a2 Milk Company Ltd (ASX:A2M) extends supply agreement

a2 Milk Company Ltd (ASX: A2M) made an early announcement to investors this morning to say that it has extended a supply agreement.

a2 Milk Company has announced a variation to its manufacturing and supply arrangements with Synlait Milk Ltd (ASX: SM1).

Originally, the supply agreement between a2 and Synlait was for a minimum of five years with a rolling three-year term from 1 August 2018.

The new deal

The deal has been given a two-year extension, meaning a new minimum term of five years to 31 July 2023. There will be an increase in volume of infant formula products over which Synlait already has exclusive supply rights.

There is an increased committed production capacity from Synlait. The pricing terms reflect the commitment from both companies to an ongoing market-competitive pricing regime.

a2 Milk Company said this extension is consistent with the global strategic supply plan a2 has been developing over recent times, with supply partnerships that provide multi-site, multi-product and geographic diversification.

The Managing Director and CEO of a2 Milk Company, Geoffrey Babidge, said “This new agreement has been carefully developed to provide the company with security for nutritionals supply to our key markets consistent with our overall strategic objective of maintaining high-quality supply with ongoing cost-competitiveness.”

David Hearn, Chairman of a2 Milk Company, said “This contract extension reflects a2 Milk company’s commitment to continue to build on the excellent relationship that both companies have enjoyed over recent years.”

Time to buy a2?

All eyes are on a2 with its full-year report. The share price is down over 20% since its high in March and there is still a lot of expectation built into the share price.

If a2’s result numbers underperform the market’s expectations over the next year the share price could drop lower despite the likely strong growth.

I expect that over the next five years it is likely to beat the market at the current price but over the next year or so there’s every chance that it falls. It’s trading at 32x FY19’s earnings and 24x FY20’s estimated earnings. It could grow into its valuation over time.

For now, I’d feel better about investing in this top growth share instead, which is much better value.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of A2 Milk. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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