Morningstar | A2’s Growth Engine Remains Solid, and Near-Term Profitability Pressure Not Concerning; FVE Unchanged. See Updated Analyst Note from 30 Apr 2019
Narrow-moat a2 Milk’s rapid growth remains impressive, as highlighted by third-quarter fiscal 2019 results, and our long-term thesis continues to play out. We increase our fair value estimate to NZD 14.50 (AUD 13.60) to account for time value of money since our last update, but following a strong run, the stock now looks slightly overheated.Infant formula remains a2’s primary growth driver, and further market share gains in both Australia and China have led to 42% consolidated revenue growth in the nine months to date in fiscal 2019 versus the previous corresponding period, or pcp. This expansion tracks management’s estimates for second-half revenue to grow in line with the 41% rate posted in the first half and our full-year estimates. Market share across key cities in China increased to 6.0% at the end of March, up from 5.4% in December, supporting our February increase in near-term share gains to a forecast 6.7% by end the end of June 2019 versus our prior 5.9%.
We continue to forecast that a2’s Chinese market share can improve to 15% by fiscal 2028, supported by further distribution expansion and solid execution. Along with gains in U.S. fresh milk, and new products such as a2 Smart Nutrition for children aged 4-12, we see slower, but still robust, consolidated top line growth, averaging midteens through fiscal 2028.
A2 remains on track to hit previously guided EBITDA margins between 31% and 32% in fiscal 2019, tracking our projection. Recent cost increases--the global dairy trade index is up more than 20% since the start of the calendar year, and 5% versus the pcp--and continued marketing investments will likely limit fiscal 2020 profitability expansion, but we expect positive pricing and continued mix shift toward higher-margin infant formula to drive longer-term improvement. However, we expect this expansion will prove slimmer than in prior years, with EBITDA margins reaching 35% by fiscal 2028, as formula already represents a sizable 81% of revenue.
A2 Milk is principally engaged in the commercialization of a2 Milk™ related products as supported by the ownership of intellectual property that enables the identification of cattle for the production of a2 Milk™. Through its associated companies, Co. is also engaged in the distribution and marketing of a2 Milk™ in Australia and Japan and commercialize the sales and licensing rights for the supply, distribution and marketing of a2 Milk™ in the U.S. Co. products are also sold under the Jalna and Fresha Valley brand names. Co. operates predominantly in New Zealand and Australia.
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