A2 Milk cut to underperform at First NZ as brokerage awaits proof Australian success can be replicated

Wednesday 25th November 2015

A2 Milk, whose shares soared 65 percent in just over two weeks, was cut to 'underperform' at brokerage First NZ Capital, which said it wants evidence the milk marketer can repeat its Australian success in other markets such as China, the UK and the US.

The shares fell 0.8 percent to $1.22 on the NZX today, having soared to a record $1.27 yesterday from 77 cents on Nov. 6. A2 Milk, whose shares also trade on the ASX, has been part of an Australian rally driven in part by media reports of a shortage of infant formula across the Tasman in the face of rising demand in that market and in China. Infant formula maker Bellamy's Australia has climbed about 32 percent in the past two weeks, while health supplements maker Blackmores, which last month announced a tie-up with Bega Cheese to market infant formula in China, jumped 35 percent at the end of October.

Analysts at First NZ say articles in the Sydney Morning Herald helped propel a2 Milk's shares in the past two weeks, starting with one on Nov. 8 that reported a shortage of infant formula on supermarket shelves, a report that the company was considering building an infant formula plant, and one that asserted the product was "the new iron ore", a reference to the boom Australia's resources sector had enjoyed supplying China's steel mills. Also helping, the company raised guidance for sales and earnings at its Nov. 17 annual meeting, which coincided with former cornerstone shareholder Freedom Foods Group selling its remaining 10.4 percent stake.

First NZ kept its share price target unchanged at $1.18, while saying successful strategy execution in Australia, the UK, China and the US "could justify a high-case DCF-based valuation of up to $1.53." The lower target price reflected an assessment of the success probability and "potential execution slippages" in a2 Milk's key markets, the brokerage said in a note.

"While we have respect for management's exceptional execution to date in Australia, our confidence in the duplication of this success elsewhere requires further progress in other markets," it said. The downgrade to 'underperform' from 'outperform' was based on a2 Milk's current stock price and the brokerage's rating framework, it said.

First NZ assumes the company's infant formula sales in Australia reach 7,500 tonnes in 2025 from a forecast 5,600 tonnes for 2016, with some of that production potentially finding its way to China via "grey channels" involving third parties. Its share of Australia's liquid milk market is assumed to reach 3.6 percent by 2025, from 2.7 percent in 2016.

Sales in China are projected to reach 3,000 tonnes a year, worth US$110 million, in 2025, from the projected 400 tonnes worth US$15 million in 2016. For the UK, the brokerage assumes a 1.5 percent share of the liquid milk market in 2025, although "until ATM demonstrates further progress and traction in the liquid milk segment, we think it is prudent to exclude possible upside from the potential introduction of other a2-type based products including ATM's infant formula portfolio," it said.

It puts the same rider on its assumptions for the US market, where it sees the company gaining 4 percent market share in California in 2025 and about 0.5 percent in the rest of the US.

Some 55 percent of First NZ's $1.18 target price is accounted for from an assumed aggregate 10,500 tonnes of infant formula sales at an average earnings margin of 27 percent by 2025, from 6,100 tonnes in 2016. A further 36 percent is from the balance of its Australian portfolio, mainly liquid milk. The remaining 9 percent of the target price comes from the risk-weighted valuation of the US and UK operations.

To justify a price target of $1.22, the company would have to lift infant formula sales to 15,500 tonnes a year.

"At this juncture, we think it is prudent to wait for confirmation from evidence of execution in ATM's direct infant formula sales into China as well as the company's planned distribution roll-out into the USA market," it said.

BusinessDesk.co.nz

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