Why brokers slashed their A2 Milk (ASX:A2M) share price target

Brokers have run the ruler on the A2 Milk Company Ltd (ASX: A2M) share price after the company's earnings downgrade. Here's the rundown.

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A2 Milk Company Ltd (ASX: A2M) may have lost its market darling status after yet another earnings downgrade. After reviewing A2's updated FY21 and first half guidance provided on 18 December, Citi and Morgan Stanley slashed their A2 Milk share price targets. Here's the rundown of what happened and how the brokers view A2 moving forward. 

Recovery slower than expected 

A2's daigou channel represents a significant proportion of its domestic infant nutrition sales in the Australia/New Zealand region. In A2's guidance update, the company revealed disruption to the channel has proved to be more significant than previously anticipated. Not only has this affected infant nutrition sales, but sales in other nutritionals segments have now also been impacted. 

The company now expects that COVID-19 related travel restrictions will continue to negatively impact the reseller channel due to reduced travel between Australia and China through the remainder of FY21. Its internal sales forecasts for both the daigou and cross border e-commerce channel (CBEC) for the remainder of FY21 are now materially lower. 

The update did highlight some positives including a strong performance in its Mother & Baby Stores (MBS) and liquid milk businesses in Australia and the United States. However, these segments represent a smaller percentage of the company's revenue when compared to daigou and CBEC sales. 

1H21 and FY21 guidance lowered

A2 now expects group revenue for the first half of FY21 to be in the order of $670 million, noting that the second quarter will be higher than the first quarter. Its group revenue for FY21 is expected to be between $1.40 billion and $1.55 billion. 

This compares to the company's previous FY21 outlook announced on 28 September, which forecasted group revenue for the first half of FY21 of $725 million to $755 million and group revenue of $1.80 billion to $1.90 billion for FY21. 

A2's updated FY21 first half performance represents a 16.9% decline compared to its FY20 first half revenue of $806.7 million. Meanwhile, the company's updated FY21 revenue represents a 10.4% to 23.1% decline on FY20 revenue of $1.73 billion. 

Brokers slash A2 Milk share price targets 

Both Citi and Morgan Stanley updated their A2 Milk share price targets on Monday after reviewing the company's guidance update.

Citi retained a sell rating while lowering its price target from $14.20 to $9.50. This represents an 8.6% downside to the current A2 Milk share price of $10.39 (at the time of writing). The broker reacted negatively to the company's revised profit guidance and was disappointed by the magnitude of the downgrade. Citi cut its expected A2 Milk earnings for FY21 by 15% and by over 20% for FY22 and FY23. 

Surprisingly, Morgan Stanley upgraded its price rating from underweight to equalweight. This rating upgrade was simply due to the significant fall in share price. The broker lowered its A2 Milk share price target from $12.40 to $11.00, or an upside of 5.9% to its current price. In doing so, Morgan Stanley highlighted A2's lower sales, building margin pressures and daigou channels remaining severely impacted by the pandemic. 

Motley Fool contributor Lina Lim has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended A2 Milk. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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