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>Times are Changing</h2>
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<p><strong>NEUTRAL</strong></p>
<p>The China Infant Formula (IF) market is changing. Over recent years it has experienced (1) a resurgence of domestic brands driven by increased local product preferences, resulting in significant market share shifts, (2) continued consumption trends towards premium product, and (3) a decline in new births to record lows, amplified by COVID-19. The last 18 months have been challenging for The a2 Milk Company (ATM), but we expect industry headwinds to persist for the foreseeable future. Our analysis suggests that industry growth will remain subdued in 2022, and we are unlikely to see a return to pre COVID levels of demand for the foreseeable future. While this may present industry consolidation opportunities we expect growth to be challenging near-term, with growth contingent on significant market share gains. We retain our NEUTRAL rating reflecting what we view as&nbsp;broadly balanced risk reward against the uncertain backdrop.</p>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/256/433/original/image_65944499331644541998023.png?1644541998" class="editor-image img-responsive" data-smartkarma-image-id="256433"></figure>
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<h3>What's changed?</h3>
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<ul>
<li><strong>Earnings</strong>:&nbsp;FY22/FY23/FY24&nbsp;EPS +1%/+11%/-2%. FY24 (and beyond) reflects our revised view on market growth and&nbsp;ATM's&nbsp;share</li>
<li><strong>Target price</strong>: Decreased to NZ$6.10 primarily reflecting lower medium-term China label revenue and revised WACC assumptions</li>
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<h3>Looking ahead — implications for IF demand</h3>
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<p>China recorded new births in 2021 of 10.62m, a -28% decline versus 2019.&nbsp;COVID-19 has exacerbated the decline, that said, demographic trends in China are unfavourable. Using a combination of data sources, our proprietary&nbsp;China IF industry macro model forms the basis of our revised market growth estimates. We acknowledge&nbsp;a wide-range of&nbsp;outcomes, however, our key takeaways&nbsp;are:</p>
<ul>
<li><strong>Near-term; could get worse before it gets better</strong>:&nbsp;We expect the market size in 2022 to decline relative to 2021 given the lag between new births and IF consumption (~60% of IF revenue is Stage 3 products — those for babies aged 12 to 36 months).</li>
<li><strong>Medium-term; a return to pre COVID industry size is highly unlikely</strong>:&nbsp;Our base case is the size of the infant population in 2025 will still be below 2021 levels, and well below pre COVID (2019) levels.​​​​​​​&nbsp;</li>
<li><strong>Longer-term; highly contingent on policy change</strong>:&nbsp;The extent of policy support&nbsp;to boost birth rates will be key to the&nbsp;outlook. Our base case is for the China infant population to return to 2021 levels by 2026/2027 with only modest growth thereafter.</li>
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<h3>Where does that leave ATM? The market is assuming significant market share gains</h3>
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<p>Against this backdrop, the evidence is clear — both us and consensus are assuming significant market share gains over the medium-term (~+150–200bps over the next four years). Prima facie, this appears challenging. That said, we are not uncomfortable with these assumptions given;&nbsp;(1) FY21 represents a low base for ATM, (2) brand health metrics remain healthy in China, and (3) our expectations of a significant step-up in marketing. In addition, we expect the changing shape of the IF industry in China to offer opportunities for industry consolidation&nbsp;along with a continuation in&nbsp;premiumisation&nbsp;trends&nbsp;and extending the customer&nbsp;lifecycle.</p>
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The a2 Milk Company Times are Changing

NEUTRAL
The China Infant Formula (IF) market is changing. Over recent years it has experienced (1) a resurgence of domestic brands driven by increased local product preferences, resulting in significant market share shifts, (2) continued consumption trends towards premium product, and (3) a decline in new births to record lows, amplified by COVID-19. The last 18 months have been challenging for The a2 Milk Company (ATM), but we expect industry headwinds to persist for the foreseeable future. Our analysis suggests that industry growth will remain subdued in 2022, and we are unlikely to see a return to pre COVID levels of demand for the foreseeable future. While this may present industry consolidation opportunities we expect growth to be challenging near-term, with growth contingent on significant market share gains. We retain our NEUTRAL rating reflecting what we view as&nbsp;broadly balanced risk reward against the uncertain backdrop.


What's changed?



Earnings:&nbsp;FY22/FY23/FY24&nbsp;EPS +1%/+11%/-2%. FY24 (and beyond) reflects our revised view on market growth and&nbsp;ATM's&nbsp;share
Target price: Decreased to NZ$6.10 primarily reflecting lower medium-term China label revenue and revised WACC assumptions



Looking ahead — implications for IF demand


China recorded new births in 2021 of 10.62m, a -28% decline versus 2019.&nbsp;COVID-19 has exacerbated the decline, that said, demographic trends in China are unfavourable. Using a combination of data sources, our proprietary&nbsp;China IF industry macro model forms the basis of our revised market growth estimates. We acknowledge&nbsp;a wide-range of&nbsp;outcomes, however, our key takeaways&nbsp;are:

Near-term; could get worse before it gets better:&nbsp;We expect the market size in 2022 to decline relative to 2021 given the lag between new births and IF consumption (~60% of IF revenue is Stage 3 products — those for babies aged 12 to 36 months).
Medium-term; a return to pre COVID industry size is highly unlikely:&nbsp;Our base case is the size of the infant population in 2025 will still be below 2021 levels, and well below pre COVID (2019) levels.​​​​​​​&nbsp;
Longer-term; highly contingent on policy change:&nbsp;The extent of policy support&nbsp;to boost birth rates will be key to the&nbsp;outlook. Our base case is for the China infant population to return to 2021 levels by 2026/2027 with only modest growth thereafter.



Where does that leave ATM? The market is assuming significant market share gains


Against this backdrop, the evidence is clear — both us and consensus are assuming significant market share gains over the medium-term (~+150–200bps over the next four years). Prima facie, this appears challenging. That said, we are not uncomfortable with these assumptions given;&nbsp;(1) FY21 represents a low base for ATM, (2) brand health metrics remain healthy in China, and (3) our expectations of a significant step-up in marketing. In addition, we expect the changing shape of the IF industry in China to offer opportunities for industry consolidation&nbsp;along with a continuation in&nbsp;premiumisation&nbsp;trends&nbsp;and extending the customer&nbsp;lifecycle.


A2 Milk Co Ltd

The A2 Milk Company: Times Are Changing