Morgans Upgrade, page-14

The A2 Milk Company (A2M)  PDF Serving it up to the competition HOLD (downgrade) | current price: A$13.64 | target price: A$13.66 (previous: A$12.35)

§  A2M delivered a strong 1H19 result which beat our NPAT forecast by 11.7%. §  FY19 outlook comments were upgraded, with the rate of 1H19 revenue growth to continue over the full year and EBITDA margins are expected to be ahead of previous expectations. As expected, earnings will be skewed to the 1H as marketing investment and SG&A increases to build brand equity and support growth in China and the US. §  After strong share price appreciation, we move to a Hold recommendation.

1H19 surprises on the upside 1H19 NPAT rose 55.1% (11.7% beat for us) and EBITDA was up 52.7% (10.5% beat). Significant earnings growth reflected the benefit of strong revenue growth (+41%), scale benefits and favourable product mix, with infant formula sales up 45.3% to NZ$495.5m (80.8% of group revenue). Sales growth benefited from strong product demand, improved sales velocity, increased points of distribution and market share gains. The gross profit and EBITDA margin both surprised on the upside, rising 580bps and 270bps to 55.6% and 35.6%. As expected, A2M increased its investment in marketing (+75%), employee (+67%) and other administrative costs (+91%) to grow brand awareness, support an expanded distribution footprint in China (now ~12,250 stores) and the US (now ~12,400 stores) and build out its organisational capabilities. Operating cashflow was slightly softer than expected and the balance sheet remained in a strong net cash position of NZ$287.9m. China opportunity remains compelling Following soft results and commentary from peers, A2M said it is not seeing China headwinds from a reportedly soft consumer or declining birth rates. A2M said its Stage 1 and 2 infant formula products delivered strong growth and that a continuation in premiumisation will support category growth over the medium-term. Relative to larger peers, A2M believes it has a more agile business model that will allow it to more readily respond to changing consumer demand. FY19 guidance is upgraded 2H19 revenue growth is now expected to be 'broadly in line' with the 1H19, implying ~41% FY19 revenue growth. In addition, the FY19 EBITDA margin is expected to be in the range of 31-32% (vs. previous guidance for a largely flat outcome or 30.7%). 2H19 marketing spend will double on the 1H19 as A2M increases its brand building activity to support revenue growth in FY20 and beyond. Further investment in organisational capability is also planned, while the US loss is expected to increase to US$27m (vs. US$22m previously). Following a stronger than expected result, we have increased our FY19/20 NPAT forecasts by 8.3%/3.4%. Our FY21 forecast remains largely unchanged. We move to a Hold recommendation and A$13.66 price target We continue to rate this company highly. It has a strong brand, continues to grow its share in the domestic and China infant formula market and increase its distribution footprint and sales velocity across China's Mother & Baby Stores (MBS). Management continues to invest in the long-term profitability of its business by accelerating its marketing spend to increase brand awareness, expanding into new geographies and developing new products. However, after strong share price appreciation we move to a Hold recommendation and A$13.66 price target (was A$12.35).

Belinda Moore  +61 7 3334 4532  [email protected]