Spoiled milk

RESULTS

Need To Know

• FY23 result delivered on guidance, however FY24 outlook softer than market expectations with margin improvement being pushed out
• Brand health and market share in China remain strong, despite challenging conditions with lower birth rates
• Whilst the FY24 outlook is subject to a range of factors, we expect reasonably material downgrades to earnings (8-12%)

FY23 results overview vs consensus

Revenue growth of 10.1% to $1,593m vs $1,590m

EBITDA up 11.8% $219.3m vs $217m

EPS up 28.7% to 21.2cps vs 19.9cps, largely helped by a buyback during the year

Investment Implications

A2M had updated its guidance in late April, and delivered on that over the results to June. China and other Asia saw strong growth (37.9%) which largely offset a significant decrease in the ANZ segment (-30.2%) due to an intentional change in English label distribution strategy. The 2H saw much slower revenue growth (3%) mainly due to a sharp decline in the Daigou market value, and cycling higher lockdown related sales in 4Q22. Gross margin only saw a minor 5bps improvement with several swing factors on fx and raw material costs being offset by price rises and other cost saving initiatives.

The overall China market continues to struggle, declining 12.1% in volume and 14.4% in value in FY23. Lower birth rates and challenging macroeconomic conditions are impacting retail sales and increased competitive intensity and promotional activity driven by excess industry capacity are also hampering market growth. A2M still expects a post Covid recovery in birth rates in the medium-term, with higher  uncertainty on a longer-term basis. Despite this, a mix shift to the ultra-premium price segment has seen A2M increase its market share, and in particular, A2M was the number 1 share gainer in CBEC with market value share increasing to 22.6%, up from 19.4% in 2022.

The Daigou channel falling 39.5% over the year heavily impacted the ANZ segment result, which fell 30.2%. Most of this was expected as A2M continues to proactively change its English label distribution model to more controlled and transparent channels, which was seen by a significant increase in CBEC sales. Liquid milk sales were up 7.1%, driven by price increases however partly offset by volume decreases. The latest lactose-free product has performed ahead of expectations, with market share in NSW already reaching 18.4%.

USA profitability improved throughout the year from a combination of higher revenue growth and cost reduction initiatives, although still recorded an EBITDA loss of $23.3m (vs $36.7m). Market share increased to 2.3% from 2.0%, with household penetration and brand loyalty ratings improving. Interestingly, A2M noted that the management team has been changed, and there will be a ‘greater focus on profitability going forward’.

FY24 Outlook. China market conditions are uncertain but “likely to become more challenging” with a further double-digit decline in market value expected. This is driven by declining birth rates and the rolling impact on later stages of IMF products. Average selling prices will also be under pressure due to increased competitive intensity.

Revenue growth is forecast to be ‘low single digits’ which is below market expectations for ~9%. Gross margins ‘similar to FY23’ is also below expectations for a 70bps improvement. Similarly, EBITDA margins of ‘broadly in line’ with FY23 are also below expectations for a 90bps improvement. This is largely due to cost of goods sold headwinds related to China label IMF re-formulation and upgraded packaging, partly offset by price increases and lower farmgate milk pricing. Overall, we are expecting FY24 downgrades of 8-10%, although management note that a ‘broad range of sales outcomes is possible’.

Investment View

The result was in-line with expectations, however we had expected A2M to provide a more constructive outlook on FY24 conditions, given improving margins outcomes and market share gains. The margin recovery is being pushed out to later years although we note the pleasing improvement in brand and product penetration in China, despite an overall declining market. Conditions in China remain challenging, however we believe guidance may prove to be conservative. Net cash on the balance sheet increased to NZ$757m which equates to ~A$0.95+ of the valuation.