My ASX share for the week is A2 Milk Company Ltd (ASX: A2M).
I think the infant formula business still has plenty more growth potential for the years ahead.
The company was recently added into the S&P/ASX 50 Index at the expense of AMP Limited (ASX: AMP).
I have been continually impressed by A2 Milk's growth over the past five years. You may not have thought that A2 Milk is the kind of business to grow even faster during a global pandemic, but it is so far.
How is FY20 going?
A couple of months ago the ASX share gave an update that said that revenue for the three months to 31 March 2020 was above expectations. Customers were buying more product to stock the pantry. A2 Milk is also benefiting from the fact that its Chinese segment revenue is transacted in US dollars which was helped by foreign currency movements.
A2 Milk said it's expecting FY20 revenue to be in the range of $1.7 billion to $1.75 billion. This would be growth of 30% to 34% on FY19's revenue. I think that would be a really strong result considering it's after years of good growth already.
The ASX share also said that the full year earnings before interest, tax, depreciation and amortisation (EBITDA) margin is expected to be higher than what was advised at the half-year result and in the range of 31% to 32%. That estimate includes spending the full $200 million marketing budget, weighted to the second half of FY20, will be fully spent before the end of the financial year.
I think this shows how profitable A2 Milk can be if/when its marketing cost growth can rise at a slower pace when it has reached sufficient scale in a region.
There were three main reasons for the higher EBITDA margin. I've already mentioned the first two – higher revenue (and therefore higher margins) and the favourable exchange rate. There were also lower than expected costs for travel and other costs relating to delayed recruitment.
The A2 Milk board is still aiming for an EBTIDA margin of 30% in the medium-term to maintain a balance between growth and investment.
Why A2 Milk is my ASX share of the week at this price
In this type of uncertain environment I think it's a good idea to go for businesses that can keep growing whether there's more global lockdowns ahead or not.
In the short-term there could be another spike in demand. Particularly from Chinese customers because there are more COVID-19 Chinese restrictions again.
Over the longer-term I believe that this ASX share still has a long growth runway ahead. A2 Milk is expanding into the Canadian market with Agrifoods for the production, distribution, sale and marketing of A2 Milk branded liquid milk. Canada is a sizeable potential market for A2 Milk.
What's most attractive about A2 Milk's growth plans is the US and Asia. In the FY20 half-year result the company said USA revenue increased by 115.7% and Asian revenue rose by 76.7%. These markets could continue to generate great results because they have such big populations and A2 Milk's market penetration isn't that big, particularly in the US. It has been rapidly increasing its US store distribution over the past three years but it takes time to win over new customers.
A2 Milk is only just getting started in Canada too and there are plenty of other countries for A2 Milk to expand into.
Is A2 Milk a buy?
The ASX share is generating excellent revenue and profit growth each year. The growth is on par with some of the highly-valued ASX tech shares. Yet A2 Milk's price/earnings ratio seems much more reasonable for its growth rate. It's currently trading at 28x FY22's estimated earnings. I'd be happy to buy some shares today for the long-term.
