Why this top investment bank has Sell ratings on a2 Milk and Bubs

A2 Milk & Bubs share price outlook: The story of Citi's Sell rating

The share prices of some Australia’s most prominent Infant formula companies have struggled in recent times – with both Bubs Australia Limited (ASX: BUB) and a2 Milk Company (ASX: A2M; NZE: ATM) trading well off their 52-week highs.

A2’s share price decline appears easily explainable: With the company in late September telling the market that it expected its first half (1H21) revenues to come in materially ‘below plan’ as a result of reseller/ daigou channel disruptions. Here, management elaborated that they now expected full-year revenues to come in at between NZ$1.8-1.9bn. Though this guidance suggests modest YoY revenue growth – it implies a lower growth rate than the market had evidently anticipated. Despite lower revenue guidance, the company has still guided for robust earnings (EBITDA) margins in FY21 – anticipated to come in at around 31%.

In addition to this, it should be noted that the stock was already trading down prior to this downgrade (as well as trading at an above market earnings multiple), this revised guidance looks to have merely exacerbated bearishness around the stock.

From the high A2M recorded in August, the stock is now down around 27% – opening Tuesday’s session at $14.62 per share.

Like A2, Bubs also posted a set of healthy figures as part of its FY20 report – reporting good overall revenue growth and a 32% improvement in its direct sales to China segment. Overall, Bubs reported revenue growth of 32% at $62 million and revealed that its infant formula sales rose 58% to $13 million. The company's normalised gross margin also improved from 21% to 24% in fiscal 2020.

Bubs, unlike the highly profitable a2 Milk, did not turn a profit in FY20 and from its 52-week high its share price is down about 39%.

Despite all this, as highlighted by a2 Milk’s FY21 outlook release, distinct issues around cross border sales in China have begun to materialise, likely impacting many companies in the infant formula/ nutritional food-products space.

European multinational food-products company Danone, in their recently released Q3, for example, noted that sales and volume performance from their specialised nutrition segment was 'penalized by the performance of China which posted a steep double-digit sales decline in the quarter against a high base last year.’

This, said Danone ‘resulted from headwinds related to channel logistics issue caused by COVID-19 (cross-border channels contraction) and pantry destocking dynamics.’

Positively at least, Danone’s management noted that in ‘the Chinese domestic market, we are continuing to see strong underlying consumer demand for our brand as Aptamil kept a good market share momentum in e-commerce and mum&baby stores, driven by the Platinum premium range.’

Despite such positives, Citibank analysts appear broadly concerned that these ‘short term’ cross border channel issues may persist for some time.

On a2 Milk, for example, the investment bank said:

‘We see risk that recent short-term challenges could last longer than expected given i) customer acquisition is likely to be suboptimal while the daigou channel is disrupted, and ii) the daigou channel may remain under pressure for longer with Chinese students and tourists largely being unable to enter Australia.’

Citi has a Sell rating and $14.20 price target on A2M.

By comparison and in relation to Bubs, while it was noted that the company has a promising brand and occupies a ‘fast growing category’, at a 6x sales multiple, Citi analysts ultimately contended that ‘we don't believe adequate risk is being priced in for the disruption in the daigou channel and the prospect that Bubs would need to materially step-up marketing and promotional investment.’

Citi has a Sell rating and 70 cent price target on Bubs.

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