Is the A2 Milk (ASX:A2M) share price now too cheap to ignore?

A2 Milk shares have fallen heavily. Is it an opportunity?

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The A2 Milk Company Ltd (ASX: A2M) share price has sank just over 50% in 2021 (to today).

It has fallen so much, could it actually be an opportunity because investors have gone too pessimistic and it's now good value, even with its problems?

Broker ratings on the A2 Milk share price

One of the latest brokers to have their say on A2 Milk is Credit Suisse.

The price target from the broker on A2 Milk is $5.75. That is higher than where it is today, but it doesn't signify a huge return over the next 12 months, just a mid-single digit rise.

A2 Milk may be seeing lower sales on lower demand because of a slowing birth rate in China. However, a positive is seemingly higher prices for its products in China.

Based on Credit Suisse's numbers, the A2 Milk share price is valued at 27x FY23's estimated earnings.

However, some brokers are far more positive on the infant formula and milk business.

For example, Citi currently rates it as a buy with a price target of $7.30. That suggests that the A2 Milk share price could rise by more than 30% over the next year if the broker is right.

Citi notes that A2 Milk's inventory is getting better and it has changed things with distributors to improve the situation.

Actions taken to improve things

A2 Milk says that the 2021 result was disappointing. However, it has taken a number of actions to try to address the COVID-19 disruption.

It has recognised stock write-downs and deliberately slowed down sales, together with other planned initiatives, to reduce inventory levels and rebalance English label infant formula pricing across channels.

A2 Milk has swapped older distributor inventory with more recent stock to improve the on-shelf product freshness.

The company has also done other things like spending on more marketing, improved its leadership team and re-organised its Asia-Pacific division.

Profit margin expectations

A2 Milk has an ambition to grow sales to over NZ$2 billion and improve margins. The earnings before interest, tax, depreciation and amortisation (EBITDA) margin target is "probably in the 'teens' in the medium term" due to market conditions and in the longer-term the target is in the "low-to-mid-20s" subject to a better recovery.

Trading update

In terms of sales, English label infant formula sales in the first quarter of FY22 were down on the first quarter of FY21, but "significantly up" on the fourth quarter of FY21. FY22 first half English label sales are expected to be down year on year, but ahead of expectations.

Chinese label infant formula sales in the first quarter were "constrained" to reduce channel inventory levels. Sales were down significantly year on year and on the fourth quarter of FY21. Chinese label infant formula sales are expected to be significantly down in the FY22 first half.

However, tier 1 inventory levels are now at required levels for both English and Chinese label products.

ANZ fresh milk volumes were up in the first quarter of FY22 year on year, though in New Zealand dollar terms the sales were flat because of foreign currency fluctuations.

US liquid milk volumes were down in the first quarter of FY22 compared to the first quarter of FY21 after the reduction of ranging by a club channel customer. Distribution cost pressures continue in the US market.

A2 Milk share price valuation

Getting back to Citi's thoughts, on the broker's numbers, A2 Milk shares are valued at 27x FY23's estimated earnings.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia 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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