3 reasons why the A2 Milk (ASX:A2M) share price could still be a buy

There might still be a few reasons to like the fallen infant formula giant.

| More on:
falling milk asx share price represented by frowning woman tasting sour milk

Image source: Getty Images

The A2 Milk Company Ltd (ASX: A2M) share price has fallen a dramatic amount over the last few months. Over the last six months it has dropped 60%. It has dropped almost 75% from the end of July 2020.

That’s despite interest rates being at record lows and there being a strong consumer environment for many ASX shares.

Just today, the business was hit with more bad news of a potential class action that is apparently being investigated by Slater & Gordon Limited (ASX: SGH). A2 Milk believes it has complied with all applicable disclosure obligations and denies any claim to the contrary.

But there are still some reasons that the A2 Milk share price could be interesting:

Lower price

It’s been a painful ride for existing shareholders. But for prospective investors, the current A2 Milk share price is almost the lowest it has been since 2017.

A lower price could mean a better long-term valuation to enter at.

If A2 Milk can turn its earnings around, as some analysts are expecting, then A2 Milk could prove to be good value.

The earnings forecast on Commsec suggests earnings per share (EPS) of 11.6 cents per share in FY21 and 26.8 cents of EPS in FY23.

If that medium-term outlook is correct (or close enough), then the A2 Milk share price is valued at 21x FY23’s estimated earnings, which could prove cheap if the business kept growing in FY24 and beyond.

Increased distribution in China

A large amount of A2 Milk’s products used to find their way into Chinese consumer hands.

Local infant formula sales have dropped off, particularly in the daigou channel.

However, not every side of its Chinese demand has disappeared.

It’s still seeing Chinese label infant nutrition growth. In the third quarter of FY21, it saw year on year growth of 5% compared to the third quarter of FY20. That was despite the prior period including a high level of COVID-related pantry stocking.

The store count of mother and baby stores in China has risen to 22,600 and the 12-month rolling market value share was stable at 2.4% at the end of March 2021, materially higher than where it was in prior years.

Plus, there are other markets outside of China that A2 Milk can grow into.

Continued growth of its liquid milk business

Liquid milk is not the biggest or most profitable part of the business, but it is steadily growing and now (after the infant formula decline) it’s a more important part of the overall picture.

In the FY21 half-year result it saw 16.3% revenue growth of liquid milk in Australia with a record value share of 11.7%.

Changes in the USA execution approach led to revenue growth of 22.3%, distribution increasing to 22,300 stores and an improvement in earnings before interest, tax, depreciation and amortisation (EBITDA).

In the most recent trading update, released on 10 May 2021, A2 Milk said the Australian liquid milk business continued to perform strongly and the USA business performed in line with the plan for the third quarter.

Foolish takeaway

However, whilst the company is confident about the long-term potential for A2 Milk infant formula, the problems are ongoing for infant nutrition and the A2 Milk share price. It has warned that its aggressive actions could potentially leak into the performance in the first quarter of FY22.

Wondering where you should invest $1,000 right now?

When investing expert Scott Phillips has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for more than eight years has provided thousands of paying members with stock picks that have doubled, tripled or even more.*

Scott just revealed what he believes could be the five best ASX stocks for investors to buy right now. These stocks are trading at near dirt-cheap prices and Scott thinks they could be great buys right now.

*Returns as of August 16th 2021

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia 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.

More on Cheap Shares