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Jess: Hello, I’m Jessica Amir, a market analyst with Bell Direct.

Since debuting on the ASX five years ago, milk protein company, The a2 Milk (ASX:A2M) has outperformed the market, grown its cash flows sales and profits.

a2 Milk recently handed down its 2020 financial year results, with net profit after tax (NPAT), earnings and revenue all growing over 30% each compared to the same time last year.

With us today to walk us through the report card and what further growth is frothing up is the company’s Chief Executive of Asia Pacific, the most important region to the group, Peter Nathan. Peter, thank you so much for your time.

Peter: My pleasure Jessica.

Jess: Before we dive into your results, just start off with a elevator pitch for a2 Milk, for those who aren’t familiar with the business.

Peter: The a2 Milk Company is genuinely a very unique business.

We’ve had rapid growth in both profit, earnings before interest and tax (EBIT) and revenue and most importantly we’ve been able to convert that to cash year in year out, so we have a very high margin business but we invest very heavily behind our brand to generate future growth and further growth.

So our business model is quite unique, I think at a global level in the consumer goods space and continues to reward shareholders very handsomely.

Jess: Now to your financial year results which we alluded to earlier.

The results were largely bolstered by stock piling but we saw that slow in the fourth quarter.

On the positive side of things, you’ve strengthened your balance sheet, significantly grown cash flows far more than expected.

On the downside and negatives though, travel restrictions were impacted as expected, the reselling channels known as the Daigou were impacted.

But you’re from the helm, what are the most important things for investors to know now?

Peter: Most important things for investors to know is that we are very much a multi-channeled business when it comes to infant formula into China, so therefore we don’t just rely on the Daigou channel.

But that we are a three-pronged channel business, so we’re involved with the Daigou channel as you indicated, involved with the CBEC channel, we’re also involved with the MBS channel, which is the what we call the mother and baby stores which is a very large part of the market, this channel represents about 50% indeed of the entire China market.

There’s over 100,000 stores within the channel, so very fragmented market.

We’ve actually only been in that channel I should say very recently, probably over the last three years or so in a meaningful way, but during that time we’ve grown very significantly.

So going back five years, the MBS channel only represented 2% of our infant formula sales and that now represents 24%.

So we very much de-risked our business, continue to invest very strongly, we have 19,000 distribution points within MBS and we continue to focus very heavily on investing to ensure that we further diversify our business within China.

Jess: You’re a high growth business, exceptionally strong cash flows, what’s in the pipeline to use this large amount of excess capital that you’ve got?

How will you deploy this?

Peter: Yeah Jessica, you are correct that cash flow generation is one of the hallmarks of our business, we now have about $850 million cash on our balance sheet.

There are three uses for that cash, firstly we want to emphasize that we’re a growth business.

So in the near term, we don’t see the need to return that cash to shareholders.

What we are saying are there’re three possible uses of that cash.

One is we’ve signaled we want to invest in manufacturing.

Now that is for those for three reasons, firstly what it will do is improve market access security into China.

Secondly it’ll further diversify our supply Chain so it de-risks the business and thirdly will improve quality and capability and capacity indeed for infant formula going into China, so that’s one use.

The second is we now signal that we are actively looking at M&A opportunities within core markets to further add another growth bill to our business.

And lastly we want some cash on the balance sheet as a safety net to help us through what may come our way, as we know COVID-19 was something that no one anticipated, so we never know what’s around the future and we do like to to make sure that we have reduced that element of risk by having some cash sitting there as well.

Jess: And a2 Milk has expanded rapidly into other markets around the globe but it’s focused now on just one brand, two labels, what’s the breakdown of earnings or revenue from each of the products and what’s the make up from each of the regions?

Peter: Yeah so within China, the three channels that we participate in which incorporates broadly Asia Pacific, which is both Australia and indeed China.

It’s roughly 52% is made up of products sourced from Australia, so that incorporates both Daigou sales and also domestic sales, but largely Daigou sales into China, around about 24% is on the cross-border e-commerce platforms, which in big platforms such as JD and Tmall and then lastly as I indicated, the other 24% is the MBS channel which is very large.

So Asia Pacific is by far the biggest component of our business, Asia Pacific is 90% plus.

U.S. is a new pillar for our business, one that is growing very rapidly.

We’ve doubled our sales into the U.S. over the last 12 months, so we obviously see a huge opportunity in the U.S. given the fact it’s the largest consumer goods market in the world and indeed the biggest fresh milk category in the world or market in the world, and that is where we currently participate in is fresh milk as opposed to infant formula in the U.S..

Jess: Your financial results were indeed very strong, but you could say that some analysts were expecting a little bit more love.

Expecting more in way of China sales, perhaps this is why on the day that your results came out we saw a bit of selling in the a2 Milk stock, even though your shares have been quite hot, are strongly outperforming the staples sector and the market every year and indeed over the last five.

So why do you think some were disappointed on the day that your results were handed down?

Peter: I suppose we can only to try to achieve our forecast, we did actually achieve the forecast we put to the market in April, so we’re above the midpoint both in EBITDA margin and revenue.

So in that regard, we believe we delivered on expectation. Yes of course some market analysts would expect that we would have done better, but you can’t obviously influence that.

And as I said, we were very pleased to be able to deliver on our forecast.

Jess: And honing in on the future now, FY21 is expected to see earnings growth of 30% – 31% in way of an earnings margin, which is exceptional given the climate.

Where is this growth coming from?

What’s in the pipeline?

What can we expect?

Peter: We’ve signaled that we will continue to invest very heavily behind our brand and our business, so we as I indicated, we invested about $190 million in marketing in FY20, we’ll continue to invest in the similar sort of percentages going forward, we’ll continue to look at new product development activities to launch into into the market.

However, we believe the core growth will come from existing product.

There is also a runway for growth for adult product in China, so to transition consumers from from babies through to infants through to adults, as we largely don’t participate in that space in China at this point in time.

But also have fledgling investments or indeed presence in Korea and in Vietnam and also we’ve indicated that we’re assessing M&A opportunities in core markets.

So there are a number of pillars that will drive future growth.

Jess: And just for a bit of fun now, in 10 words or less, why should someone invest in a2 Milk now?

Peter: In ten words or less, there’s very few companies that you can invest in which will convert sales, into margin, into EBITDA, into cash as effectively as the a2 Milk Company.

We’ve got a very consistent track record of delivering on that, we’ve got a very consistent track record on delivering on our forecasts.

We’re a well-managed business with a very good management team, so we believe it’s a very good investment.

Jess: Peter Nathan from The a2 Milk Company, thanks so much for your time.

Peter: My pleasure.

Jess: And thank you for watching.

For more information about The a2 Milk Company, head over to Bell Direct’s website.