A2 Milk shares continue to fall while Fonterra rises on FY19 results

A well-articulated mid-term strategy may have boosted investor optimism around Fonterra; while bearish sentiment for a2 Milk's stock continues, as the market darling drops to a six-month low.

The fates of a2 Milk (ASX: A2M) and Fonterra Co-operative Group Limited (ASX: FSF; NZE: FCG) seem to a degree intertwined.

Earlier this year for example, the two struck a deal that would see Fonterra – one of New Zealand’s largest public companies – sign up farms to supply milk to a2 Milk in 2019 and 2020.

Unsurprisingly, the response from both companies was an optimistic one. Mike Cronin, Fonterra's Director of Co-operative Affairs said of the deal:

‘Signing up New Zealand farms to significantly increase supply of high quality milk to The a2 Milk Company is a positive step forward. It clearly shows the strength of our strategic relationship, and our shared commitment to fast-track market growth and enable farmers to create additional value from their milk.’

By comparison, Jayne Hrdlicka, esteemed CEO of a2 Milk said:

‘The a2 Milk Company is pleased to be making progress on our relationship with Fonterra. These farms will help support new growth areas for our company across existing and new markets.’

Even so, such deals have done little to soften investor bearishness around a2 Milk’s shares in recent times; following FY19 results that have caused some analysts concern around lower margins going forward.

Comparatively, Fonterra’s latest full-year results – delivered to the market last week – has seen a modest spike in investor enthusiasm. In the last five days the Fonterra share price has risen a little over 9%.

Fonterra share price in focus: FY19 results

Driven by a number of ‘one-off accounting adjustments’, the headline figure of Fonterra’s latest 2019 results was a net loss after tax of NZ$605 million.

Speaking of the write-downs that contributed to this loss, CEO Miles Hurrell commented that:

‘When it came to DPA Brazil, Fonterra Brands New Zealand and China Farms, we saw there were either some changes in their local economies, increased competition or business challenges impacting their forecast earnings. This meant we needed to reduce their carrying value.’

In addition to this, the company sold ‘Tip Top for NZ$380 million and our share of DFE Pharma for NZ$633 million,’ as the co-op seeks to position itself for robust future growth.

Though tough decisions, Fonterra’s management is of the opinion that such actions are an integral part of the co-operative’s strategic focus of reducing debt, improving cash flow and strengthening the company’s overall financial position.

Some of this has already began to show. Indeed, while the co-operative’s normalised EBIT came in 9% lower in FY19, at NZ$819 million; its free cash flow soared 83%, rising to NZ$1,095 million.

In addition to this, Fonterra’s overall sales revenue remained strong: coming in a shade lower in FY19 at NZ$20.1 billion – a 2% decline from the year prior.

As part of its results, Fonterra (ASX: FSF; NZE: FCG) did not announce a dividend.

This caps off a difficult year for the Fonterra share price, which has dropped around 24% since the beginning of January.

A simple strategy and bigger earnings potential

Overall, Fonterra’s simplified strategy is one underpinned by the idea of long-term shareholder value creation.

As the company aptly pointed out, ‘simplicity shouldn’t be confused with a lack of ambition. Our forecast earnings range for FY20 starts at 15-25 cents per share, but the five-year plan is to deliver a target of 50 cents per share.’

By comparison, Fonterra’s FY19 results saw normalised earnings per share of NZ$0.17.

A2 Milk share price continues to falter

Investors seemed relatively impressive by Fonterra’s results, with its share price rising close to 10% across the last five trading sessions. In contrast, a2 Milk (ASX: A2M) has faced significantly less optimism in the wake of its FY19 results, with its share price falling approximately 29% since its July 30 peak.

In the last week a2 Milk shares have continued to drop, falling from A$12.52 to A$12.24 per share.

It was a bearish broker note from banking giant Citibank that likely contributed to this continued slide. Here, Citibank downgraded a2 Milk from neutral to sell, and slapped a significantly lower price target of A$12.20 per share on the milk company.

Mind you, this price target stands in stark comparison to the likes of UBS, who reiterated their buy recommendation and price target of NZ$17.10 following A2M’s recent China Strategy Day presentation.

Ultimately, Citibank cited the unreliable nature of the Daigou channel and concerns over lower EBITDA margins going forward. In general and in line with a2 Milk’s own increased marketing spend: brokers have worried that to achieve comparable levels of growth a2 Milk would have to spend significantly more going forward.

The investment bank also cited increased competition as a catalyst for its sell recommendation.

YTD the a2 Milk share price has now risen a little over 16%.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.

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