I think that the A2 Milk Company Ltd (ASX: A2M) share price is a strong buy due to the current short-term issues facing the sector.
What’s going on?
In the initial months of COVID-19, there was huge buying of food products by consumers to make sure that they had enough to last through the lockdowns.
Infant formula businesses like A2 Milk and Bubs Australia Ltd (ASX: BUB) saw large growth of sales in March 2020. But since then there has been a bit of difficulty.
A2 Milk previously said it was expecting some moderation of economic activity in FY21, which could have various impacts, including on participants within the supply chains.
Firstly, there is the pantry de-stocking effect. Households need to get through what they previously bought before they will resume normal buying patterns.
There are also lower than anticipated sales to retail daigous in Australia because of reduced tourism from China and international student numbers. There is also disruption to the corporate daigou and reseller channel, particularly because of the stage 4 lockdowns in Melbourne.
A2 Milk said that because of all of the above, the daigou channel has contracted beyond previous expectations and there hasn’t been the replenishment orders the company is expected.
All of this is expected to cause A2 Milk revenue in the first half of FY21 to drop by 4% to 10% to $725 million to $775 million.
Why I think the A2 Milk share price is a buy
I firmly believe these conditions are shorter-term that will pass. It’s hard to say exactly when things will turn around. The COVID-19 situation is very unpredictable because of the healthcare issues. Australia may be in a good COVID-19 position, but many countries aren’t and that’s largely why the borders are still shut.
But I’m sure there are still large numbers of Asian consumers that want to buy A2 Milk products. It’s just that it’s harder for them to get a hold of products due to COVID-19.
To get around that, A2 Milk is rapidly building its Chinese-based business and it continues to increase its distribution in the country to more mother and baby (MAB) stores.
A2 Milk itself said that it’s of the view that this is a short-term impact to the daigou channel and it will prove to be temporary, assuming the COVID-19 situation remains stable.
That’s why A2 Milk is expecting total FY21 revenue to be between $1.8 billion and $1.9 billion, which would be growth of 4% to 10% if that eventuates.
A2 Milk can sell its products through several different channels. Its US liquid milk business is growing really strongly.
I think the North American side of the business looks really exciting for the long-term. It’s already doing well in the USA and it is just starting to grow into Canada as well.
A2 Milk is still expecting the earnings before interest, tax, depreciation and amortisation (EBITDA) margin to be “in the order of 31%”.
At the current A2 Milk share price it’s priced at 23x FY23’s estimated earnings. I think the short-term weakness – down 26% in three months – represents a really good opportunity to buy shares of a business that has a strong brand with good growth potential and a robust balance sheet.
It’s true that the business is suffering from short-term issues, but I see it as a long-term opportunity. To me, it offers much better value than other popular ASX tech growth shares. I think it is worth buying today. Others in the sector like Bubs or even Clover Corporation Limited (ASX: CLV) could also be worth considering.
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Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Clover Limited. The Motley Fool Australia owns shares of and has recommended A2 Milk and BUBS AUST FPO. 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.