There is a bull case to be made for the A2 Milk Company Ltd (ASX: A2M) share price. There are a few interesting factors that could turn things around.
What’s going wrong for the A2 Milk share price?
A lot has gone wrong for A2 Milk over the last year.
The A2 Milk share price has fallen by around 66% over the last 12 months. It has been the worst performer in the ASX 200.
In the first few months after COVID-19 hit in 2020, A2 Milk saw a huge boom in demand for its products, including its infant formula.
In FY20, it saw total revenue of $1.73 billion – an increase of 32.8%. Net profit increased 34.1% to $385.8 million.
FY21 saw a reversal of performance. Revenue fell 30.3% to $1.21 billion and net profit sank 79.1% to $80.7 million.
Several negative factors combined. There has been a lack of demand from the daigou/reseller channel. A2 Milk has had too much inventory. Chinese customers have been shifting their preferences.
What is the bull case for the A2 Milk share price?
Things certainly look bleak for the business. It hasn’t been this low since 2017.
But there may be some positives that could turn things around, though I’m certainly not an expert on infant formula sales to Chinese customers.
Valuation
A2 Milk shares certainly reflect the pain it has gone through. It’s possible that investors have been too harsh on A2 Milk. The market is often too optimistic or too pessimistic on a particular business.
A drop of two thirds may be too harsh on the A2 Milk share price. Just ignoring the inventory write off of $108.6 million back into A2 Milk’s numbers make it seem decent value if it made a similar underlying profit in FY22. The write-down was after a board-initiated inventory review. Lower sales and the various COVID-19 impacts led to that position of too much inventory. Actions taken to improve this is helping with improving freshness across all labels and channels, as well as leading to price stabilisation.
Looking at the CommSec forecast for FY23, the A2 Milk share price is valued at 28 times the estimated earnings for the 2023 financial year.
Ex-Chinese consumer growth
A lot of the infant formula that A2 Milk produces ended up in Chinese hands. But with A2 Milk shares falling so much, the other parts of the business are more important and represent a larger percentage of the revenue pie. And those other areas are doing reasonably well.
Australian fresh milk revenue increased by 10.8% to $169 million compared to the prior corresponding period (pcp) of FY20. During the year, the company acquired the manufacturing facilities of Kyvalley.
In the US, in constant currency terms, net revenue increased 5.5% to $69.7 million during the year with underlying volume growth for the year was 13%. Distribution grew to 26,800 stores, up from 24,000 stores at June 2020. In the second half of FY21, A2 Milk said it was the strongest performing premium brand over the period.
In Canada, products were first launched in July 2020, initially focusing on Western Canada, with subsequent distribution expansion.
If these areas can continue to grow revenue then those segments will hopefully grow profit too.
Possible turnaround of Chinese demand
Lots of things have gone wrong over the last 12 months. But there could be a turnaround when you consider international borders are likely to lift at some point sooner rather than later.
A2 Milk Chinese label infant nutrition sales were $389.9 million, an increase of 15.4% over FY20. Retail sales for Chinese mother and baby stores (MBS) for the overall market were up 9% for the year. Its 12 month rolling market share in MBS was 2.5% at June 2021, compared to 2.4% at the end of December 2020 and 2% at the end of June 2020. Distribution increased to 22,800 stores, up from 21,800 at December 2020 and 18,200 at the end of June 2020.
I think it’s setting the scene well here for potential growth in sales to Chinese customers in total, even if cross-border commerce (CBEC) and daigou sales don’t bounce back. But they could, though I wouldn’t count on it.
Summary thoughts on the A2 Milk share price
A2 Milk is going to have a bumpy ride whatever happens next. But I think it may have fallen so far that a bit of good news could really turn sentiment around. Local Australian infant formula sales surely can’t go much lower and other segments, including Chinese label sales, could continue to grow.
It could be one to consider for now, though there are plenty of possibilities that aren’t as volatile.
