Which is the better beaten-up buy, Bubs or A2 Milk shares?

A decline in the Chinese infant formula market has hurt both of these companies.

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Key points

  • Both Bubs and A2 Milk shares have suffered since the start of COVID
  • A2 Milk lost daigou sales, but it’s expecting revenue growth in FY22
  • Bubs has returned to elevated double-digit growth

The A2 Milk Company Ltd (ASX: A2M) share price and the Bubs Australia Ltd (ASX: BUB) share price have both suffered in recent times.

Over the last six months, the Bubs share price is down around 33%. The A2 Milk share price is down a similar level, around 35%.

From the peak in July 2020, A2 Milk shares are down around 80%. Looking at Bubs, it has declined more than 60% since July 2020.

Both businesses have seen similar falls, but which one is the better buy?

What’s the problem?

China is a key market for infant formula from both of these businesses. The country had a population of around 1.4 billion in 2021, so that’s a very large potential market of families that may want to buy infant nutrition.

A2 Milk blamed the decline on the prolonged impact of COVID-19 and a rapidly changing infant formula market. In FY21, it said that over the year the Chinese market growth reduced significantly from “globally high rates to be flat, and cross-border trade has been disrupted significantly which has had a profound impact on the company’s results”.

A2 Milk shares faltered as sales through the daigou/reseller and e-commerce channels suffered.

In FY21, the company saw revenue fall 30.3% to $1.21 billion and net profit after tax (NPAT) sank 79.1% to $80.7 million. A2 Milk took action to address excess inventory. It said this was reducing channel inventory, improving product freshness, and market pricing.

Bubs also saw a significant drop in daigou sales in FY21, with gross revenue dropping 24% to $46.8 million. It also suffered from an inventory write-down to the tune of $12.6 million.

Growth returning?

While FY21 saw a lot of disruption, things are improving.

A2 Milk is expecting to deliver revenue growth in FY22. The HY22 revenue was slightly down by 2.5% to $660.5 million. The overall Chinese infant formula market declined by 3.3% in value during the first half due to the impact of a lower birth rate.

A2 Milk is expecting the FY22 second-half revenue to be much more than that in the FY21 second half.

The latest update we’ve seen from Bubs is the FY22 third quarter. Gross revenue was up 49% to $17.6 million, the third consecutive quarter of growth on the prior year. Domestic retail infant formula sales rose 108% year on year. Total Chinese sales were up 8%. Excluding China, international gross revenue was up 153%, with international sales of Bubs-branded products growing by 63%.

Profitability

Bubs is not yet profitable, while A2 Milk is. Profitability can be a help for the A2 Milk share price.

A2 Milk made an NPAT of $56.1 million in the first half of FY22, though this was down 53.3%.

Despite the revenue growth expectations, A2 Milk isn’t expecting higher earnings as it “significantly” invests in the market and other activities related to its growth strategy.

Which one is better?

It may be that A2 Milk has a stronger brand, for now at least.

But Bubs is growing quickly. It’s growing strongly internationally, in Asian countries outside of China.

The broker Citi currently rates Bubs as a buy, with a price target of 59 cents. That implies a possible upside of around 57% on its current price of 37.5 cents. It noted the Chinese lockdowns could slow growth in the short term. It also noted Bubs’ new A2 beta-casein protein infant formula range, with the corporate daigou partner Willis Trading putting in an order valued at $32.9 million.

Citi rates A2 Milk shares as a sell, with a price target of $4.80. Citi thinks that A2 Milk could suffer from the lockdowns.

In my opinion, Bubs has managed to turn things around over the last several months. Its growth is now looking stronger than A2 Milk, it’s growing its product range and it’s setting the scene for good growth internationally by expanding its footprint in the US. For those reasons, I’d pick Bubs of the two. But share market volatility could remain elevated for a while.

Citigroup is an advertising partner of The Ascent, a Motley Fool company. Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended A2 Milk and BUBS AUST FPO. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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