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The a2 Milk Company – Update

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A2 Milk has had a disappointing year, having fallen from $21 NZD per share in July 2020 to under $6 at its lowest. Nevertheless, shares in a2 Milk continue to screen as good value at current prices. A2’s brand metrics remain healthy.

A2 shares have fallen primarily due to the logistical issues caused by the pandemic. Previously, A2 sold a lot of their products through a grey channel called “Diagou”. This channel was filled with Chinese students and tourist buying their products from Australian shelves and shipping them back to China. These have largely been replaced with corporate resellers and direct to market distribution. This has lowered margins materially.

As the pandemic hit and borders closed these channels effectively closed overnight. The company has been busily restructuring its management team and oversight of its distribution network. There have been some encouraging signs at the company’s latest investor day and further signs of improvement in their English label products.

A2’s overall infant formula brand awareness continues to improve quarter on quarter, and surveys indicate of six key infant formula brands in China, a2 enjoys top conversion and loyalty metrics once customers trial the product.

The company’s increased marketing focus should further improve unprompted awareness, which has upside compared with peers.

A strong brand is increasingly crucial as the preference for international infant formula brands in China wanes, and consumers are increasingly viewing domestic and international products on an even keel. Despite increasing pricing pressure from foreign and domestic competitors, a2 continues to gain share in Chinese label infant formula.

The main catalyst for this stock improving is easing of the freight bottle necks and the reopening of borders, specifically between Australia and China. Both of which will happen over the medium term. There are signs of easing in the congestion of global logistical lines as the price of freight forwarding has fallen circa 20% since the start of September.

The company has $600m in cash, no debt and is still profitable. It may be difficult for the company to get back to $21 NZD per share, that being said, we see circa $10-12 NZD per share as a real possibility, implying a potential 53% to 83% return over next two to three years from current levels.

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