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Is the A2 Milk share price a buy?

Is the A2 Milk Company Ltd (ASX: A2M) share price a buy?

Investors have certainly been answering that question “yes” less enthusiastically in recent months, the A2 Milk share price is down 20% since the end of July 2019.

This was despite reporting that in FY19 revenue grew by 41.4%, earnings before interest, tax, depreciation and amortisation (EBITDA) went up 46.1% and net profit increased by 47%.

But reporting season is more about the profit expectations of businesses compared to the result rather than the result itself.

Whilst the revenue and profit numbers were good, I thought what was even more important was that infant formula market share in China grew to 6.4% and US milk revenue more than doubled and distribution increased to 13,100 stores.

The US and Chinese markets are so large and so important for A2 Milk that it’s okay if other areas of the business (like the UK) didn’t do as well as expected.

Investors may be worried that although the gross profit margin is increasing thanks to economies of scale, the EBITDA margin is expected to be lower in FY20 than FY19. It was 28.2% in the second half of FY19 and likely to be similar in FY20 due to higher marketing investment and organisational capability investment.

On the one hand higher marketing could be due to trying to reach bigger and bigger audiences globally, which is a positive for future growth. However it could also be a signal that competition is rising in its target markets and that A2 Milk needs to spend more to continue on its growth trajectory.

Foolish takeaway

Despite a lower EBITDA margin, A2 Milk is still expected to grow at a good rate in FY20 and into FY21. A2 Milk has a strong brand name and is known for quality, despite its products being in somewhat commodity-like areas of nutrition. I think it’s an impressive, quality business. Quality is worth buying at a good price in this investment environment. 

A2 Milk is trading at 27x FY21’s estimated earnings. It’s not mega cheap, but I think this is quite an attractive price for the profit growth it’s likely to achieve in the next few years compared to many other highly-priced ASX growth shares. I’d be happy to take a position at today’s price.

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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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