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Is the A2 Milk (ASX:A2M) share price a deep value opportunity?

Could the A2 Milk Company Ltd (ASX: A2M) share price be a deep value opportunity?

A2 Milk shares have dropped significantly over the last nine months, down 60%. Even just the last month was a pretty painful experience with a decline of 18%.

There’s nothing to say that A2 Milk won’t just keep falling. It still has a market capitalisation of close to $6 billion, according to the ASX.

The A2 Milk guidance keeps getting worse.

In FY20 it generated NZ$1.73 billion of revenue and it was expecting “continued strong revenue growth”.

However, in September 2020 it said that it was expecting FY21 revenue to be between NZ$1.8 billion to NZ$1.9 billion with impacts to the daigou channel.

In December 2020, it told the market that problems were continuing and FY21 revenue was expected to be between NZ$1.4 billion to NZ$1.55 billion.

The latest (and final?) blow came with the FY21 half-year result – revenue for FY21 is now expected to be “in the order” of $1.4 billion.

Even that latest guidance assumes that actions being taken to re-activate the daigou channel deliver a significant improvement in quarter on quarter growth from the third quarter of FY21 to the fourth quarter. Which may not happen.

What’s next?

It doesn’t seem like things are turning around (yet). The latest insight we’ve received is the Synlait Milk Ltd (ASX: SM1) FY21 half-year result, which is a major supplier to A2 Milk. Synlait said that it continues to experience significant uncertainty and volatility, commenting that it was partly due to:

“Ongoing uncertainty in The a2 Milk Company’s expected demand for the remainder of FY21 and FY22. Synlait does not currently have sufficient confidence to forecast when this recovery will occur.”

Global shipping delays are also causing an issue for Synlait and A2 Milk.

Is the A2 Milk share price a deep value opportunity?

It has certainly fallen a lot. It could fall more. But sometimes investors do become too pessimistic about a business.

Whilst the main part of A2 Milk’s business – infant formula sales in Australia and New Zealand – are suffering, there are still some growth areas. HY21 Chinese label infant nutrition revenue grew by 45.2% and it saw an increase of market share to 2.4%, with mother and baby store (MBS) distribution rising to 22,000.

Australian liquid milk revenue grew 16.3% and USA revenue grew 22.3%, with distribution rising to 22,300. Canada and other non-Chinese Asian growth could also be promising.

It’s still not exactly cheap, using CommSec numbers it’s valued at 25x the estimated earnings for the 2021 financial year and 20x times the estimated earnings for the 2022 financial year. Remember, these numbers are based on lower profit expectations.

It is possible that A2 Milk and the share price will disappoint again with its FY21 result if that recovery doesn’t come through. But I think that A2 Milk is getting to the point where you are getting compensated for that risk – the Chinese label infant label nutrition is still growing strongly and that could make up for the lost local revenue over the long term despite the lost daigou sales.

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