Is the A2 Milk (ASX:A2M) share price too cheap to ignore?

Is the A2 Milk Company Ltd (ASX:A2M) share price so cheap that investors shouldn’t ignore it any more? It has fallen a long way.

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Could the A2 Milk Company Ltd (ASX: A2M) share price be too cheap to ignore any more?

It has certainly had a really rough time. Over the last month it’s down 16%, in the year to date it’s down 34% and over the last six months it has fallen 46%.

Reporting season was an opportunity for the business to reassure investors that things are turning around. But it wasn’t able to do that.

Headline figures in A2 Milk’s HY21 report

Total revenue was down 16% to $677.4 million, earnings before interest, tax, depreciation and amortisation (EBITDA) declined 32.2% to $178.5 million and the net profit after tax (NPAT) declined 35% to $120 million.

A2 Milk attributed some of the decline to pantry destocking after strong FY20 third quarter sales, with reduced tourism from China and international student numbers. This is one of the main issues impacting the A2 Milk share price.

The company went on to say:

In September the company further advised that it had also started to observe additional disruption to the corporate daigou/reseller channel, particularly due to the prolonged stage 4 lockdown in Victoria, with a contraction beyond its previous expectations. These events, combined with subdued online pricing and channel inventory unwinding, have resulted in daigou/resellers being slower to re-enter the market to promote the brand. While there was some improvement in the channel towards the end of the period, the recovery was not as strong as had previously been expected.

How is management trying to fix this?

A2 Milk continues to focus on re-activating the daigou/reseller channel and is confident that it remains attractive and an strategically important channel for distribution penetration and new user recruitment.

There are three key areas that A2 Milk is doing. It’s ‘rebalancing’ its inventory levels and improving traceability through the channel. A2 Milk is providing support to the daigou/resellers. It’s also working with corporate daigou to drive innovation in distribution.

Is the A2 Milk share price too cheap to ignore?

Speaking to Angus Kennedy from Livewire, Chris Tynan from DNR Capital said that A2 Milk’s greatest asset right now is not being Australian. But it’s tricky with regulators wanting local Chinese players to play a bigger part in the market.

Mr Tynan pointed to escalating inventory problems, he said this was:

concerning because management has been quite dismissive of this problem in the past – they tied themselves in knots dancing around this problem on the earnings call. It’s probably going to be a bigger focus going forward just given the limited visibility they’ve got across these unique distribution platforms. If you lose control of this inventory, especially as expiration dates on products approach, there is risk of uncontrolled discounting which can result in brand damage and further margin impacts on other channels.

However, DNR Capital liked that A2 Milk is improving its market share locally in China, with the Chinese label brands growing sales and mother and baby store (MBS) penetration continuing to increase. The liquid milk business was also a good thing, but a bit of a sideshow.

Mr Tynan said that there are some things that the company can do to help things, but it won’t be cheap or easy. The new CEO may do well, but it’s a big job. Even so, the company has a very trusted brand and it has very strong market credentials.

He concluded:

So I do think the structures are there for performance to improve. But unfortunately, a lot of this relies on factors outside of their control. The one thing they can control is capital allocation to brand and channel. It is likely that they will have to bear more pain in the short to medium term as invest to fend off stiffer competition from domestic producers. This investment is key to driving future success, but it will likely take some time.

Both UBS and Morgans rate the A2 Milk share price as a buy. UBS thinks A2 Milk’s formula sales will recover over two years and it still has a good opportunity in China, with good online sales growth. Morgans has a price target of $10.40 on A2 Milk.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended A2 Milk. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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