Stock Takes: A2 Milk’s can conundrum - what to do with a mountain of money

A2 Milk is facing a problem most other companies would love to have: what to do with a mountain of cash.

The company’s annual net profit was a creditable $144.8 million, up 26.2 per cent on the previous year, but the market punished the stock for what was deemed to be a lacklustre earnings outlook.

Cash on hand, however, is not a problem.

Even after completing a recent on-market share buyback of $149.1m, at balance date the company still had a lazy $757.2m lying around.

Devon Funds head of retail Greg Smith said there was some disappointment that a2 did not announce a dividend or share buyback.

“Companies return cash in the form of buybacks when they have no better use for it, typically.

“A2 Milk does have some capex requirements coming — up to $100 million for Matarua Valley — and they are investing in their supply chain,” Smith said.

“Potentially, once all that is done, there may be something in the way of a distribution to shareholders.”

There is always conjecture in the market about whether buybacks are preferable to straight-out cash distributions to shareholders, Smith added.

Buybacks are less “visible” to shareholders.

“A dividend of $100m to shareholders is more visible than a company announcing that it is going to buy back $100 million in shares,” Smith said.

China — a2 Milk’s biggest market and New Zealand’s biggest export destination for dairy, meat and logs — is weighing on the company.

“The big thing about a2 Milk is that they are gaining market share, but they are getting market share in a declining market,” said Smith.

“China’s birth rate is at record lows, so it’s not going in the right direction for a company that sells infant formula.

“Add to that the fact that China’s economy has not bounced back as many had thought, and there’s increased competition.”

Not only is China weighing on New Zealand; it is also a factor in global market sentiment at the moment, he said.

Clouds are gathering over the dairy sector after a series of big downgrades in the forecast milk price and a worsening economic conditions in the People’s Republic.

A2 said despite an expected double-digit decline in China’s infant formula market in 2024, the company expects to increase its market share and achieve group revenue growth in the low single digits in 2024, and an ebitda-to-sales margin broadly in line with the 13.8 per cent achieved in the 2023 year.

Analysts had expected a material improvement margin forecast for the year ahead.

The first wave

Brokers Craigs Investment Partners noted the wave of results out this week, with a2 Milk, Mercury, Chorus, Freightways, Genesis, Air NZ and others releasing their numbers.

“Overall, we are seeing things progress as expected – results are solid, but some outlook statements are missing the mark [and being punished].

“The more defensive names are holding up better, although even good results are seeing small amounts of share price weakness,” Craigs said.

“For now, it feels like the market is focused on sizing up the guidance statements for 2024.

The more defensive names are holding up better, although even good results are seeing small amounts of share price weakness, analysts said in the wake of some big company results this week. Photo / NZME

“The key question is whether the outlook statements are realistic or conservative.

“We have seen companies where the macro outlook is uncertain [and recent momentum has been negative] get sold off, regardless of valuations.

“Some of our more defensive names have produced good results and stable guidance, but have still seen soft share price moves. We put this down to 1) a reasonably full starting valuation, and 2) the recent lift in swap rates will be making some of the yield names slightly less compelling.

“No doubt some bargains will emerge, but at this stage, our best guess is that a meaningful recovery in any of the ‘beaten up’ stocks won’t occur until the dust settles on the reporting season.

“We expect less of the typical bargain-hunting activity we have seen in the past.”

Air NZ mojo

Air New Zealand is paying a special dividend of 6c a share, meaning it will pay out just on $200m to shareholders. It’s the first dividend since 2019 and is fully imputed, and it came as the airline reported the second biggest underlying profit in its history, $585 million.

Jarden analysts say the “encouraging” dividend was higher than forecast and the airline doesn’t expect to have imputation credits for future dividends until it has absorbed $239m of accumulated tax losses.

Following a June update, the airline’s result came with few surprises, Jarden said.

“The return of dividends was well signalled, and a conservative payout range likely reflects uncertainty around the near-term macro environment alongside elevated capex plans.”

Fuel makes up about 25 per cent of the cost of operating a long-haul flight and the airline’s chief executive Greg Foran says a $1 shift in the price of a barrel of jet fuel has a $12m impact on its bottom line.

The airline was helped in the past year by a fall in prices, but faces higher costs in the current year.

Air New Zealand assumes an average jet fuel price of US$105 per barrel for the 2024 financial year and an associated total fuel cost of $1.8b versus $1.3b in 2019.

“Air [NZ] has not provided guidance for 2024 [a feature of pre-Covid full-year results] noting uncertainty around international competition, fuel prices, a weaker NZ dollar and ongoing wage inflation,” Jarden said.

Senior portfolio manager at Harbour Asset Management, Shane Solly, said the airline had delivered strong financials and conservative guidance. He said Air New Zealand was “getting its mojo back”.

Next week

Meanwhile, the reporting season trundles on next week. Restaurant Brands reports its half-year result on Monday, while Tuesday will see annual results from Meridian Energy, Tourism Holdings and Vulcan Steel. On Wednesday, Move Logistics is set to report.