A2 Milk goes sour after another disappointing year

Dual-listed kiwi A2 Milk (ASX:A2M) posted another disappointing year, as Covid-19 headwinds and changing conditions in China hit the bottom line. In its FY21 report, the company says the once-booming Chinese market has shrunk significantly due to cross-border trade implications.

Its primary issue is that the “daigou” buyers, individuals buying goods to on-sell in China, are long gone. Since the first lockdown early last year, particularly in Victoria, the daigou channels have  dried up. They are also turning to their own, improving-quality domestic products as Chinese regulatory pressure increases.

A2M tried to dispel market concerns by saying, “In response to the dramatic change in circumstances, significant actions were taken from 4Q21 to address excess inventory issues, rebuild the management team, increase brand investment and commence a growth strategy review,” but the company was unable to change its long-term outlook for FY22. The company says it “remains challenging and uncertain and it will take time to recover.”

The company financials were as follows:

• Net profit after tax down 79.1% to NZ$80.7 million
• Revenue down 30.3% to NZ$1.21 billion
• EBITDA fell 77.6% to NZ$123 million
• Stock write-downs of NZ$109 million
• Cash balance of NZ$875.2 million
• Cancelled capital return
• Outlook: Tough year ahead in FY 2022

Despite posting an net profit number in line with consensus expectations, the market didn’t take to A2’s guidance downgrade. This is the fourth time the company has downgraded guidance. Other challenges include:

• Some $112.2 million in inventory at year’s end, reflecting the impact of stock write downs
• Challenges experienced in the English-label infant nutrition channels
• The need to rebalance channel inventory in 2H
• Distribution costs higher due to increased warehousing costs

Despite the gloomy outlook, the company is confident that daigou shoppers will return fairly quickly as Melbourne comes out of lockdown. Another concern is that an unusual amount of key directors and executives have been selling down large chunks of company shares, according to The Age. It’s always a concern when management are offloading shares during gloom and doom.

Citi has a “neutral” recommendation with a target price of $6.05. First the positives – The FY21 result includes a better-than-expected operating cash flow, and a beat on Australia and New Zealand underlying earnings. The negatives – Include a miss on the headline profit number which came in at $91 million, a 13 per cent miss on Citi’s numbers. The company also upped its loss guidance to a $20m loss from a $10 million one, given uncertainty around third-party volumes. A2M did not provide FY22 guidance, but going by the narrative, lower revenue is expected in 1H22 but higher revenue is tipped for 2H22.

Citi sees this as a ‘turnaround’ opportunity. But things can continue to deteriorate, and the share price can fall a lot further. There will be an opportune time to buy A2 Milk, but it isn’t now.

Ishan Dan

Ishan is an experienced journalist covering The Inside Investor and The Insider Adviser publications.