Investors will soon discover what's next in store for a2 Milk after Covid-19 lockdowns, greater competition and a declining birth rate in China disrupted its infant formula business, causing a slump in the former high-flier's share price.
A2 Milk's net profit plunged 79.1 per cent to $80.7 million in the June year due to the prolonged impact of the pandemic and a rapidly changing China infant nutrition market, prompting the company to review its growth strategy.
Chief executive David Bortolussi, who has been in the job for just under a year, is set to update the market on that review on Wednesday.
Craigs Investment Partners, in a research note, said the decline in sales for a2 Milk since before the pandemic was due to three major factors.
• Continued decline in the market share of international brands in China versus domestic, from 56 per cent in 2018 to 49 per cent in 2020.
• Increasing competition in the A2 category, so that a2 Milk has been losing market shares since early 2020.
• A decline in China's birth rate, which is expected to continue, despite the government's relaxation of its birth policy.
The a2 Milk business model is based on the premise that milk containing just the a2 beta protein can help people who have trouble digesting milk.
Much of its success has been put down to its popularity in the grey market daigou channels from Victoria and New South Wales into China.
The company's share price, while nowhere near last year's peak of $21.51, has been building in recent weeks based on positive news from other foreign infant formula players selling product in the PRC.
However, reports of class action lawsuits by disgruntled shareholders against the company over a perceived lack of disclosure have taken the shine off sentiment surrounding the stock, which last traded at $7.18.
Positive noises have emerged in recent weeks from Australia's Bubs - a minor player in the Chinese infant formula market - and the multi-national French food giant Danone.
Bubs, which specialises in goat milk products, said its China business had rebounded strongly with total gross revenues increasing in its first quarter by 156 per cent on the same period last year, and nearly double that of the previous quarter.
Demand for Bubs infant formula has surged in the daigou channel, up 6.5 times on the prior year and up 265 per cent quarter-on-quarter.
It was a similar message from Danone in its third-quarter report.
"As expected, growth was led by China, which grew double digits with a broad-based contribution from all channels. Channels distributing domestic labels delivered another quarter of mid to high single-digit growth while International labels sold in cross-border e-commerce platforms kept posting steep double-digit growth," Danone said.
The French company said its cross-border indirect channels, which notably include the informal daigou trade channels were back to growth after having declined by about 60 per cent in the same period last year.
Sam Trethewey, portfolio manager at Milford Asset Management, said reports from Bubs and Danone had boosted optimism about a2 Milk's prospects.
"Shareholder ownership (of a2 Milk) is light at present given it has been such an underperformer last year," Trethewey said.
"A lot of people gave up on it last year - it's come back a long way from over $21."
But it's not all good news for the foreign infant formula companies in China.
Nestle, in its latest nine-month report, reported weaker sales in China. The Swiss food giant, in a bid to turn its China infant formula business around, is reviewing its portfolio and distribution strategies.
On what to expect at a2 Milk's investor day, Trethewey said: "We would like to see a clear plan from a2 Milk outlining their new strategy and how they are going to compete in what has become a more competitive Chinese market, where the dominant players are now the domestic brands.
"The cost of doing business in China has materially changed, so the amount that they have to pay in terms of marketing and distribution has gone up as well," he said.
The foreign infant formula companies doing business in China are facing increasingly stiff competition from the local players, particularly Feihe.
A report from Bloomberg Intelligence said Feihe may ratchet up its rivalry with Nestle and Danone in China's affluent cities, capitalising on new mothers ditching overseas infant formula brands for homegrown alternatives, with a nudge from Covid-19.
"Feihe's premium and super-premium infant-formula product lineups position it well to capture affluent Chinese urban moms' growing preference for homegrown infant formulas, giving it an edge over Nestle, Danone and Reckitt Benckiser," the report said.
While data on pregnancy intentions in China is scarce, a survey by popular baby website mama.cn found that 59 per cent of women that had been planning to have a baby had decided to delay pregnancy until three or more months after getting vaccinated, according to Craig's research.
Given China only achieved high vaccination rates in August, a further decline in China's birth rate appears likely over the next 6-9 months.
This may be followed by a "baby boom" from late 2022, however timing is unclear given the need for booster shots.
The long-term trend remained challenging.
"We also doubt that China's new Three Child policy will have much success in arresting the structural decline in the country's birth rate. This, after all, has chiefly been driven by increasing wealth, and has followed trends in Japan, Taiwan and South Korea," the Craigs report said.
Harbour Asset Management senior research analyst Oyvinn Rimer expects Wednesday's presentation to map out the likely direction of the company over the next two to four years.
He expected the review to cover how to deal with China's declining birth rate and insights into new products.
"Probably one of the most disappointing things about a2 Milk in the last number of years is their lack of product development - so basically they have been running the same product for a very long time now without putting something new out there," Rimer said.
"David has been in the hotseat for about a year now and he has come to a point where he will have a view as to how best to turn the company around."