Grass on the A2 side of the dairy fence is looking greener – and the profits plusher

The  contrasting   fortunes of  Fonterra  and  A2 Milk came into the  spotlight   this  week,  after the  latter  reported a  startling 55%  rise in  half-year net profit  to  $152m.  Fonterra  shareholders will be  ruefelly recalling  their  company’s  performance last year  when  it  reported its  first-ever  net  loss  of  $196m.

A2 Milk  shareholders  are  marching to a  very  different  tune.  Despite  one market  analyst  reckoning its shareprice had  become over-priced, buyers  pushed  it up  by  more than  a dollar to  $13.95  as they absorbed  news  of   strong sales growth in all key product segments – infant formula, liquid milk and milk powders.

Sales of infant formula totalled $495.5m for the half – a 45.3%  increase on the previous half, driven by share gains in China and Australia.

The company is accelerating its investment in building brand equity through enhanced marketing campaigns in its key markets of China, US and Australia, alongside continued investments in R&D and further development of its intellectual property.

The group’s investment in marketing in the first half increased by 75% to $45.5m primarily as a result of increases in brand building activities in China and the US. The rate of investment in marketing will step up further in the second half as it increases in-market brand building activities.

A2  Milk’s closing cash position reflects the growth in revenue and earnings, partially offset by its increased investment in Synlait Milk (August 2018). Net operating cash flow for the half was $112.3m, with cash on hand at  December 31 of $287.9m.

Business  is expanding  in  key  markets. The Australian fresh milk business has further strengthened with 11.7% revenue growth and a record 10.8% market share , up from 10% for the same period a year ago. a2 Milk™ was the fastest growing major liquid milk brand in Australian supermarkets.

China segment revenue rose to $171.7m, up 50.1%, with EBITDA up 41.6% to $68.4m as a result of strong distribution and market share gains.

The Kantar infant formula consumption value share increased to 5.7% in the latest 12 month data for Tier 1 and Key A cities, up from 4.4%. The positive velocity growth in store combined with the company’s stronger distribution footprint is supporting an increase in sales of China label infant formula with growth of 82.6% relative to first half a year ago.

The cross border e-commerce channel (CBEC) remains a strong pathway to the Chinese consumer for the infant formula category, enabling consumers across all regions  more easily to access international brands. The company performed well during the online seasonal events and continues to perform strongly across all CBEC platforms.

In August last year the company renewed its agreement with China State Farm. This relationship is strong and enduring and an important part of building the business in China for the long term.

The company is well ahead on the appointment of a CEO for Greater China who will lead the business through its next phase of growth in the region.

The Chinese government issued a number of important regulatory updates during the half with respect to e-commerce and cross border trade in general. This included a new e-commerce law to strengthen the compliance obligations for e-commerce operators, and a new CBEC policy framework containing implementation guidance for future CBEC trade.

In the  US sales momentum continued with sales growth of 114.1% in the half underpinned by increased investment in brand awareness and a stronger distribution base.

By the end of December 2018 US distribution exceeded 10,000 stores. More recently, a further 2,400 stores have been added, taking the distribution of the brand to 12,400 stores by the end of January 2019. The significant rate of distribution growth in January is driven by building brand awareness and new store planogram reset timings within the respective retail chains.

While the second half will continue to focus on increased distribution, there will also be a focus on improving in-store productivity in relatively newer stores.

Pleasingly, recent US research data indicates the US brand development looks a lot like the experience with fresh milk in Australia. The a2 Milk™ brand in the US is successfully growing category consumption, sourcing volume across multiple product segments and trading up consumers from conventional milk while demonstrating high levels of consumer loyalty once the brand is trialled.

There will be increased investment in the second half of the financial year  to support continued velocity growth in market. The planned investment for FY19 is now about US$27m.

The company expects  group revenue growth rate in the second half to continue broadly in line with the first half. The increased investment in brand building in 2H19 is expected to support revenue growth in FY20 and beyond.   But  it  says second half ebitda margins will consequently be lower than in the first half, with full year FY19 ebitda as a percentage of sales expected to be about 31-32%.

After absorbing  all  that,  Fonterra  shareholders  might be  saying to themselves:   “If  only….”