Daily notes

Daily notes – Freedom Foods, A2 Milk, Bellamy’s, Blackmores

Freedom Foods (FNP) – Build out phase still underway… A2 Milk (A2M) –  Robust growth, everywhere… Bellamy’s (BAL) – Sales turnaround needed… Blackmores (BKL) – Business stable, some growth, but not much

Freedom Foods (FNP) – Build out phase still underway

Freedom continues to invest heavily on new plant and equipment, spending another $84m during H1 19. There was also a significant increase in working capital during the period of $33m. The working capital investment reflected a rise in dairy milk purchases as a result of increased dairy demand, higher trade investment for key brands and investment in raw materials and packaging for increased demand expected in the 2nd half of FY 2019.

Massive investment in plant and equipment, working capital and intangibles, with sales just keeping up and returns on capital miles away from where they need to be. A familiar story for the company over the last few years.

Gross margin, EBIT margin and asset turnover are the key ratios to keep an eye on in this situation. Gross margin was up slightly to 24.7% from 23.3% during the period. Asset turnover for the last 12 months to December 31 was 0.59, compared to 0.52 during the 12 months to June 30. EBIT margin was steady at 4.2%.

Something needs to budge in a big way in order for the company to earn an acceptable return on capital eventually.

The capital expenditure program will eventually run off, and sales need to increase substantially for it all to have been worthwhile. The company has relatively strong global ambitions across each of its divisions, but it seems that the market is pausing for the moment to see if sales and margins can scale in the way that the company is hoping.   

A2 Milk (A2M) –  Robust growth, everywhere

A2 Milk released another set of strong half-year results. Revenue grew 41% to $613m and EBITDA grew 53% to $218.4m. Net profit grew 55% to $153m.

Even though marketing spend was up 75% to $45m, margins were able to continue expanding from 33% to 35%, which shows the power of a growing consumer franchise. More sales leads to increased ability to fund marketing, which leads to more sales and more marketing again, further entrenching the brand’s position.

Marketing spend is expected to double in H2 to $90m, which will reduce margins for the time being. Attacking larger markets such as the US and China is expensive; however, presumably, the sales opportunity will make it worthwhile.   

In contrast to Freedom Foods, A2 does not own much in the way of fixed assets and instead outsource all production. The company sought to strengthen its supply arrangements during the half by increasing its shareholding in Synlait to 17% by investing $170m, which represents the company’s first significant capital investment.  

Sales growth in the second half is expected to be broadly in line with H1. EBITDA margins are expected to moderate to 31-32% due primarily to increased marketing spend.

Bellamy’s (BAL) – Sales turnaround needed

Bellamy’s sales continued to fall during the first half to $130m, down 25% from $170m, which is in stark contrast to A2 Milk’s revenue growth of 41%. The company grew gross margins to 42.8% from 37.1%, while EBITDA margins were stable at 21%, not including the $12m inventory provision for all legacy label inventory, following the rebrand.

Regarding branding, the company seems to be struggling to differentiate itself in a competitive market. Organic, made in Australia is no longer enough. As a response, the company added DHA (as well as ARA and GOS, whatever they are) to the formulation and supported the change with new branding and product labeling.

BAL is expecting sales in the order of $145-$170m during H2, bring FY 19 sales to $275-$300m and margins of 18-22%. The company is targeting sales of $500m+ by FY21, which implies a growth rate of 30% over the next two years. While not wholly fanciful, this will require the newly branded product to re-engage consumers, both in Australia and China.

Marketing expense, which was only $7m during H1 will need to be stepped up to compete effectively. Merely having product on the shelf is no longer enough, though it was for a while. It seems that the market is becoming more sophisticated.

In summary, not dead yet, big opportunity but need to execute.  

Blackmores (BKL) – Business stable, some growth, but not much

Blackmores reported sales growth for H1 19 of 11% to $319m. Gross margin was steady at 39%, while marketing expenses were up 31% to $32m and operating expenses were up 12% to $114m. As a result, EBIT margins reduced from 17.1% to 15.8% and EBIT was approximately flat at $50m.

Operating expense growth reflected investments across Asia and in strategic initiatives. Selling and marketing expense growth predominantly relate to China. With that, China segment sales were down 11% during the half year compared to the PCP to $65m.

However, other Asia segment revenue was up 34% to $53m. More specifically, Korea +67%, Taiwan +150%, Hong Kong +39%. Indonesia sales grew 72%, driven by entry into the country’s largest pharmacy retail chain, Kimia Farma.

The outlook is for modest full-year revenue growth and profit in line with H1. The company has established a business improvement program to target $60 million of savings over the next three years, which we do not expect to fall to the bottom line but instead will be used to fund further investment to kick sales growth up a notch, particularly in the Chinese market.  

By Danny Sandler

Founder of Ocean Asset Management.