The a2 Milk Company Ltd [ASX:A2M] share price is down 24% since the start of the year due to COVID-19 impacts. Are A2M shares now a value play?
After trading as high as $20.05 per share last year, a2 Milk shares are now languishing at $8.68 per share.
The company’s shares are now down 24% YTD and down 40% over one year.
Compared to the S&P/ASX 200 [XJO] benchmark, A2M is trailing a significant 70%.
At its $20 peak, A2M’s P/E ratio might’ve looked to be a bit overstretched but the recent sell-off means a2 Milk’s current P/E is in the low 20s, with a P/E TTM of 22.
Does this suggest that a2 Milk is now a value-type company should its share price slide continue?
Or will investors remain cautious, considering the potential risk factors like rising bond yields, higher milk prices and trade difficulties with China?
a2 Milk guidance downgrade
The A2M share plunge owes a lot to the company’s string of downgrades.
February saw A2M downgrade its outlook for the third time in five months.
The company attributed the downgrades to ‘unprecedented levels of uncertainty and volatility due to COVID-19.’
COVID-19 severely impacted the daigou (reseller) channels the company relies on for boosted sales.
The recovery in the daigou channels is still slow, tempering the company’s guidance.
As a2 Milk commented in the results release, ‘the pace of the recovery in the daigou/reseller channel and in the CBEC channel has been slower than previously anticipated and the Company now expects revenue to be at the lower end of the previous guidance range.’
A2 Milk now expects a lower EBITDA margin due to lower revenue, higher brand investment, longer daigou support (as in the company is helping out resellers) and an adverse channel mix relative to what was expected in December.
a2 Milk half-year results
A2 Milk’s half-year results showed a 16% decline in revenue and a substantial 35% drop in half-year earnings.
According to CommSec, the results were just below the expectations of three analysts surveyed by Bloomberg.
However, revenue was largely in line with the company’s own downgraded revenue guidance on 18 December.
While revenue from the company’s liquid milk products rose 18%, a2M’s revenue from infant nutrition products declined 20% with the company’s ANZ infant nutrition revenue down 31%.
A2 Milk’s gross profit margins shrunk to 26.4%.
Can A2M return to its pre-COVID position?
Vaccines are rolling out worldwide.
China is ramping up its vaccination program.
Australia has largely suppressed the virus.
And, according to CommSec, the end of January saw consumer confidence hit a 14-month high.
So, are things looking up for A2M?
The company believes so, stating in its latest results release that it remains ‘confident in the underlying fundamentals of the business and will continue to invest behind the brand and in its capacity to drive long term growth.’
As evidence, A2M will no doubt hope that investors noticed that its China label infant nutrition sales were up 45.2% and US liquid milk sales were up 22%.
But even if one takes COVID-19 out of the equation, a2 Milk will still have to grapple with fresh variables.
Australia-China volatile trade relations
A2 Milk is in danger of being caught in the crossfire between Australian and Chinese governments, as the two countries hash out diplomatic issues.
As the Sydney Morning Herald reported just this month, China’s embassy in Canberra warned that ‘China-Australia relations will only sustain further damage’ after Australia granted a visa to a Hong Kong pro-democracy politician.
Tensions between the two nations have already resulted in trade restrictions on Australian seafood, coal, wine and six other exports throughout 2020.
Speaking to Livewire Markets, DNR Capital’s Chris Tynan commented that the ‘Chinese government has shown a willingness to intervene in any number of markets’ as wine producers can attest.
However, Mr Tynan did point out that, at a government level, New Zealand fared better diplomatically than Australia.
For Mr Tynan, ‘A2 Milk’s greatest asset right now is probably not being Australian.’
But putting any risks of China’s trade restrictions impacting A2M aside, there is also the competition risk of China’s local infant formula producers.
As Mr Tynan noted, Chinese producers like Feihe have invested aggressively recently and have managed to ‘deliver innovative formulations and new product developments.’
A2 Milk management drama
As the Australian Financial Review reported, a2 Milk is also reeling from a management spat.
Former A2M chief executive Jayne Hrdlicka claimed in a feature profile that she resigned in December 2019 ‘because her husband had cancer’ and ‘I don’t think A2 handled that particularly well.’
In response, the company’s chairman David Hearn wrote to Hrdlicka requesting that she immediately correct ‘material misstatements’.
Investors interested in A2M shares will certainly follow both its moves and the wider COVID-19 recovery when making their investment decision.
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