In response to Synlait Milk’s (SM1.AX – not covered) guidance downgrade for FY23, A2M released a statement detailing its surprise at the quantum of the downgrade. As a reminder, A2M is SM1’s largest customer as it manufactures the formula for it, and A2M also owns just under 20% of the company. Since SM1’s last update on 17 March 2023, A2M provided two production forecasts which were lowered by ~1,650mt for the period of March-June 2023 for its English Label (EL) product. This equates to less than 5% of SM1’s reported sales volume over the last 12-months.
There was no material change to its FY23 outlook but expects EL revenue growth to be down mid-single digits, however offset by strong double-digit growth in China Label (CL). The fall in EL is in part driven by inventory management changes, with more customers and distributors being supplied directly out of Hong Kong and China, leading to lower future A2M inventory requirements.
A2M expect its revenue growth therefore to be ~10%, with EBITDA margins ‘in-line’ with FY22 levels, implying EBITDA of ~$216m, around ~2.5% below consensus. There were no FY24 comments, however we note that the recent guidance from SM1 implies softer demand from A2M. With lower EL sales (which are higher margin), impacted by a continued delay in the daigou channel recovery, there will also be a delayed impact on the margin recovery, which has slightly magnified the FY24 downgrades.
The SAMR approval is still on track for CL production and expected in 4Q23. A2M is also in discussions with SM1 regarding allocation of certain one-off production/supply chain and other related costs between the two companies.
Investment View
The downgrade whilst disappointing, largely appears to be one-off in nature with a change in inventory mix, however, has further pushed out the recovery to later years. The stronger CL sales implies continued market share gains, lowering the margin mix moving forward. With the SM1 price materially below book value, there is opportunity for an EPS accretive acquisition from A2M, although at the expense of higher margins. There are positive catalysts on the horizon with the SAMR approval and channel improvement and we retain our Buy recommendation with the risk/reward looking more favourable.
Risks to Investment View
If China’s birth-rate does not improve, the overall Infant Formula market will shrink, leading to a downgrade in forecast volume growth. An increasing fall in the daigou channel would see channel recovery delayed further, impacting volumes and margin mix. If significant evidence that there are limited benefits of A2 based milk is found, there would be a material brand image impact. The SAMR registration is a key catalyst in the production of China Label product, if it is not granted, there would be material downgrades to A2M’s volume outlook.
Recommendation
We have retained our Buy recommendation.
