The a2 Milk Company Ltd (ASX: A2M) share price got crunched today, falling nearly 24% as shares emerged from a trading halt.
The sharp sell-down was in response to downgraded FY21 guidance, where management cited weaker than expected sales from its daigou and cross border e-commerce (CBEC) channels.
Outlook sours
The often murky ‘daigou’ channel, which roughly translates to ‘buy on behalf of’ in Mandarin, refers to a network of shopping agents who buy things for residents in China. For example, a daigou shopper in Australia would receive an order for, say, a2 Milk baby formula, purchase the product at a local supermarket or chemist and then post it back to China (while collecting a fee).
This channel relies on international borders being open. Without the influx of international students, visitors and migrants from China, along with the recent restriction of movement of daigou shoppers in places such as Victoria, a2 Milk’s daigou sales have dried up.
The company first released subdued guidance in September, noting additional disruption to the corporate daigou channel in light of the prolonged stage four lockdown in Victoria.
At the time, the company saw this as a single channel logistics issue and thought the impact to the Daigou channel would be temporary.
However, the company’s messaging has now changed:
“The effect of the disruption in the daigou channel, which represents a significant proportion of our infant nutrition sales in our ANZ business, has proved to be more significant and protracted than was previously anticipated. While this has predominantly affected infant nutrition sales, sales in our other nutritionals segment have now also been impacted.”
The company noted that while there has been some improvement in the daigou channel during the second quarter, the acceleration of the recovery in recent weeks has been slower than expected.
What’s also concerning is that these impacts have flowed through to the company’s CBEC channel, which includes popular Chinese e-commerce sites like JD.com and Alibaba’s Tmall.
“As previously noted, the daigou channel plays an important role in stimulating demand across multiple sales channels, including CBEC. While our performance in CBEC in the competitive 11/11 online sales event showed year on year growth, sales in the CBEC channel in the period following that event have been below expectation.”
Now what?
A2 Milk is expecting FY21 revenue in the range of NZ$1.40 billion and NZ$1.55 billion. The midpoint of this range represents a ~15% fall compared to FY20 revenue of NZ$1.73 million.
Earnings have also taken a hit, with the company now expecting its FY21 EBITDA margin to sit between 26% and 29%, down from FY20’s margin of 31.7%.
On a positive note, a2 Milk’s liquid milk business in the US and Australia has reportedly performed well through the first half. The company also highlighted its performance in the China mother and baby stores (MBS) channel, with increases in both same-store sales and the number of new stores in the first half.
Is this a buying opportunity?
The a2 Milk share price is certainly turning heads at around the $10 mark. Those who once dismissed shares as too expensive are taking another look, while shareholders are likely scratching their heads wondering what happens next.
Although the market may have overreacted today, the fragility of a2 Milk’s business model is coming into question, with a significant reliance on China to fuel growth. While weakness in the daigou and CBEC channels may be temporary, there’s no telling when or how fast the recovery will be.
Looking further out, a shift in consumer behaviour towards local brands in China, the upcoming arrival of a new CEO and the potential for a2 Milk to be at the mercy of key partners in China are other factors to consider.
While I view a2 Milk as a quality business and a terrific success story, the coming months are sure to be rocky.
