The market has soured 20% on the A2 Milk share price. Is it a turnaround buy?

A man in a business suit holds a mobile phone to his ear while he drinks a large glass of milk.A man in a business suit holds a mobile phone to his ear while he drinks a large glass of milk.

The A2 Milk Company Ltd (ASX: A2M) share price has shed 20% in 2023 to date. But when businesses drop heavily, it’s worth considering whether they are a beaten-up opportunity.

Most investors will likely already know that A2 Milk’s two main product categories are infant formula and liquid milk. Though it does sell other types of products including ice cream and milk powder.

Why is the A2 Milk share price falling?

As we can see on the chart above, the last 12 months have been a volatile time for the company.

Much of its recent decline started in March and has continued. The fall in share price appears to have been triggered by another dairy company Synlait Milk Ltd (ASX: SM1). It is a major supplier to A2 Milk and, in turn, A2 Milk owns a significant parcel of Synlait shares.

Given their relationship, Synlait’s comments could also speak to (future) demand for A2 Milk products.

On 17 March 2023, Synlait said its two-year recovery plan was going to take three years. It spoke of a “reduction or delay in advanced nutrition demand” following “forecast changes by Synlait’s largest customer”.

At the time of that March update, Synlait was guiding that net profit after tax (NPAT) would be between $15 million to $25 million.

Synlait then gave another update near the end of April 2023. This reduced its guidance range to between a net loss of $5 million to a net profit of $5 million.

It said that was due to “further advanced nutrition demand reductions, mostly from one of Synlait’s customers, which impact consumer packaged infant formula volumes and base powder production”, as well as other factors.  

A2 Milk response

In an ASX announcement, A2 Milk responded to the comments, saying it was surprised by the extent of the reduction in Synlait’s guidance.

However, A2 Milk acknowledged in two Synlait forecasts, A2 Milk had also lowered its total forecast production volume needs. Specifically, these were for English-label consumer-packaged infant formula for March, April, May, and June 2023 production months. The volumes needed dropped around 1,650 metric tonnes in total. This equated to less than 5% of Synlait’s advanced nutritional sales volumes over the 12 months to 31 January 2023.

A2 Milk also said there has been “continued weakness” in the Australia-New Zealand daigou market. This is where private sellers supply directly to China. According to the company, it is “down 49% in the most recently reported quarter from Kantar”.

It also talked about significant cumulative delays in English-label consumer-packaging infant formula deliveries from Synlait to A2 Milk over an extended period. These were expected to be fulfilled in the fourth quarter of FY23, resulting in a “material amount” of inventory arriving within a relatively short period which “needs to be managed”.

A2 Milk also referred to the “ongoing refinement of the company’s English label distribution model”.

Taking into account all the factors A2 Milk has talked about, the infant formula company confirmed: “there is no material change to its FY23 outlook”. Certainly, one could argue this is supportive of the A2 Milk share price.

The company is expecting FY23 revenue to grow in the low-double digits, though English-label revenue is now expected to be down in the mid-single digits. This would be partially offset by “continued strong double-digit growth in Chinese label infant formula revenue”, the company said.

FY23 revenue growth is expected to be “at the low end of its previous expectations”, meaning around 10%. However, A2 Milk is still expecting an earnings before interest, tax, depreciation and amortisation (EBITDA) margin similar to FY22.

My view on the A2 Milk share price

It’s understandable the market may not have enjoyed hearing of potentially lower-than-expected volumes and revenue growth at the bottom of its guidance range.

But A2 Milk has a strong brand and it seems to be going well in China, a key market for the company’s success. It will be interesting to see how FY23 progresses for A2 Milk (and Synlait).

A2 Milk’s ongoing expansion in markets outside of Australia and New Zealand is promising in my opinion. Looking at profit projections on Commsec for the next few years, earnings per share (EPS) could rise each year to FY25.

The current A2 Milk share price is valued at 19 times FY25’s estimated earnings. Certainly, a growing profit would be a good tailwind for hopeful share price growth.

The post The market has soured 20% on the A2 Milk share price. Is it a turnaround buy? appeared first on The Motley Fool Australia.

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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 Scott Phillips.

from The Motley Fool Australia

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