A2 Milk shares: what’s the outlook following China strategy day?

As the market mulls the full implications of the Mengniu-backed Bellamy's takeover bid, a number of Australian IMF stocks climbed (then traded flat) in response.

On Monday we saw: BAL-AU skyrocket 55% and Wattle Health Australia Limited rise 12%; BUBS Australia also opened higher.

While a2 Milk Co Ltd (ASX: A2M) also initially soared on this takeover news – rising around 7% on Monday, its share price pulled back sharply during yesterday’s session – closing out the day at A$13.10 per share

This volatility persisted even as a2 Milk unveiled its latest investor Strategy Day presentation – which reiterated the company’s lofty China ambitions.

A2 Milk share price: strategy day in focus

Though nothing fundamentally new was revealed as part of this strategy day – taking place in Shanghai from September 17 to 18 – it has given more ‘colour’ to a2 Milk’s all-important China growth strategy.

The main takeaway: a2 Milk Co Ltd is pursuing the two largest consumer markets in the world – China and the US – which between them have a population of 1,720 million.

Australia’s population by comparison stands at just 25 million.

Broader consumer reach is the name of the game here, with the company interestingly noting that: ‘we have high consumer loyalty, yet relatively low awareness – indicating significant growth opportunity.’

Such comments go far to point out why A2M is aggressively bumping up its marketing spend – anticipating it to hit roughly 12% of revenue in FY20.

To that end, a2 Milk is currently focusing on deepening ‘consumer understanding and engagement’, diversifying the company’s business portfolio, and leveraging technology to innovate rapidly.

This focus, says the company, ‘builds on all that has come before us, but requires stepping up.’

Citi, in a broker note this morning noted that this 'stepping up' is likely to come at a cost: with short-term profitability being sacrificed for near-term top-line growth.

To grow or not to grow?

For investors, growth – and whether or not a company can maintain it – is almost certainly one of the most central questions when stocks trade at high multiples. Even after a2 Milk’s recent downward price action – the company continues to trade at a premium to the broader market: commanding a PE ratio of 36.2, according to the ASX.

Indeed, it was this growth: that came in not-quite-high-enough in FY19 that saw a2 Milk Co Ltd’s shares fall off a cliff during reporting season.

Here, the stock dropped around 14%.

Besides this, and as we previously wrote, a particular concern surrounds FY20 margin guidance – which, according to Morgans – looks to be materially weaker than previously expected.

The corollary here is that it expected that it will be harder (and more expensive for that matter) for a2 Milk to see the kind of revenue growth it did in the past.

Click here to read our full coverage of a2 Milk's FY19 results now.

A changing macro environment

Even as those concerns circle, a growing Chinese middle class, stronger fertility rates and taste changes all have the potential to impact a2 Milk’s growth prospects.

For one, in 2013 the company noted that that the average Chinese woman had her first child at 27. By 2018 that age rose to 30 and by 2028 it’s expected to hit 34.

In addition to this, though a2 Milk has noted that birth rates in China have declined, it may very well be offset by rising fertility rates.

Yet maybe the most important macro trend is the prospect of a wealthier China. Citing research from Euromonitor, a2 Milk notes that the ‘higher income’ and the ‘upper middle’ wealth bands are set to significantly increase in the next decade.

Finally, changing consumer tastes look to be well-backed by these growing wealth bands, as demand for health and wellness products rise in China.

A2 Milk’s share price and its investors have been distinct benefactors of these trends in recent years: as a wealthier middle-class buy up a2 Milk's product at a rapid click.

Tellingly, since April 2015, A2M’s share price has risen over 2,000%.

With these favourable conditions emerging, the question investors will likely now be asking is: can a2 Milk Co Ltd ‘step up’ and take advantage of them?

Only time will tell.

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