I own a2 Milk shares so made some time to dig through the company’s annual report. This is a great way to get a better understanding of the challenges and opportunities that face the company. But three things in particular caught me by surprise:
1. a2 Milk Company is accumulating a huge pile of cash
The first surprise was the huge pile of cash a2 Milk has built up. In fact, in the 2020 financial year, the company’s cash position jumped by a massive 83% to NZ$854 million.
A2 Milk Company is a very capital light business. It doesn’t directly own farms or factories and doesn’t need to spend much cash to grow production.
But what will the company do with all that cash? One option is for a2 Milk to pay a dividend to shareholders. However, a2 Milk says that a dividend is not on the cards. Instead the company is focused on using the cash to execute its long-term growth ambitions.
These include potential acquisitions and last week a2 Milk Company announced it is in discussions to acquire a controlling position in New Zealand dairy processing business Mataura Valley Milk. A2 Milk has proposed splurging up to NZ$270m to acquire a 75.1% stake in the business.
2. COVID-19 is creating problems in the US market
The COVID-19 pandemic created a bump in earnings of infant nutrition in the 2020 financial year, but it is making life a lot more difficult for sales in the United States. Higher unemployment rates and economic uncertainty have made US consumers more cautious and this has forced a2 Milk to change strategies. Price discounting and in-store promotion will now be used to drive increased volumes.
Disappointingly, a2 Milk says that it expects revenue in the US to remain flat in FY21 after jumping 91% in FY20.
3. Return on equity dropped
One surprising result of building up such a huge cash pile is that a2 Milk Company’s monster return on equity (ROE) dropped from 44% in 2019 to 40%.
Return on equity (ROE) is a company’s net profit after tax (NPAT) divided by the average shareholder equity over the year. Having a large cash pile increases the equity in the business, so we end up dividing profit by a larger number. Although this is a surprise, the cash pile gives a2 Milk options to reinvest back into the business and compound returns in the years ahead.
You can follow him on Twitter @Regan_Invests.
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.