A2 Milk Revises Business Strategy to Build Brand Awareness

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A2 Milk Revises Business Strategy to Build Brand Awareness

  • Declining Chinese birth rate from 1.6 live births in 2017 to 1.3 in 2020
  • FY20 EBITDA margin declining from 31.7 percent to forecast medium term margin in the ‘teens’
  • Current 5-year sales target of NZD$2 billion looks ambitious

a2 Milk Company (‘a2M’ or the ‘Company‘) is a business built on clever science for the benefit of human health. Scientist Dr Corrie McLachlan recognised that not all milk is the same. Dr McLachlan’s research revealed that A1 -protein milk promoted intestinal inflammation, causing discomfort in milk-sensitive consumers. Dr McLachlan discovered there was a safe and simple way to identify cows that produced milk that was naturally free of A1 -protein. This is how the a2 Milk Company was born, by recognising the nutritional benefits of the naturally occurring a2 Milk. This explains the extraordinary brand value of milk produced from cows that produce the A2 beta casein protein rather than A1.

Changed market, changed strategy

a2 Milk has released details of how it intends to respond to the unprecedented change in the China infant milk formula market, which is having a debilitating impact on investor sentiment for the Company. The source of this fundamental market shift is the decline in China’s birth rate from 1.6 live births in 2017 to 1.3 in 2020. These Chinese birth rate numbers were released on 11 May 2021. To put it into context, 12 million babies were born in China in 2020, down from 14.65 million in 2019.  This fertility rate of 1.3 is among the lowest anywhere in the world and implies that the Chinese population is expected to begin to decline from 2030.

This explains why on 10 May 2021, a2M confirmed that trading dynamics in the China infant nutritional market were challenging and that revised execution strategies were needed to address these challenges. The most recent message released on 27 October refers to in more detail the revised business strategy to deal with these challenges.

a2M plans to focus on in-store marketing initiatives, including promotional people, ‘mama’ classes, and point of sale materials. This means assuming greater control over its Chinese label and English label products in key channels, by aligning more closely to the consumer. The strategy also includes investing more behind the unique a2 Milk brand, especially within digital markets and ecommerce. The Company intends to expand the China infant milk formula market into new product categories and access more China label registrations over time. Another key strategy is the transformation of the Company’s supply chain, especially in China.

Medium-term outlook

Clearly a2M is facing medium term margin pressure as confirmed by its statement that target margins over the medium term are in the ‘teens’ and over the medium to longer term margins are expected be in the ‘low-to-mid 20s’. These loosely worded estimates compare to the full year FY20 EBITDA margin of 31.7 percent, while on 25 February 2021, a2M announced that its EBITDA margin was at 26.4 percent. The Company has also indicated a medium-term indicative sales ambition of NZD$2 billion. This compares to a2M’s FY21 sales of NZD$1.205 billion. A2M has a lot of work to do in restoring margins to previous historical levels while its 5-year medium term sales target of NZD$2 billion looks ambitious under current circumstances. Nevertheless, a2M has a unique natural product for which a needs-based demand exists.

Caroline Wong

Caroline Wong is a Research Analyst at KOSEC – Kodari Securities. She writes on markets and focuses on ASX Top 300 companies. Email Caroline at c.wong@kosec.com.au.

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