China sales fuel a2 Milk profit jump

A2 Milk is seeking to bolster its supplies after doubling its infant formula sales in China.

a2 skim milk powder. Picture: PETER HEMPHILL

A2 Milk is mulling switching from being solely a brand owner to a manufacturer in a bid to bolster supplies of infant formula after a doubling of sales in China and the outbreak of coronavirus further strengthened demand.

The company has a long-standing contract with New Zealand dairy group Synlait, which holds the exclusive to manufacture its infant formula, and has a nutritional milk powder manufacturing partnership with Fonterra.

While A2’s board has been considering whether to transition from brand ownership to manufacturing for the past five years, chief executive Geoff Babidge said it was unlikely it would follow beleaguered vitamins group Blackmores in buying its own factory.

“Our preference would be to work with others in taking some kind of investment in manufacturing capacity,” Mr Babidge told The Australian.

“The important thing is we have very strong relationships with Synlait and Fonterra and we want to be doing something that is complementary and ensures we maintain those positive relationships.”

“We understand our strengths and our weaknesses, and manufacturing per se is not a core strength of our business at this point in time.”

Blackmores made the switch from brand owner to manufacturer last year when it acquired a factory in Braeside east of Melbourne for $43m from US pharmaceutical giant Catalent. On Tuesday, Blackmores chief executive Alastair Symington said while the factory was “in good shape” it was expected to wipe $9.5m off full-year earnings.

Citi analyst Sam Teeger said if A2 followed Blackmores and built its own factory it would reduce the “capital-light nature of the business”.

“But (A2’s own factory) is required in our view to ensure it can comply with evolving Chinese regulations over the longer term,” Mr Teeger wrote in a note to investors.

Sales of A2 infant formula in China soared 100 per cent to $NZ146.7m ($140,) in the six months to December 31. Mr Babidge said sales in China had remained strong in the first two months of 2020, despite the outbreak of the deadly coronavirus, which has killed almost 3000 people and infected tens of thousands more and see China ground to a halt in an effort to limit its spread.

A2’s shares surged 5 per cent to $15.75 on Thursday, lifting as much as 7 per cent intraday, against a flat broader market.

Mr Babidge said A2 had continued to get products into China using sea and air freight, while its partnership with China State Farm had ensured distribution throughout China had remained uninterrupted.

During December 2019, distributors requested additional product in advance of Chinese New Year which brought forward about $NZ8m of sales from January to December.

Mr Babidge said online sales had risen, with most people in China working from home to avoid possible infection of the virus.

“We are working very hard to ensure our product is available through the various channels. You would expect, as is the case, the online channel would be higher in consequence of the coronavirus.

“But also our China label sales are also higher because of the support and processes we have in place with China State Farm to get product out to various regions.”

While strong sales have continued in China in January and February, Mr Babidge said it was too early to gauge the full impact of the virus.

“Clearly because the product is not discretionary, there is a clear need. But we can’t be certain as to the impact of the full (second) half as to whether that will continue to be positive.”

Overall, the company’s revenue rose 31.6 per cent to $NZ805.3m. Its infant nutrition segment was the biggest driver of growth, increasing 33.1 per cent to $NZ659.2m. Meanwhile net profit jumped more than 21 per cent to $NZ184.9m.

Mr Teeger said the rise in net profit beat Citi’s forecast by 8 per cent, which he was driven largely by stronger-than-expected sales growth.

“The coronavirus has led to second-half revenue to date being above company expectations,” Mr Teeger said.

Macquarie analysts said A2 “continues to deliver strong top line growth, gross margin expansion and EBITDA margins”.

“We still see significant runway for growth in existing markets, and new product/market scalability.”

In other markets, Mr Babidge said A2 was on track to hit $US100m ($152.6m) a year in sales in the US, although he didn’t give an exact timeframe on when the company would achieve that milestone, only to say it would be in the “near future”.

It comes following a tumultuous period for the company which included Mr Babidge returning to his role in early December after former chief executive Jane Hrdlicka agreed to step down from the company after 18 months in the top job.

Chairman David Hearn said at the time A2 Milk’s board and some of its investors were worried about the pace at which Ms Hrdlicka was transforming the company, which was eating away at its profit margins.

At the group’s full year results last August, Ms Hrdlicka warned an increase in marketing would result in EBITDA margins falling from 31.7 per cent in 2019 to about 28 per cent in 2020.

But on Thursday, Mr Babidge unveiled an EBITDA margin of 32.6 per cent for the half year, which he said was better than expected.

When asked how much of the half-year result was attributable to Ms Hrdlicka’s leadership, Mr Babidge was gracious towards his predecessor and said it was “team effort”.

“The reality is that this performance is reflective of the contribution Jane, management and the board have all made in continuing to take the business forward, quite frankly from the time when I was (last) in the chair.

“It’s important to understand that this a result that is shared all across the team.

“The business today is stronger, larger and more successful from even the time I stepped down and we will continue to take all of the good things that have progressed in recent times forward.”

The company will not pay an interim dividend.