ASX baby formula shares have faced tailwinds following the collapse of the A2 Milk Company Ltd (ASX: A2M) share price, increasing regulatory demands and potential overseas competitors. But a2 may have re-ignited its growth story following its annual general meeting (AGM) yesterday, which provided a HY20 business update.
The business update was very positive, highlighting improving margins with strong sales growth across the board.
Back in August, the market was very skeptical of a2's decision to spend roughly $135.3 million or 10.4% of sales on marketing and branding efforts. However, the company's FY20 outlook shows early signs that its marketing and branding efforts are paying dividends.
A2 highlighted that FY20 should see:
- Continued strong revenue growth across key regions supported by branding and marketing investment in China and the US
- Full-year EBITDA margin % is now anticipated to be stronger than previously communicated and in the range of 29–30%
For 1H20 the company reported:
- Anticipated revenue in the range of $780–800 million
- China label infant nutrition sales forecast to be approximately $135 million (up 84%)
- Cross-border e-commerce infant nutrition sales forecast to be approximately $155 million (up 54%)
- ANZ English label infant nutrition sales forecast to be approximately $350 million (up 9%)
- US sales forecast to be approximately $27 million (up 110%)
- Australia fresh milk sales forecast to be $75 million (up 12%)
It was just a few weeks ago that the market witnessed a sell off of high price-to-earnings shares such as the Afterpay Touch Group Ltd (ASX: APT), Appen Ltd (ASX: APX) and Nearmap Ltd (ASX: NEA). However, there has been a subtle change in sentiment as these companies deliver positive results in their AGMs.
Where do we go from here?
I believe a2's outlook is impressive following strong growth in its China label and cross-border e-commerce channels. This positive result should be enough to give the a2 share price a kick for the coming weeks or months. However, the company has not addressed the finer details, which investors would need to wait until February 2020 to find out.
The company announced that US sales are forecasted to have a growth rate of approximately 110%. However, US sales have always been growing at a rate of >100% for the past 3 years. The key figure for the US region is its EBITDA. In a2's FY19 results, the US region delivered a significant EBITDA loss of $44 million. The company needs to demonstrate that its marketing and distribution efforts in the US are paving a road to profitability, not growing at an expense of the company's overall performance.
a2's earnings have also traditionally been skewed towards H2. I believe the announcement that full-year EBITDA margins are stronger than previously anticipated should have a positive flow on effect to H2. The weak Australian dollar and increasing likelihood of further interest rate cuts should further help with margins.
Finally, the growth numbers are good at face value, but market share will also be a key statistic. In FY19, a2 cited that it had 6.4% market share in Kantar Tier 1, Key A, B, C and D cities in China, while its a2 Milk branded fresh milk reported 11.2% market share. The company needs to continue to demonstrate leadership in its brand and ability to grow market share both domestically and across China.
Foolish takeaway
a2 has provided a pleasing FY20 outlook. The company is looking to grow strongly while trading at a modest price-to-earnings ratio of approximately 30. I believe the a2 share price should see some blue skies ahead.
