The A2 Milk Company Ltd (ASX: A2M) share price slumped 10% on Monday following an earnings downgrade. Could this be an opportunity for investors to jump on board the Bubs Australia Ltd (ASX: BUB) share price?
Bubs share price performance
Even after this week's selloff, the a2 Milk share price is a little higher than breakeven for the year. By comparison, the Bubs share price is down nearly 23% in 2020. Bubs is likely weighed down by its $40 million capital raising that took place earlier this month. The capital raising offered a placement of up to $28.3 million at 80 cents per share and share purchase plan of up to $10 million at the same price. The significant discount combined with the broader market sell off is likely to have pushed the Bubs share price lower in September.
FY20 performance
Bubs delivered a fair FY20 performance with a 24% increase in revenue to $54.6 million and a normalised earnings before interest, tax, depreciation and amortisation (EBITDA) loss of $9.1 million. The company's growth was fuelled by strong infant formula growth with sales up 58%. The contribution share of infant formula earnings now represents 55% of the company's earnings, up from 30% two years ago.
Moving forward, China remains a key focus as the company's primary export market with the highest growth potential for goat's milk infant formula. Furthermore, it plans to diversify its China dependency risk with new market launches including Vietnam and Hong Kong in FY20 and Malaysia and the Middle East in Q2 FY21.
Key risks
The Bubs FY20 results highlighted similar challenges that a2 Milk faced with regards to pantry stocking. Its report cited that significant pantry stocking "brought forward demand" with "Australian domestic consumption from local consumers now returning to pre-COVID levels". In light of such concerns, it did mention that increasing demand was evident in China and that cross border e-commerce (CBEC) China sales were growing.
It further highlighted the barriers to entry for businesses in China, especially for infant formula. Tightening regulations and long lead times for regulatory approvals all impose risks for Bubs' success in China. Furthermore, consumers increasingly want to see a brand's local relevance, increasing the need for Bubs to invest in marketing and sponsorship in China.
Foolish takeaway
Following its capital raising, I believe Bubs is in a solid position to capitalise on its growth initiatives and kickstart China-related operations. However, the business faces similar challenges as a2 Milk with regards to pantry destocking and additional risks with doing business in China. I believe the Bubs share price has underperformed a2 Milk for a reason. Being a smaller business with a niche product, it could face greater earnings risks and regulatory set backs. As such, more time might be needed for the Bubs share price to find a bottom before considering it as a buying opportunity.
