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How to value the A2M share price

Want to value the A2 Milk Company Ltd (ASX:A2M) share price? Here are 6 key metrics you need to consider.
The A2 Milk Company Ltd (ASX:A2M) share price is up 14.39% in 2024. Let’s take a look at why you might want A2M shares on your watchlist.

A2M share price in focus

Founded in New Zealand in 2000, The a2 Milk Company sells dairy products which contain the naturally occurring A2 protein type. Most other dairy products on the market contain the A1 protein, which is claimed to be harder to digest for some people.

The company is responsible mainly for distribution and marketing, with the production outsourced to suppliers who source from over 25 certified dairy farms across Australia. A large part of the a2 business is infant formula, which is produced by its supply partner Synlait Milk in New Zealand.

While the science is a little uncertain on why a2 milk might be easier to digest, randomised studies have repeatedly shown that it is an effective solution for many people who struggle with ‘normal’ dairy products.

Let’s talk profits

If you’ve ever tried to read a company’s income statement on the annual report, you’ll know it can get pretty complex. While there are any number of figures you could pull from this statement, three key ones are revenue, gross margin, and profit.

Revenue is important for obvious reasons – everything starts here. If you can’t generate revenue, you can’t generate profit. What we’re concerned about is not so much the absolute number, but the trend. A2M last reported an annual revenue of $1,673m with a compound annual growth rate (CAGR) over the last 3 years of 11.6% per year.

Moving down the income statement, we then get to gross margin. The gross margin tells us how profitable the core products/services are – before you take into account all the overhead costs, how much money does the company make from selling $100 worth of goods or services? A2M’s latest reported gross margin was 45.8%.

Finally, we get to profit, arguably the most important figure. Last financial year A2 Milk Company Ltd reported a profit of $168m. That compares to 3 years ago when they made a profit of $81m, representing a CAGR of 27.6%.

A pulse check on A2M shares

The next thing we need to consider is the capital ‘health’ of the company. What we’re trying to assess here is whether they’re generating a reasonable return on their equity (the total shareholder value) and have a decent safety buffer. One measure we can look at is net debt. This is simply the total debt minus the company’s cash holdings. In the case of A2M, the current net debt sits at -$903m.

A high number here means that a company has a lot of debt which potentially means higher interest payments, greater instability, and higher sensitivity to interest rates. A negative value on the other hand indicates the company has more cash than debt (a useful safety buffer).

Another figure we can look at is the debt/equity percentage. This tells us how much debt the company has relative to shareholder ownership. In other words, how leveraged is the company? A2M has a debt/equity ratio of 5.3%, which means they have more equity than debt.

Finally, we can look at the return on equity (ROE). The ROE tells us how much profit a company is generating as a percentage of its total equity – high numbers indicate the company is allocating capital well and generating value, while a low number suggests the profits might offer more value if they were paid to shareholders as a dividend. A2M generated an ROE of 12.8% in FY24.

What to make of A2M shares?

With strong revenue growth over the last 3 years, profits trending upwards, and a solid ROE, A2M shares could be worth adding to your ASX share price watchlist.

Please keep in mind this should only be the beginning of your research. It’s important to get a good grasp of the company’s financials and compare it to its peers. It’s also important to make sure the company is priced fairly. To learn more about share price valuation, you can sign up for one of our many free online investing courses.

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