Supply Constraints And Capital Costs Will Weigh On Earnings, But New Products May Improve Future Prospects

Key Takeaways

• The company's expansion and reliance on costly air freight impact margins and could pressure revenue if investment returns disappoint.
  
• Challenges in key markets, including declining ANZ performance and competition in China, threaten growth amidst costly product launches.
  
• Strategic growth in China and other regions, product innovation, and efficient supply chain management drive strong revenue and shareholder returns for a2 Milk.

Catalysts

Sells A2 protein type branded milk and related products in Australia, New Zealand, China, rest of Asia, and the United States.

• The declining financial performance in the ANZ segment, especially in the daigou channel, could indicate a potential drop in revenue as a2 Milk struggles to sustain growth in this key market. This situation may worsen if issues persist.
  
• The reliance on significant air freight costs to overcome supply constraints has already impacted EBITDA and net profit margins in the short term, and similar unplanned costs in the future could further compress net margins.
  
• The company's expansion plans, including establishing additional China-label IMF registrations and developing new manufacturing capabilities, require considerable capital expenditure. This may impact future earnings if the return on investment is not as high as expected.
  
• The competitive landscape in the China IMF market is consolidating, with top brands taking more market share. If a2 Milk fails to secure additional SAMR slots for China-label products or does not sufficiently address consumer demand shifts, it may face revenue growth challenges.
  
• The focus on new product launches, such as a2 Genesis and fortified milk for seniors, requires significant marketing investments upfront, which could put pressure on short-term EBITDA margins before these products potentially contribute to revenue.

a2 Milk Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming a2 Milk's revenue will grow by 8.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 9.9% today to 12.9% in 3 years time.
• Analysts expect earnings to reach NZ$288.1 million (and earnings per share of NZ$0.42) by about March 2028, up from NZ$174.0 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as NZ$223.4 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 23.4x on those 2028 earnings, down from 38.4x today. This future PE is greater than the current PE for the AU Food industry at 16.1x.
• Analysts expect the number of shares outstanding to grow by 0.15% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.61%, as per the Simply Wall St company report.

a2 Milk Future Earnings Per Share Growth

Risks

• The a2 Milk Company experienced significant revenue growth in the first half of FY '25 and has increased its full-year guidance, indicating strong financial performance and potential to maintain or increase revenue in the future. This contradicts the belief that the share price will decrease.
  
• a2 Milk has resolved supply constraints and achieved double-digit revenue growth in the China segment, particularly with its English label infant milk formula. The company's focus on product innovation and brand investment could continue to drive revenue growth despite market challenges.
  
• The introduction of dividends and strong cash conversion suggests healthy financials and indicates potential for future shareholder returns, which may positively influence the share price.
  
• The company's strategic advancements in strengthening its supply chain, including transitioning some manufacturing to China for certain product ranges, are supporting efficiency and may bolster profit margins and earnings.
  
• Growth in the U.S. and other regions, along with the expansion into new markets and product categories, such as senior nutrition and fortified milk powders, may contribute to increased revenue and profitability.

Valuation

• The analysts have a consensus price target of NZ$7.649 for a2 Milk based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of NZ$8.68, and the most bearish reporting a price target of just NZ$6.5.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be NZ$2.2 billion, earnings will come to NZ$288.1 million, and it would be trading on a PE ratio of 23.4x, assuming you use a discount rate of 6.6%.
• Given the current share price of NZ$9.24, the analyst price target of NZ$7.65 is 20.8% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• 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.