Strong 1H18 led by a2 Platinum market share wins
The A2 Milk Company (A2M) reported a strong 1H18 result with sales up 70% on the previous corresponding period, EBITDA up 123% and NPAT up 150%. Margins continued to rise with the gross profit margin up to 49.8% vs 46.5% in the previous corresponding period and the EBITDA margin increased 790bps to 32.9% due to product mix (infant formula was 78% of revenue) and scale benefits. a2 Platinum remains the fastest growing infant formula brand with a market share of approximately 30% by value in Australian supermarkets. a2 Platinum's market share by value is also rapidly rising in China and it is one of the fastest growing brands in this market (worth about US$20bn per annum). Market share in China currently stands at 5.4% according to Kantar.
Despite starting to rebuild its inventory, operating cashflow rose 205% and A2M ended the half with net cash of NZ$240.2m.
Well placed to continue to deliver strong earnings growth
A2M is on a strong earnings trajectory as it builds a global branded dairy nutritionals business across ANZ, China (and other Asia), UK and USA. We believe its strategic relationship with Fonterra should fast track A2M's entry to its other priority markets (South East Asia and Middle East) where Fonterra has strong distribution. It will also see A2M expand its product range. The strong growth in a2 Platinum has transformed A2M's earnings in recent years and we expect this to continue given there is plenty of market share to be won in existing and new markets.
FY19 should benefit from the additional marketing spend in 2H18, a full year of CFDA approval and strong growth in Mother and Baby stores in China. In FY20, we forecast the US business to reach monthly break even and the Fonterra strategic relationship to make a positive contribution.
A2M's point of differentiation (products only contain the A2 beta casein type rather than both A1 and A2 types found in conventional cows' milk) with health and digestive benefits has allowed it to win market share across product lines and geographies. It has also allowed it to price products at a premium to peers. The company generates strong EBITDA margins, considerable free cashflow (capital light business model) and a high Return On Equity.
A2M's balance sheet should allow it to fund a blending and canning facility, new products and global expansion plans whilst rewarding shareholders through dividends and other capital management initiatives.
With low market shares in some very large markets (China, US, UK), we expect A2M to continue to win market share across its product range and believe A2M can generate strong earnings growth over the medium term. We think consensus estimates in outer years will prove conservative and the upgrade cycle should continue.
Importantly, A2M is led by an impressive management team that has successfully managed regulatory changes in China at a time when others have failed.
We initiate coverage with an Add recommendation.
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