The A2 Milk Company Ltd (ASX: A2M) share price has fallen by as much as 13% upon a poor trading update. Here’s my take on why the a2 milk share price has taken a nosedive.
A2M share price
Has the a2 milk brand lost its gloss?
A2 milk generates a majority of its revenue from infant formula sales, which continues to decline.
Infant nutrition sales in Australia and New Zealand and the cross-border e-commerce channels (CBEC) experienced year on year declines of 56% and 77% for the third quarter respectively.
This is in light of an increase in marketing expenditure since a2 milk released its HY21 results.
It’s possible that the risk of domestic alternatives in China and the growing number of alternative milk options competing away A2 milk’s market is being played out.
A2 milk revises strategy
Management has acknowledged the challenges in the China infant nutrition market, in particular the shift towards China label products.
On top of this, A2 milk recognises that new product innovation has ramped up, channels to markets are changing and competitive intensity is rising.
A2 milk also indicated market growth is being impacted by a pronounced decline in birth rates.
This is supported by data released by the Chinese ministry of public security, showing the number of new birth registrations falling from 11.8 million in 2019 to 10.03 million in 2020. The 2019 figure was also the lowest point since the People’s Republic of China was founded in 1949.
As a result, the company looks to evolve its channels to market and brand marketing programs to drive demand.
Is the cash cow deflating?
Despite facing market and structural tailwinds in the Chinese market, A2 milk still holds significant cash and capital.
The key factor to monitor and analyse is management’s use of capital.
An underlying problem with a2 milk is that its growth was primarily driven by the Chinese infant nutrition demand. Given birth rates are declining, the overall market is shrinking.
When you throw in more competition in a potentially declining market, I don’t think marketing and sales expenditure will make a significant difference.
If sales continue to slide in the Chinese segment in light of more marketing expenditure, it may be a strong sign that the a2 milk brand is further diminishing.
My bearish view of a2 Milk should be considered in light of the bull case published by my colleague, Lachlan Buur-Jensen.
