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Home / Business / Markets

Stock Takes: The a2 Milk conundrum - what to do with a lazy $700m?

Jamie Gray
By Jamie Gray
Business Reporter·NZ Herald·
26 Aug, 2022 05:30 AM6 mins to read

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What will a2 Milk do with its lazy $700 million? Photo / Supplied

What will a2 Milk do with its lazy $700 million? Photo / Supplied

A2 Milk doesn't make as much as it used to, but it has one problem that many companies wouldn't mind sharing: what to do with a $700 million cash mountain?

The milk and infant formula company reports its annual result on Monday, and analysts expect the numbers to show the business is a work in progress after suffering severe disruption to its operations, mostly arising from Covid-19's impact on its biggest market - China.

In the bigger picture, there is the re-emergence of the Chinese domestic companies which have won back market share after the infamous melamine scandal of 2008.

But perhaps the most important issue for infant formula producers has been China's declining birth rate, which hit a record low in 2021.

Forsyth Barr analysts Matt Montgomerie and Andy Bowley expect a mixed bag from the company, once one of New Zealand's biggest by market capitalisation.

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"After a solid first-half result, we forecast a second-half sequential Ebitda decline to $87.3m from $97.6m given lower margins as marketing and other [selling, general and administrative] costs outpace revenue growth," they said in a research note.

Now that the former high-flyer - which has recently become a manufacturer through its majority owned Mataura Valley Milk - appears to be on a more modest trajectory, it has given rise to talk that the company many soon pay a dividend or undertake more capital spending.

Forsyth Barr said the result was likely to contain a number of moving parts, given lockdown impacts on both costs and revenue in the second half.

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A2 Milk's infant formula trade into China is in two broad forms.

There is China label (CL) - formula marketed in the PRC with a Chinese label, which is likely to have landed via conventional export channels.

Then there is English label (EL) - product that is likely to have come off a shop shelf in Australia before being sent to China either though the unofficial "daigou" route or via cross-border e-commerce channels.

Forsyth Barr says the data remains supportive for strong CL growth, driven by market share gains.

"We forecast second-half CL revenue of about $227m, up 20 per cent, versus first-half 2022 and up 28 per cent versus second-half 2021."

However, the English-label business is likely to remain under pressure.

A2 Milk does not typically issue earnings guidance at its annual result, but the company can be expected to make forward-looking comments.

Dual-listed a2Milk has an estimated $700m on its books - retained earnings from more prosperous times.

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"Updates on balance sheet utilisation will be of interest," Forsyth Barr said.

A2 in the news

A2 Milk has lately been in the news as a possible supplier of formula to the US market, where there is a shortage.

But early this month, a2 Milk said it had received notification from the US Food and Drug Administration (FDA) that it was deferring further consideration of the company's request for enforcement discretion to import infant milk formula products into the US.

A2 Milk's main infant formula market is China, and analysts have debated whether the ability to send stock to the US would be a help or a hindrance.

While a2 Milk does not sell formula in the US, the company has for many years made a big push there with its dairy products, which contain just the a2 beta protein and not the a1 beta protein that exists in standard milk.

The US infant formula market has been notoriously difficult for outsiders to break into, with major US players Abbott and Mead controlling about 70 to 80 per cent of the market.

Still, the FDA episode raises questions about what a2 Milk's plans are in the US.

Market consensus

In Monday's result, the consensus of market expectations is for revenue of $1.3956 billion in the year, up from $1.206b in the 2021 year.

Market expectations are for Ebitda of $185.8m, up from $133.8m, and an underlying profit of $115.1m (from $91.0m).

The company peaked in the June year of 2020 when its revenue came in at $1.73b, reporting Ebitda of $549.7m and a net profit of $385.8m.

Heartland's search

Heartland Group Holdings this week revealed that it is eyeing the purchase of an Australian start-up bank called Avenue Bank.

Deputy CEO Chris Flood told Stock Takes it had been looking at businesses in Australia for some time.

"It has been very frustrating for the five-year period where we have looked at lots and haven't been able to get anything across the line.

"The real jewel in the crown for us is access to the Australian deposit market to help fund our Australian book."

He said the business was seeing very strong growth in its Australian reverse mortgage book and was excited about the prospects for its new livestock finance business.

"Funding that through retail deposits gives us a lot more diversity and security."

Flood said once it became an authorised deposit-taking institution, Heartland would look to take its business model to Australia.

He said it would take some time to get together but was a long-term opportunity.

"There is nothing certain about the proposal, we are still working on that and there are a number of things that have to land for that to happen."

The deal requires regulatory approvals and Heartland is still working through how it would fund the acquisition.

Heartland Group Holdings is still working through how it will fund its purchase of Australian start-up bank called Avenue Bank. Photo / Google Maps
Heartland Group Holdings is still working through how it will fund its purchase of Australian start-up bank called Avenue Bank. Photo / Google Maps

Asked why it didn't just apply for a banking license directly, Flood said it considered three options: buying a small bank, starting a bank themselves, or going down the emerging bank pathway.

"We elected the third option because we think it is more efficient and effective for us to do that. Buying an existing bank - given I have been through the merger that formed Heartland and a few acquisitions since - it is hard work, changing the culture and the focus. So that was discounted."

He said starting up a bank itself in Australia would be a long pathway so buying the start-up was the best option.

Wages and inflation

As the reporting season nears its end, the key themes have been wages and inflation.

Wage and other cost inflation pressures have been pointed out by companies across a wide range of sectors including Summerset, Freightways, Auckland Airport, My Food Bag and Genesis Energy.

"The ability to pass this on varies and is a key differentiator between how companies are performing," said Salt Funds managing director Matt Goodson.

Softening consumer demand is beginning to emerge in some areas.

Where it has been given, guidance is generally softer, and many more companies than normal in Australia and New Zealand are not providing guidance at all.

"Elevated uncertainty regarding what 'normal' looks like post-Covid is a factor here," Goodson said.

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