a2 Milk lifts earnings guidance, extends Synlait supply deal

The a2 Milk Company ASX A2M infant formula China US sales
Infant formula giant The a2 Milk Company has upgraded its outlook thanks to stronger sales in China and the US.

Infant formula giant The a2 Milk Company (ASX: A2M) has upgraded its earnings outlook for the 2020 financial year on stronger sales performance in China and US markets.

In its annual meeting, the New Zealand-based dairy company said its full-year earnings before interest, tax, depreciation and amortisation (EBITDA) margin is now anticipated to be in the range of 29-30% – higher than the 28.2% margin forecast upon the release of the 2019 fiscal results in August.

The company attributed the uplift to its “strategic gross margin focus”, with gross margin benefiting from an improved price yield and a reduction in costs of goods sold.

At the annual meeting, a2 chief executive officer and managing director Jayne Hrdlicka said the company has been trying to “step up” the role it plays as a “unique, premium and modern” dairy nutritional company and is pleased with the early momentum in FY 2020.

“While we have only just begun our journey in both Greater China and the US, the results of strategic focus and investment are starting to come through,” she said.

“Competitive intensity will continue to increase in China and thus far, we have been well prepared.”

“Our investments are strategic and designed to build the brand, deepen our capability and create further organisational depth and resilience to thrive in this environment,” Ms Hrdlicka added.

First-half revenue outlook

According to a2, revenue for the first half of FY 2020 is anticipated to be in the range of $780-800 million.

This expected revenue growth is the result of strong sales performance across several markets including China, Australia, the US and the cross-border e-commence (CBEC) market.

The company said its China label infant nutrition sales are expected to grow by about 84% to reach $135 million, while CBEC infant nutrition sales should increase by 54% to $155 million.

Its ANZ English label infant nutrition sales are forecast to grow by 9% to $350 million and fresh milk sales in Australia are anticipated to grow by 12% to $75 million.

In addition, sales in the US are projected to grow by about 110% to $27 million.

This earnings guidance means the EBITDA margin for the first half is expected to be in the range of 31-32% – higher than the full year.

a2 said this is a result of an expected increase in the cost of goods including lactoferrin and packaging materials in the second half, as well as increased levels of “strategically important trade marketing activation” in China and higher investment in marketing and capability in the second half.

The changing market in China

One of the areas in which a2 is aiming to “step up” is the Greater China region, where Ms Hrdlicka said the company must “evolve dynamically in a fast-changing consumer world”.

“Daigous are sourcing products direct from Australian retail outlets or directly from us as a company. However, this Australian reseller network is evolving well beyond being just personal shoppers,” she said.

“Australian resellers are now more sophisticated using a combination of web-based selling tools, commission-based selling, tapping into social e-commerce networks and other channel pathways into China.”

“We believe we also need to continue to improve the way we engage these channels to accurately track and measure a range of Australian reseller activity as the product flows from them to a combination of ‘new generation’ trade customers and consumers,” Ms Hrdlicka said.

She added that this pathway into China serves only a small part of the total addressable market and a2 will need to increase its ability to execute effectively in other channels including mother and baby stores and CBEC channels.

Ms Hrdlicka also acknowledged that channels outside of what is sourced directly from Australia account for about 90% of the market’s infant nutrition category value and said a2 was “significantly underdeveloped” in the majority of these consumer channels.

“We’re clear as a team that building a sustainable long-term China business requires serving all major established and emerging channels well. This requires continued investment in capability and tools to understand each unique channel in a constantly evolving market,” she said.

Extended supply deal

In a separate announcement today, it was revealed a2 has extended a manufacturing and supply deal with fellow New Zealand dairy company Synlait Milk (ASX: SM1).

The original agreement, for the supply of a2 Platinum formula and other nutritional products, was announced in July 2018 and was for a minimum five-year term, with a rolling three-year term from August 2020.

The revised deal has added two years onto the term duration, making the new minimum term July 2025.

In addition, Synlait has increased its committed production capacity and volume of nutritional products over which it already has exclusive supply rights.

Pricing terms have also been renegotiated to reflect an “ongoing market-competitive pricing regime”, Synlait reported.

Synlait chief executive officer Leon Clement said this long-term partnership is a key component of the duo’s success.

“Infant nutrition is a core focus for both companies as we continue to invest in our future; building capacity and capability to support our respective growth stories,” he said.