The a2 Milk Company Ltd (ASX: A2M) share price is at risk of being sold off again after another poor trading update.
Why is the a2 Milk share price in danger?
a2 Milk gave investors another update. It said that trading in the Chinese infant formula nutrition market is still challenging.
The FY21 third quarter trading was roughly in line with what it was expecting. However, actions it has taken have not been enough to spark a recovery.
After doing an inventory review, a2 Milk concluded that inventory is too high and the challenges in the daigou, reseller and cross-border e-commerce channels (CBEC) have been exacerbated by excess inventory as well as difficulties with ‘visibility’.
Infant nutrition sales in Australia and New Zealand were $99.5 million, and $22.1 million in the CBEC channel in the third quarter, which is a year on year decline of 56% and 77% respectively. Sales in CBEC fell particularly hard because of actions taken to reduce distributor inventory.
The China label infant nutrition FY21 third quarter sales amounted to $98 million, representing 5% growth year on year, whilst being 18% lower compared to the FY21 second quarter.
Peter Nathan, the CEO of Asia Pacific, has resigned from his role but will remain to ensure a smooth transition.
How is the infant formula company going to respond?
It said that in the interest of long-term health of the a2 brand and the medium-term trading, it’s going to take more “aggressive” actions to address excess inventory. This is going to impact FY21 revenue and EBITDA (EBITDA explained) and it could spill over into the first quarter of FY22.
The inventory management actions being taken will provide Chinese mothers with the freshest infant milk formula and benefit customers, distributors and partners. In other words, it sounds like it’s going to prioritise selling its new(er) product.
It’s going to take a further stock provision of approximately $80 million to $90 million, on top of the $23 million that was provisioned in the first half of FY21.
a2 Milk is also going to increase its marketing expenditure yet again in the fourth quarter and FY22 to increase consumer demand.
Due to these challenging circumstances, a2 Milk has started a process to review its growth strategy and plans to respond to this environment.
A2 Milk could also consider capital management initiatives, such as a share buy back.
Summary thoughts on the a2 Milk share price
a2 Milk is now targeting FY21 revenue of $1.2 billion to $1.25 billion. The EBITDA margin is expected to be 11% to 12%, excluding acquisition costs. That’s worse than what was guided at the HY21 result.
Management warned it will take some time to rebalance inventory levels and restore channel health. An immediate recovery is not expected. We’ll have to see what the a2 Milk share price does today.
It’s difficult to call this. Prior to COVID hitting, a2 Milk was one of the high quality businesses on the ASX. Have things really permanently gone bad? Things can look the worst before they start getting better. I’m not sure what will trigger a recovery of earnings in China. At some point, A2 Milk shares may become too cheap to ignore. But who knows how long this troubling period will last?
There are probably other ASX growth shares that have a simpler path to making shareholder returns.
