Outlook for 2021 | A2 Milk & QBE Downgrades

29 December 2020

This will be our last regular daily market insights email for the year until we resume in mid-January. Thank you for your readership and support over a very unique 2020. We hope you have an enjoyable holiday period and wish everyone a prosperous 2021 new year.

Global markets were lower on Friday (S&P 500 index -0.4%) with market moves reasonably subdued as investors waited on the outcome of Brexit and US fiscal stimulus negotiations.

In news over the weekend, the UK announced that London would go into full lockdown as new Covid-19 cases surge while a $900 billion US fiscal stimulus deal looks to have been secured. Closer to home, the recent emergence of Covid-19 cases in the Northern Sydney beach suburbs has seen several Australian states place travel restrictions on those from Sydney or New South Wales.  The Sydney cluster highlights the challenges with the proposed Trans-Tasman bubble, which NZ PM Ardern had earmarked for Q1 next year.

There has been discussion around the outlook for 2021 and the return of “value” stock outperformance. We think it pays for investors to have exposure to both "growth" and "value" stocks as we head into the new year. Beaten up "value" stocks have played catch up, and only 10% of S&P500 stocks in the US remain in a bear market (down -20% or more) since COVID-19 shook markets earlier this year. 2020 was a year of return dispersion across sectors and stock names and we think this will continue in 2021, a good environment for active sector/ stock/region picks.

Investor sentiment is no doubt frothy and data shows traders are positioning for upside and not downside. The most bullish 2021 outlook from a major market strategist we have seen so far has come from JPMorgan, who see 25% upside for US equities in 2021.

We are constructive heading into 2021 given the backdrop of cheap money and an economic recovery boom. However, we remain cognizant of risks such as issues with vaccines, higher inflation/interest rates, and central bank / government policy missteps.

In stock news on Friday, there were 2 unwelcome Xmas gifts for shareholders of A2 Milk and QBE insurance which we discuss below.

A2 Milk (:NZX / A2M:ASX)

A2 Milk shares fell -22% on Friday as it lowered its earnings guidance to NZ$670m from a range of NZ$725m-NZ$775m forecast in September due to disruptions COVID-19 caused to its crucial daigou channel. A2 had already downgraded its earnings around 10% in September due to similar reasons and had just re-iterated recent events. guidance at their AGM last month. This is of most concern to us, and we believe it will take management a long time to get their credibility back in the market after (very disappointing) recent events

Looking at the numbers, revenue is now expected to be NZ$1.40–1.55bn, -10% to -19% against the prior year, with margin guidance also lowered materially.

A2 guidance now incorporates a sharp and protracted decline in daigou not made up for by other channels. The market now appears to be pricing some combination of (1) daigou not recovering or getting worse (geopolitical tensions and/or changed behaviour), (2) Chinese consumer demand moderating for the brand and/or (3) inventory issues. We still view the issues as largely temporary (stemmed from COVID-19).

There is a lot of unknowns, with recent announcements a stark reminder visibility is low and the high margin of error in earnings forecasts. does appear to be prioritising longer-term brand positioning and brand health, rather than short-term profit. The path forward is unlikely to be smooth and 2021 is not risk-free. The company does have a large cash balance which provides the option to help market confidence with a share buyback. Taking a longer term view, given the harsh share price fall since August, we see valuation support and remain BUY rated with a medium term horizon.
 

   
Australia & New Zealand Market Movers

The Australian market slipped on Friday (ASX 200 index -1.2%) but the market still recorded its seventh consecutive week of gains. Investors are on edge and watching how a Sydney coronavirus outbreak unfolds.

QBE shares dived -12% on Friday after guiding to an adjusted cash loss of circa US$780million for the 2020 calendar year, citing US$470millon of COVID-19 costs. For a second year running QBE has delivered an unwelcomed Christmas surprise, downgrading earnings off the back of reserve top-ups and higher CAT and Crop claims. While partly one-off in nature, higher claims inflation trends in the US and lower bond yields are more recurring features in our view. However, global commercial premium rate rises continue to accelerate in response to these industry-wide headwinds, with QBE enjoying an average 9.8% premium rate rise in the 3rd quarter and flagging rate acceleration across all regions in the 4th quarter of 2020. We currently have a HOLD rating on QBE.

The New Zealand market fell on Friday (NZX 50 index -1.6%) as one of the index’s biggest stocks, A2 Milk, lost a fifth of its value after another earnings downgrade. Dairy processor Synlait Milk, a key supplier of A2, also saw a further share price decline -3%, after falling more than -7% a day earlier. Trading was halted in the afternoon while Synlait worked out what A2's downgrade meant for it.

 

Team

We are constructive heading into 2021 given the backdrop of cheap money and an economic recovery boom. However, we remain cognizant of risks such as issues with vaccines, higher inflation/interest rates, and central bank / government policy missteps.

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