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A2's shares hit record on 1H results, Fonterra deal

Wednesday 21st February 2018

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A2 Milk shares spiked 16 percent to a record after the company announced it had more than doubled first-half profit on strong infant formula sales and has aligned itself with Fonterra Cooperative Group which will see the two companies partner up on a range of products. 

Net profit rose to $98.5 million in the six months ended Dec. 31 from $39.4 million a year earlier as sales climbed to $434.6 million from $256 million, Auckland-based, Sydney-headquartered a2 said. The shares jumped to a record $10.80 in the first two minutes of trading this morning.

The milk marketing firm used its first-half result to unveil a strategic partnership with Fonterra, with the world's biggest dairy exporter agreeing to exclusively supply a2 with A1 protein-free milk products in bulk powder and consumer packaged forms, in exchange for an exclusive licensing agreement to produce, sell and market a2 branded fresh milk for end sale in the New Zealand market.

The two companies will establish an A1 protein-free milk pool in New Zealand and a new  A1 protein-free milk pool in Australia, and Fonterra also gets exclusive supply rights for some products in new markets for a2 in South East Asia and the Middle East up to a specified volume. The companies are also evaluating selling new a2-branded products such as butter and cheese in Australia, New Zealand and China.

On a media conference call this morning, A2 managing director Geoff Babidge said the Fonterra deal had come after the two companies had been in talks for some time. A2's board had looked at a number of different options to introduce its branded fresh milk to the local market, something which shareholders have been asking about as the product is available in Australia, but he was satisfied it was "the optimum model to introduce our brand in a meaningful way across all of New Zealand moving forward."

"It's the start of a journey moving forward, and a number of these things will take time to flow through," Babidge said. "We're extremely satisfied with our supply agreement with Synlait but we also have to look to the future and make sure we have sufficient capability to supply products."

Despite this, Synlait's shares dropped 6.7 percent to $6.58 in the first four minutes of trading, while Fonterra Shareholders Fund units were up 0.3 percent to $6.02.

The a2 milk will have a premium farmgate price, Babidge said, though he said the detail of how this is put in place in conjunction with Fonterra in Australia and New Zealand is subject to further discussion. 

Babidge said the geographic diversification of production Fonterra can offer was seen to be a benefit, though said the company doesn't have an issue of limitation by supply in any of its markets. It sources locally for its fresh milk in Australia, the UK and US, and gets supply for its formula from Synlait in the South Island.

"The available pool of a2 cows internationally is certainly not a limiting factor for the growth of our business, or over time to Fonterra," he said. "We will work with Fonterra in building herds and farmer relationships, and that will start to further develop in the next 12 months."

Over time, Babidge said he expects a2 fresh milk will take share from products such as almond milk because of nutritional benefits and naturalness of the product. A2 milk is credited as being easier to digest for people with lactose intolerance.

In the results commentary, Babidge said he expects continued revenue growth in nutritional products in Australia, New Zealand and China in the second half, along with further growth in fresh milk in the United States. He said gross margin will be broadly consistent with the first half's 49.8 percent, and earnings growth in the second half will be in the range of $35 million to $40 million.

A2's board didn't declare an interim dividend, and said it was continuing to consider implementing a dividend policy along with an on-market share buyback as it evaluates the best use of its available capital. The board is also reviewing opportunities to invest directly in blending and canning capability as part of its longer-term nutritional products sourcing plan, it said.


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