Still the right formula, Citi sticks with a2 Milk despite falling China birth rate

Data released on Wednesday by China's National Bureau of Statistics (NBS) showed another decrease in China’s birth rate in 2023. The birth rate slowed to 6.39 per 1,000 people, down from 6.77 per 1,000 people in 2022, a 5% decrease.

This is despite a range of measures implemented by Beijing to encourage Chinese couples to expand their families. The Chinese government wishes to stem the decline in China’s population, which in 2023 declined another 2 million to 1.409 billion.

China is an important market for dairy products and infant formula manufacturer, The a2 Milk Company (ASX: A2M), and a slowdown in China’s birth rate could have negative impacts on the company’s bottom line. Citi has reviewed the latest China birth rate data and issued an update on its views on A2M, deciding to retain its “Buy” rating and its price target of $4.81.

Year of the baby

Despite the weaker data on China’s birth rate, and the prevailing gradual trend lower in China’s population, Citi is rather upbeat on the prospects of a mini-Chinese baby boom in 2024. The broker expects the number of babies born in China in 2024 to increase by around 2% to approximately 9.2 million. Reasons for the likely increase include:

• A continued catch-up as couples resume family planning goals in the wake of the COVID-19 pandemic

• A 4% jump in marriage registrations last year

• A customary desire to have children born in this year’s Year of the Dragon

Longer term, Citi is more conservative on its estimates because it expects the number of females who are within the typical childbearing years of 20-34 to continue to decline by 5% in 2024, and longer term, families may reconsider their options given what the broker calls growing “economic and demographic challenges”.

Putting all of the above together, Citi believes China’s infant population will decline by 5 percent next year, but at a slower rate than 2023’s 9% decline. This would lead to “shrinking demand” for infant formula which would likely trigger a decline in the value of formula sales.

Industry supply is also expected to decrease, though, as inventory destocking diminishes in the wake of the new GB standards which were implemented last year. On the Chinese infant formula market, Citi notes “competition will remain tough and consolidation will continue”.

Still the right formula

So, what are the implications of this complex set of inputs for a2 Milk? Citi says that the industry dynamics of the Chinese infant formula market are a well-known and understood “headwind” for manufacturers. The broker is pleased that a2 Milk “somewhat unexpectedly” reiterated its earnings guidance for FY24 at the company’s AGM in November.

“We think the 1H24 result might be better than expected”, Citi says, noting the success of a2 Milk's China label transition and sales during the popular Double-11 annual sales festival coming in-line with expectations. Citi notes this could lead to an evening out of a2 Milk’s sales across the full financial year, instead of the usual skew towards the second half.

In terms of valuation, Citi believes a2 Milk’s current price-to-earnings-ratio (“PE Ratio”) is an “undemanding” twenty times. The broker notes this as a “material discount” to the company’s historical average PE Ratio of 28 times. As stated above, Citi retained its “Buy” rating on a2 Milk as well as its price target of $4.81 – some 11.6% higher than the last price at the time of writing.