Stock Takes: How Covid-19 is taking NZ stocks in different directions

A2 Milk’s share price has slumped while Fisher & Paykel Healthcare is back on a roll – all thanks to Covid-19.

The alternative milk company’s share price was close to a three-and-a-half-year low this week as more brokers turned bearish on its prospects.

The depressed share price means the stock runs the risk of dropping out of the all-important MSCI New Zealand Index, which is used as a benchmark for influential passive index tracking funds.

Shares in a2 Milk – once the market’s biggest stock by market capitalisation – last traded at $7.65, down from its peak last year of $21.51 and $14.20 mid-way through December.The fall has acted as a drag on the wider sharemarket this year.

Australian brokerage Morgans said e-commerce pricing of infant formula in China does not appear to be materially improving and Australian stores are discounting products to clear ageing inventory.

The rapidly changing environment caused by Covid-19, and its impact on the important unofficial – or “daigou” – trade in infant formula, has forced a2 Milk to downgrade its earnings forecast three times.

In its last guidance for the June 2021 year, a2 Milk said it expected group revenue to be in the order of $1.4 billion and group EBITDA margin for 2021 of 24 per cent to 26 per cent.

Morgans said a fourth earnings downgrade between now and the end of the financial year would be another blow to a2 Milk’s credibility.

With a market capitalisation of $5.6b, down from $16b at its peak last July, a2 Milk is a mere shadow of its former self, prompting speculation in the Aussie media that it may become a takeover target for food groups wanting a share of the market for milk products free of the a1 beta-casein, which is what a2 sells.

Local broker Jarden said a2 Milk had gone from being an early beneficiary of the Covid-19 outbreak, which led to pantry stocking as areas went into lockdown, to being disrupted by the pandemic’s effect on sales channels.

“On the macro front, our analysis highlights the China infant formula market – mostly due to declining birth rates – has shifted from a growth industry into volume decline,” Jarden said in a research note.

“Whilst not new, when coupled with Covid disruption to cross-border trade and stronger competition, these prior macro tailwinds have turned to headwinds, raising the execution risk of a2 Milk returning to its previous strong growth story,” Jarden said.

Jarden’s analysis of the Chinese consumer retail platform Tmall this month showed some stabilisation in pricing but no improvement, raising the risk of a further downgrade to a2’s profit guidance, “which we think the market is increasingly expecting”.

Australian store checks also pointed to ageing stock on the shelf, reinforcing the likelihood of a2 Milk needing to buy back stock, it said.

The broker said some of the pre-Covid daigou activity would return once borders reopen and freight rates normalise.

“The harder question is the structural impact of closed gift stores and whether new online models are sufficient to rebuild this activity.”

Jarden’s base case assumed daigou returning to 60 per cent of pre-Covid levels in the next five years.

On the periphery, the problems of the closely-connected Synlait Milk are difficult to ignore.

Synlait, a2 Milk’s sole infant formula supplier, has reported a 76 per cent slump in its first-half profit to $6.4m, driven by Covid-19 disruption. The company expects to be “broadly breakeven” in the full year.

Primed for downgrade

Shane Solly, portfolio manager at Harbour Asset Management, which has a stake in a2 Milk, said the market was primed for an earnings downgrade.

“The data that is coming through from external sources suggests that there may still be some washing through of inventory,” he said.

“This is a case where the farm gate has been left open a little bit and things may have bolted.

“Against that, this business has a lot of cash – it is well capitalised unlike some others whose profitability may be at risk.

Some consumer staples companies had reported slower year-on-year sales, reflecting past pantry stuffing, so the market was primed for an a2 Milk downgrade, said Solly.

But over the medium term, a2 Milk’s brand recognition continued to increase within China, he noted.

Market lags

A2 Milk’s fall from grace has played a part in the local sharemarket’s relative underperformance.

Wall Street has gone from strength to strength but the local market’s S&P/NZX50 Index is well short of its record high, reached on January 8, of 13,558.

The New Zealand equity market’s performance is skewed by some large companies that make up a big proportion of the index.

“A2 Milk accounts for most of the damage to the S&P/NZX50 this year to date,” said Castle Point Funds co-founder Richard Stubbs.

“It was roughly 6.5 per cent of the index at the beginning of the year and is down 38 per cent. That hurts.”

Stubbs says a2 Milk is now closer to 4 per cent of the index, so any further falls won’t have so much impact.

Passive vs active

In the long-running debate about passive investment strategy versus active, Milford Asset Management has claimed a victory in the aftermath of the BlackRock-Contact debacle.

The US investment giant, through its iShares Clean Energy exchange traded funds, built up a big stake in the power generator, only to dramatically sell many of its shares when Contact’s weighting on the influential index dropped.

Milford bought $176 million of Contact stock at an average price of $7.04 and sold $66m of stock at an average price of $8.98 over the past four months.

Sam Trethewey, portfolio manager at Milford, said it was a good example of active management taking advantage of passive flows.

F&P back again

Fisher & Paykel Healthcare is back on a roll as investors price in what would be the company’s eighth earnings upgrade in the past 18 months.

Sam Dickie, senior portfolio manager at Fisher Funds – which has a large stake in the respiratory products maker – said investors are revisiting their estimates as the world encounters a fourth wave of Covid-19.

“The bears will tell you that all the hardware that they have sold will gather dust in the cupboard once Covid eventually is brought under control,” he said.

But Dickie said there are some facts to offset that view.

“Nasal high flow (NHF) products, or ‘Optiflow’ stood up well in a crisis in new hospitals – Brazil and India being a case in point,” he said. “NHF productsalso stood up well in areas outside hospital intensive care units.”

Shares in F&P Healthcare last traded at $36.46, up substantially from $27.34 on March 8 and not far off last year’s record of $37.68.

Focus on Z

Z Energy reports its 2021 result on May 6, but brokers are more focused on the following year.

Jarden has forecast EBITDA of $243m for 2021 – the top end of the $235m to NZ$245m guidance range.

With Z having reinstated its dividend, Jarden forecasts a 13.5cps payout.

“We expect 2022 to see some recovery, with an EBITDA forecast at $300m (dividend of 20cps) as jet fuel demand grows with the Tasman bubble and the [Marsden Point] refinery begins as an import terminal from calendar 2022,” Jarden said.

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