A2 Milk share price: why Citi upgraded the stock to buy

We unpack Citibank's latest research on the a2 Milk Company.

For better or worse: broker ratings have the ability to make or break a stock.

Maybe one of the most interesting cases of this comes from Citi’s recently revised take on market darling a2 Milk (ASX: A2M).

The last couple of months have indeed proven a bullish turn for the stock: with the a2 Milk share price rising ~10% since early January.

But here comes the most curious bit. As we wrote in late-January:

‘Sam Teeger has raised Citi’s price target on a2 Milk (ASX: A2M) from $12.30 to $14.85 per share – and upgraded the rating on the stock from sell to neutral.’

That alone marked a large reversal in views for the broker. Last week though, Citi took this reversal one step further: upgrading their rating on a2 Milk to buy from neutral and slapping the IMF stock with a bullish price target of $17.45 per share.

All up, in percentage terms that’s a 41% upward revision. Talk about a view change!

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A2 Milk share price: the Citi take

The thrust of this newly minted upgrade though is probably the most interesting part of all this; with Citi analysts contending that the Coronavirus may actually have a positive impact on A2M’s second-half FY20 margins.

Citi had previously held a sell recommendation on the stock based on the thesis that A2M could not sustain its high margins in the face of growing competitive realities.

Returning to the current view, while the broker does indeed acknowledge that public health concerns surrounding the Coronavirus have impacted foot traffic around physical storefronts, Citi suggests that this may be offset by a 'surge in online orders'

As the broker further points out as part of its buy thesis: ‘household stockpiling could result in stronger than expected sales and consumers increasingly staying at home may reduce the need for 2H20 trade and outdoor marketing activities,’ and ‘travel restrictions could help the company reduce its travel expenses.’

Quantifying the impact this would have on the company’s underlying fundamentals, Citi increased their FY20 second half sales estimates by 14% and is currently projecting that A2’s earnings margins will come in at 31% (in H1) and 32% (in FY20).

Other points to consider

A2 Milk (ASX: A2M) is set to report its first-half results on 27 February. In the lead up to these earnings and over the last 5 days, the A2 Milk share price has risen an impressive 6.78%.

Finally, just yesterday, in the wake of Synlait Milk's earnings release and outlook, a2 Milk itself reiterated that ‘its business performance remains strong and it continues to be in compliance with its continuous disclosure obligations.’

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