China Expansion And Vertical Integration Will Drive Strong Long Term Upside Potential

Catalysts

About a2 Milk

The a2 Milk Company produces and markets premium dairy and nutritional products based on A1 protein free milk across key global markets, with a particular strength in infant and child nutrition.

What are the underlying business or industry changes driving this perspective?

• Expansion of China label access via the Pokeno acquisition, lifting product registrations from one to as many as three, positions a2 Milk to capture structurally higher share in the world’s largest infant formula market, supporting sustained revenue growth and higher brand earnings contribution by FY 2030.
• In sourcing of a2 Platinum and other IMF production into a2 Pokeno, combined with divestment of the loss making MVM asset, is expected to unlock substantial vertical margin capture and drive a step change in group EBITDA margin and returns on invested capital from FY 2027 onward.
• Strengthening consumer preference for English label IMF, supported by premiumization, online channel expansion and products such as Genesis and Gentle Gold, provides a long runway for mix driven revenue growth and gross margin expansion in China and Other Asia.
• Broadening the life stage portfolio into kids, adults and seniors, alongside entry into emerging markets such as Vietnam and ongoing growth in North America and South Korea, diversifies earnings and supports a higher long term revenue base with improved resilience of cash flows.
• Deepening partnerships with Fonterra and Open Country to secure large scale A1 protein free milk pools, together with manufacturing investment and sustainability initiatives like low emission boilers, should enhance supply reliability and cost efficiency, underpinning net margin and earnings growth over the medium term.

Assumptions

This narrative explores a more optimistic perspective on a2 Milk compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts. How have these above catalysts been quantified?

• The bullish analysts are assuming a2 Milk's revenue will grow by 8.9% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 10.7% today to 15.1% in 3 years time.
• The bullish analysts expect earnings to reach NZ$369.6 million (and earnings per share of NZ$0.51) by about December 2028, up from NZ$202.9 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as NZ$273.6 million.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 29.8x on those 2028 earnings, down from 36.3x today. This future PE is greater than the current PE for the AU Food industry at 10.6x.
• The bullish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.1%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• China infant formula demand may remain structurally weak despite a recent Year of the Dragon bump, as the long-term trend of declining birth rates and an overall market contraction persists. This would limit a2 Milk's ability to grow China label and English label volumes and could slow consolidated revenue growth and earnings expansion over time.
• The Pokeno acquisition and broader supply chain transformation introduce execution and regulatory risks, including delays or failure to secure and amend SAMR registrations, and slower than planned in-sourcing of a2 Platinum and ramp up of new China label products. This could leave the facility loss making for longer than expected and depress group EBITDA margin and returns on invested capital through FY 2029 and beyond.
• Intensifying competition in both English label and China label IMF, particularly from global incumbents with advanced HMO and specialty formulations, may cap a2 Milk's market share recovery in key cross border and online channels. This could force higher marketing and trade spend to defend share, which would pressure net margins and may prevent EPS from compounding at the bullish assumed rate.
• Heavy strategic dependence on China, with China and Other Asia driving most of the company’s growth, leaves a2 Milk exposed to long-term policy, regulatory and channel changes, such as shifts in cross border rules, changes in childcare subsidies or tighter product standards. Any of these could disrupt distribution, constrain pricing power and reduce revenue visibility and cash conversion.
• The strategy to capture vertical manufacturing margin requires substantial upfront capital expenditure, working capital build and the exit of the MVM asset. If facility economics at Pokeno underperform, if utilization lags plan or if milk input costs rise structurally, the anticipated margin uplift may not materialize, leading to lower than targeted EBITDA, weaker net profit and a reduced return on the more than $400 million of net invested capital.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for a2 Milk is NZ$12.4, which represents up to two standard deviations above the consensus price target of NZ$10.16. This valuation is based on what can be assumed as the expectations of a2 Milk's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of NZ$12.4, and the most bearish reporting a price target of just NZ$8.0.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be NZ$2.5 billion, earnings will come to NZ$369.6 million, and it would be trading on a PE ratio of 29.8x, assuming you use a discount rate of 7.1%.
  
• Given the current share price of NZ$10.16, the analyst price target of NZ$12.4 is 18.1% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.