A2 Milk Still Attractive Despite Near-Term Headwinds and More Muted China Outlook

A2 Milk’s latest downgrade indicates our prior expectation for the firm’s share of the Chinese infant formula market to continue its rapid ascent was too optimistic. Persistently high inventory through the sales channel has stifled reordering from key corporate daigou partners, weighed on market pricing, and led to ageing of available product. While we continue to expect continued growth in Chinese-label baby formula and some recovery in the daigou channel, we now anticipate market share growth will prove more gradual as continued expansion of Chinese-label products begin to cannibalise English-label daigou sales and domestic Chinese players increase traction. We therefore lower our fair value estimate for a2 Milk by 34% to $10 per share. The current share price sits at $6.51 per share.

Pre-pandemic, a2 Milk had carved a meaningful brand position, as evidenced by its estimated 7% pre-pandemic value share and premium pricing. However, we now expect it won’t return to those levels until fiscal 2023. Further, while market share gains have been strong to this point, we estimate future market share gains to be more gradual particularly while the firm rebalances its channel inventory.

We are less optimistic on a2 Milk’s longer-term market share potential in China. While we still expect the company to capture market share amid a falling number of births in the country, we now forecast a2 to see more-gradual improvements in infant formula value share. We’ve reduced our expected value share to around 9% by fiscal 2026, down from our prior forecast for sustained market share growth over the next decade to around 16%. The primary reason for this is a2’s Chinese-label formula increasingly competing with its English-label formula sold through alternative channels, cannibalising sales.

Bulls Say

• China remains a major long-term growth opportunity for a2, and should help to drive continued margin improvement.
• While the science is currently uncertain, further studies on the benefits of A1-protein-free dairy products could support positive health claims for a2 Milk.
• A2 generates solid free cash flow, which could be used to make accretive acquisitions or vertically integrate, or returned to shareholders.

Bears Say

• A2 relies heavily on only two major suppliers, which risks price hikes, supply challenges, or future competition.
• The company fights against strong competition in China and elsewhere. In the longer term, a2 may be under capitalised to take on the marketing arms of dairy behemoths such as Nestle and Danone.
• China could further alter the regulatory environment for infant formula, which may lead to supply disruptions for a2 or a greater ability for local manufacturers to compete.