A2 share price rallies sharply after the dairy processor reports big jump in net profit

A mixed  bag  of  news  came  down the  line  for  New Zealand’s  dairy  industry  over the  past  week.  On  one  side,  Fonterra trimmed   its  forecast  payout  for  the  season, while  on  another a2  Milk   surprised   its  critics  by  reporting  a  42% jump  in  net  profit  to $114m.

Any   company  listed  on  the NZX  and  sitting  on a  cash  mountain  of  $800m  must  be  doing  something  right.    Yet  some of  the  headlines  on   its  result  focussed  on  what  might  go  wrong   for   the  company  that specialises  in marketing  a2 milk  and  infant  formula.

For  example  Business  Desk’s  Jenny Ruth  says the    biggest source of uncertainty for a2 Milk right now is China’s State Administration for Market Regulation (SAMR) deadline of February 21, 2023, for companies selling infant formula in China to get a new form of approval.  It’s called the GB standard, which is a Chinese national standard. Foreign companies won’t be able to manufacture formula for the Chinese market beyond that date unless they meet the new standard and have that all-important tick from SAMR.

But the  investment  community  was  cheered  by the  result in  what  is  currently  a rather downmarket climate. A2 Milk’s  share price rallied sharply after the company reported the  leap in profit which was driven by strong growth in its infant formula business in China.

The company also said it intended to return capital through a $150m on-market share buyback. How  about  that?  Some of  Fonterra’s  farmers  might be  envious of  that.

A2  Milk  is  now  operating  the  Mataura  Valley  plant (in  which it is  majority owner)   in Gore, Southland,  to manufacture  its high-quality infant formula  from   a2 milk.

In its statement to the market, a2 Milk said it  has made significant progress in implementing its refreshed growth strategy and improving performance during 20-2021. More specifically, the inventory management actions taken last calendar year to address excess infant milk formula (IMF) inventory have proven effective with channel inventory at target levels, product freshness among the best in the industry and improved market pricing .

“ The refreshed growth strategy which focuses on capturing the full potential of the China market opportunity is having an impact achieving new highs in brand health metrics and record market shares. Full year result for FY22 is in line with the company’s expectations  outlined on 21 Feruary 2022, delivering double digit revenue and earnings growth despite challenging market conditions driven by the refreshed growth strategy and improved execution

“The outlook for the business in FY23 is positive with continued revenue and earnings growth expected, and the company is on track to deliver on its medium-term financial and non-financial ambitions 2021.”

A2 Milk chief executive David Bortolussi says the company has a long way to go after Covid- 19 hit the company hard.

The company’s result showed revenue in the June year grew 19.8% to $1.44 billion – which it said was on the way to reaching its plan of $2b in five years’ time.

Earnings before interest, tax, depreciation and amortisation (ebitda) were up 59 per cent to $196.2m while cash on hand came to $816.5m.

Covid-19 disruption – particularly of the “daigou” trade in infant formula from Australia to China – was a key factor behind a2 Milk’s profit after tax sliding 79% to $80.7m in the previous June year.

The daigou trade has many forms but it typically involves individuals or businesses buying English label formula in Australia and sending it back to China.

“We are really pleased with the progress that we have made over the last six to nine months.”

Bortolussi said all the tough decisions that a2 Milk had made on inventory management earlier last year had set the foundation for growth.

He saw the company returning to double-digit growth in revenue and earnings despite significant headwinds.

“We are pleased with the progress that has been made in stabilising the business, refreshing our strategy and improving our execution,” he said.

China-label and English-label infant formula sales were up 12.2 per cent and 11.6 per cent respectively.

Australia-New Zealand and US liquid milk sales were up 1.8% and 30.2% respectively.

Bortolussi said there were signs the daigou channel was stabilising after a challenging year affected by Covid travel restrictions.

While the share buyback is an expression of confidence in the company’s strategy, the company will  still preserve opportunities to invest in “organic” growth in the business or to pursue merger and acquisition opportunities.

From an M&A point of view, there may be some opportunities as the company looked to develop its supply chain capacity in New Zealand and, over time, in China, he said.

In the US, the business had yet to see a significant turnaround in profitability.

Bortolussi said China – the company’s biggest market for infant formula – was suffering economic conditions similar to many other countries.

Data out early this year showed China’s birth rate plummeted for a fifth consecutive year, hitting a record low in 2021.

“In our category, the market is down in value terms by 3 per cent, but within the segment that we play in – the ultra-premium segment – is up 9 per cent.

“And the a2 protein category that we pioneered has almost doubled in the year to almost 100 per cent growth.

“There are a lot of headlines about the decline in the birth rate – which is true – and it has a compounding impact in the stages from one to four – against those market headwinds, we are gaining share.

“Our share is increasing and the key reason for that is that we are well positioned in the ultra-premium segment in the a2 category.

“I still think we have a huge opportunity to grow  the  business”.

Meanwhile  Fonterra’s  farmers  maybe  a   bit  more  downbeat  after the  co-op  announced it is trimming its milk payout forecast for the 2022/23 season by -25c to a mid-point of 9.25kg/MS.

The new range is $8.50-$10.00kg/MS.

However the current advance payment rate of $5.70 per kg/MS remains unchanged.

The dairy giant said

“… the change in the 2022/23 forecast Farmgate Milk Price will be disappointing for our farmers but it reflects a number of factors, including the recent downward trend in global dairy prices driven by some short-term softening in global demand, and the general impact of inflation on purchasing behaviour. However, we believe the longer-term outlook for dairy remains positive.”

Fonterra will release its financial results for the year ended July 31 2022 on Thursday, September 22, 2022.