Could the A2 Milk Company Ltd (ASX: A2M) share price now be too cheap to ignore considering it's almost at $5?
The company and shareholders have been suffering over the last year. It's hard to believe that since the end of July 2020, the A2 Milk share price has fallen by almost 75%.
But operating conditions have materially worsened since then. Every few months A2 Milk has given out a disappointing trading update to investors.
The latest one was handed out just over a week ago.
A2 Milk told investors that the trading dynamics in the China infant nutrition market have been and continue to be challenging for A2 Milk and many international competitors.
Whilst the FY21 third quarter trading was broadly in line with management's plan, it was clear to the company that actions taken to improve things with the daigou channel as well as cross-border e-commerce (CBEC) channels will not result in a sufficient improvement in pricing, sales and inventory levels to meet previous guidance based on April sales being well below the plan.
Not only that, but A2 Milk has ended up with a lot more inventory than expected. The business plans to rebalance inventory by further reducing sell-in to the daigou and CBEC channels and this will need to continue for the rest of the FY21 fourth quarter. This may continue into the first quarter of FY22 too. This is aimed at reducing customer and distributor inventory to target levels, which will significantly reduce sales for FY21.
There will be an additional stock provision in FY21 of between NZ$80 million to NZ$90 million, on top of the NZ$23 million recognised in the FY21 first half.
A2 Milk is also going to spend more on marketing to drive demand.
All of these problems and solutions will result in a significantly lower earnings before interest, tax, depreciation and amortisation (EBITDA) margin in FY21, of between 11% to 12%.
FY21 revenue is now expected to be in a range of between NZ$1.2 billion to NZ$1.25 billion.
Is the A2 Milk share price too cheap to ignore?
A2 Milk itself said these actions are being taken to return to growth as quickly as possible and to deliver acceptable margins.
The company estimated that if the one-off charges and sales reductions to reduce inventory were ignored, the business would record annual revenue in the order of NZ$1.3 billion and an EBITDA margin in the low to mid-twenties.
Brokers on the whole don't think this is an incredible price. Credit Suisse still rates A2 Milk as a sell after the big decline with a price target of $5 on concerns that the Chinese demand may not return with a change for families choose local Chinese products.
However, there's also a broker like Morgans that rates A2 Milk shares as a buy with a price target of $6.65. Whilst it's not expecting a recovery back above $10 any time soon, Morgans is suggesting a share price return of around 30% over the next 12 months. FY22 could include a lot of earnings growth as these issues are worked out. Even just solving the stock problem would help significantly next financial year.
