ATM signalled&nbsp;a material step-up in costs (primarily marketing) to support growth. The need for greater cost investment aligns with our recent channel checking, albeit the magnitude of the increase is materially ahead of our (and the market's) previous expectations. EBITDA margin expectations are now to be in the teens&nbsp;over the near to medium term with the potential for low 20s longer-term, this is below prior commentary and&nbsp;highlights the fundamental change in&nbsp;ATM's&nbsp;margin profile.</li>
<li><strong>Brand health metrics remain healthy</strong>:&nbsp;A key positive was improved transparency&nbsp;on underlying brand fundamentals (an area that has been difficult to gauge historically). Pleasingly, despite the disappointing&nbsp;COVID-19 impacted FY21,&nbsp;brand health appears strong, particularly&nbsp;on the ground in China with brand awareness amongst consumers continuing to improve.</li>
<li><strong>Runway of growth remains significant</strong>:&nbsp;There is nothing to change our view that the opportunity for ATM&nbsp;is material in offline channels in China,&nbsp;where it currently under-indexes. China label product is the key medium-term growth driver and we see ATM as well placed to continue to grow, however, the challenging macro backdrop will likely continue to weigh on growth near-term.</li>
</ul>
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<h3>Valuation and our view</h3>
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<p>ATM is trading on a cash-adjusted 12m forward PE of ~35x on our revised earnings estimates. This falls to ~28x after adjusting for US losses, or ~25x when also excluding the recently acquired&nbsp;Mataura&nbsp;Valley Milk (MVM).&nbsp;On an adjusted basis this is broadly in-line with international peers.&nbsp; We continue to expect ATM to be&nbsp;newsflow&nbsp;driven and view risk/reward as broadly balanced at this juncture.</p>
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The a2 Milk Company Market Intolerant to Lower Margins

NEUTRAL
The a2 Milk Company's (ATM) 2021 investor day had something for everyone but reinforced; (1) the continued uncertainty in the current environment, (2) the magnitude of investment required to drive revenue growth, (3) brand health appears strong, and (4) the significant runway of growth remaining for ATM, particularly in China label where it under-indexes. There is no change to our view that ATM offers a number of quality features (strong brand, net cash position, attractive return profile), however, the ongoing&nbsp;uncertainty means we continue to view the risk/reward as broadly balanced until clarity on the near-term outlook and longer-term market opportunity improves. Retain NEUTRAL.


What's changed?&nbsp;



Earnings:&nbsp;Material near-term downgrades;&nbsp; FY22E/FY23E/FY24E EBITDA down -18%/-15%/-15% in light of&nbsp;significantly increased cost assumptions (primarily marketing)
Target price:&nbsp;No change; near-term earnings downgrades offset by higher medium to longer-term revenue assumptions



Key takeaways from the 2021 investor day



Revenue growth pathway well articulated but magnitude of cost investment is significant:&nbsp;ATM provided a high level road-map outlining its expected revenue and EBITDA margin pathway over the medium-term (&gt;5 years). While significant uncertainties&nbsp;exist (with variability likely between each driver) we do not view&nbsp;ATM's&nbsp;revenue target (~NZ$2bn over the medium-term) as stretched. However,&nbsp;against this ATM signalled&nbsp;a material step-up in costs (primarily marketing) to support growth. The need for greater cost investment aligns with our recent channel checking, albeit the magnitude of the increase is materially ahead of our (and the market's) previous expectations. EBITDA margin expectations are now to be in the teens&nbsp;over the near to medium term with the potential for low 20s longer-term, this is below prior commentary and&nbsp;highlights the fundamental change in&nbsp;ATM's&nbsp;margin profile.
Brand health metrics remain healthy:&nbsp;A key positive was improved transparency&nbsp;on underlying brand fundamentals (an area that has been difficult to gauge historically). Pleasingly, despite the disappointing&nbsp;COVID-19 impacted FY21,&nbsp;brand health appears strong, particularly&nbsp;on the ground in China with brand awareness amongst consumers continuing to improve.
Runway of growth remains significant:&nbsp;There is nothing to change our view that the opportunity for ATM&nbsp;is material in offline channels in China,&nbsp;where it currently under-indexes. China label product is the key medium-term growth driver and we see ATM as well placed to continue to grow, however, the challenging macro backdrop will likely continue to weigh on growth near-term.



Valuation and our view


ATM is trading on a cash-adjusted 12m forward PE of ~35x on our revised earnings estimates. This falls to ~28x after adjusting for US losses, or ~25x when also excluding the recently acquired&nbsp;Mataura&nbsp;Valley Milk (MVM).&nbsp;On an adjusted basis this is broadly in-line with international peers.&nbsp; We continue to expect ATM to be&nbsp;newsflow&nbsp;driven and view risk/reward as broadly balanced at this juncture.


The A2 Milk Company: Market Intolerant to Lower Margins

A2 Milk Co Ltd

The A2 Milk Company: Market Intolerant to Lower Margins