It is a rare sight to see the A2 Milk Company Ltd (ASX: A2M) share price underperforming the S&P/ASX200. Ever since the company’s FY19 results were released back on 21 August, the share price has either been going lower, or going sideways.
So, when will investors witness a2’s return to former glory as one of the leading growth shares in the ASX?
How did we get here?
a2’s full year result was the catalyst that triggered the sell-down and flipped sentiment upside down. As a whole, the result read quite well with revenues increasing 41.4% and net profit increasing 47%. However, the result was overshadowed as a slight earnings miss that also highlighted the withdrawal of its UK business segment, a significant $44 million earnings before interest, tax, depreciation and amortisation (EBITDA) loss in its US business and an abnormally high expenditure on marketing.
The company had come to the conclusion that the UK opportunity was not of sufficient scale when compared to the significant growth potential in Greater China and the US. The decision to leave the UK after 7 years of operation was disappointing.
The US business had revenues increase by more than 160%, driven by heavy marketing efforts and a significant expansion in distribution. However, investors were troubled when the segment delivered an EBITDA loss of $44.0 million.
In an effort to build sustainable growth, the company has made a significant investment in marketing and branding efforts. The results announcement cited that the company would be spending “$135.3 million representing 10.4% of sales and an increase of 83.7%” on marketing. Investors are eager to see if such a large marketing spend will pay dividends for the company’s future earnings.
What do investors need to see from a2?
The US business segment needs to regain the trust and confidence of investors. While US revenue has grown by more than 100% during each of the last 3 years, it is not worth an FY19 EBITDA loss of $44 million. a2 needs to demonstrate that its marketing and distribution efforts are paving the road to profitability in the US.
a2 has traditionally performed very well in the Australian and New Zealand markets. The company needs to continue to demonstrate leadership in this space by growing market share in fresh milk and baby formula. However, the growth of other business segments, such as cross-border e-commerce (CBEC) and China label segments have outpaced the growth of its ANZ segment.
The current trajectory indicates that CBEC and China-label channels could generate more revenue for a2 Milk than ANZ in the next 1–3 years. a2 has provided examples of its marketing activities in China including broadcast media to build awareness, in-store education and activation to drive trial, trade and retail awareness buildings. Whether it’s growing market share in China, or CBEC and China-label channels overtaking ANZ revenues, a2 needs to demonstrate that its marketing efforts will make a sustainable difference to its growth.
a2 Milk will have its annual general meeting on 19th November, which may include a business update and/or renewed guidance.
Overall, I believe a2 has a lot to prove to the market before it becomes a worthwhile growth story. Therefore I would prefer to watch the stock from the sidelines.
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Motley Fool contributor Lina Lim 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.