I think the A2 Milk share price is a buy

I think that the A2 Milk Company Ltd (ASX:A2M) share price is a buy after reporting its FY20 result to the share market.

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I believe that the A2 Milk Company Ltd (ASX: A2M) share price is a buy after the infant formula company reported its FY20 result.

The highlights

There were a number of impressive financial numbers reported by the company.

Total revenue increased by 32.8% to NZ$1.73 billion. Earnings before interest, tax, depreciation and amortisation (EBITDA) increased by 32.9% to NZ$549.7 million.

Net profit after tax (NPAT) rose by 34.1% to NZ$385.8 million with operating cash flow of $427.4 million.

The business finished with a closing cash balance of NZ$854.2 million.

Segment growth

Infant nutrition revenue rose by 33.8% to NZ$1.42 billion, which is impressive considering this came after years of strong growth.

Liquid sales revenue across the business rose by 29.7% to NZ$222 million.

One of the main reasons I think that the A2 Milk share price is a buy is due to the international growth potential.

Chinese label infant nutrition sales more than doubled to NZ$337.7 million and the distribution was expanded to 19,100 stores. The China label infant formula brand now accounts for 24% of the total infant formula business.

In October the company launched a new Hong Kong label range of infant formula and in December it launched stage 1 to stage 3 infant formula in South Korea with its partner YuhanCARE. In March A2 Milk entered into a licensing agreement with AgriFoods in Canada to produce, market and distribute the A2 Milk fresh milk brand. These are promising moves. 

A2 Milk is growing strongly in the US with revenue growth of 91.2% to $66.1 million. Distribution has now reached 20,300 stores, up from 17,500 stores at the end of December 2019. Interestingly, the company said the economic environment has led the company to reduce its focus on broadcast advertising and emphasise the in-store price and activation to drive demand. It's expecting an improved EBITDA result here for FY21.

Guidance

The company said there continues to be uncertainty due to COVID-19, but overall in FY21 it's expecting "continued strong revenue growth" supported by continuing investments in marketing and operational capability.

It's expecting the FY21 EBITDA margin to be between 30% to 31% due to higher raw material and packaging costs (partly offset by price increases), more marketing spending, foreign currency and pantry stocking benefits unlikely to be repeated. Over the longer-term A2 Milk is still aiming for a 30% EBITDA margin – I think that strikes the right balance of profitability and investing for growth.

The A2 Milk share price fell heavily during the second half of 2019 when the company was guiding that its EBITDA margin would decline due to investing more for growth. 

Growing balance sheet

I thought the comments on its capital allocation were particularly interesting. A2 Milk said that due to the growing scale of its business, it considers it appropriate to assess participation in its manufacturing capacity and capability to complement its existing supply chain relationships. The company is evaluating the options.

There is potential for returns to shareholders after the company said it was reviewing its capital requirements for the future. It needs to keep enough capital to remain robust, but I think A2 Milk could (and should) start to reward shareholders with a reasonable dividend, or perhaps share buybacks if it's at a good share price to do so. It may soon have NZ$1 billion of cash on the balance sheet to decide what to do with.

At this share price I think A2 Milk is a buy

At the time of writing the A2 Milk share price is down around 5%. But that's just today's reaction. Since the start of 2020 the A2 Milk share price has risen by 32%.

The company has enormous international growth potential. It's early days in the US and it's only just getting started in Canada. There are legitimate China worries, but don't forget that A2 Milk is a New Zealand company, not an Australian one.

It's currently trading at 28x FY22's estimated earnings. I think that seems much more reasonable than many other growth shares that are trading much more expensively, even though the profit growth rates aren't that different. I'd be happy to buy A2 Milk shares for the long-term today. 

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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