Tech Stocks Sell Off | Another A2 Milk Downgrade

12 May 2021

Global markets were mostly lower overnight  (S&P 500 index -1.0%) as US technology stocks led the market lower, against the backdrop of inflation fears with key industrial commodity prices stretching higher.  

Investors recommenced the rotation out of mega cap growth names, resuming a noticeable trend seen earlier this year as the anticipated rise in inflation increases the chances of interest rates rising. Most sectors were in the red, led by Tech down -2.5%, followed by Consumer Discretionary (-2.0%), while some defensive sectors were up including Utilities (+1.0%), Consumer Staples(+.08%), Real Estate (+0.4%) and Healthcare (0.1%). 

European markets (STOXX 600 index +0.1%) inched higher, as basic resource stocks jumped +2.2%, offset by a fall in the tech sector -1.4%. German vaccine company BioNTech was highlight of the day, jumping +8.8% after revealing plans to build a manufacturing site in Singapore. As we have mentioned earlier, highly valued/inflated assets (particularly high growth tech stocks) are set to be most prone to any market pullbacks regarding concerns around rising interest rates, which are currently being triggered by elevated commodity prices as parts of the economy boom.

A2 Milk Company (:NZX / A2M:ASX)

A2 shares slumped yesterday, down -12.8% after announcing its fourth downgrade since September 2020 which was partly expected but came much sooner and was larger than we could have anticipated.
A2 now expects 2021 full year revenue to be between $1.2 billion to $1.25 billion, and slashed earnings margins as they were forced to limit sales and write off excess inventory (~$100m of stock) due to challenging market conditions, and unfavourable macro conditions including a significant decline in birth rates (-15% last year). While brand strength remains supportive, it appears conditions are more likely to remain challenging over the near-term, before any turn around and even when growth returns it is anticipated to be at a much more subdued level.

Assuming a modest and slow turn around we believe A2 milk is fairly priced at the current juncture, given A2 milk is still profitable and continues to hold excess cash reserves we see no reason for existing shareholders to panic sell. In saying that, we would not BUY this current dip either and prefer to buy once we see a turnaround in macro conditions.

We believe there is room for more selling pressure over the next few days, especially as the MSCI index calculation announcement is due out tomorrow (in the worst case scenario A2 is removed form the index, which would see forced selling of shares from index tracking funds). 

On balance, and after much consideration, we are downgrading our rating on A2 Milk to a HOLD, with a view to re-instate a BUY recommendation when we see signs of positive news. 


Australia & New Zealand Market Movers

The Australian market (ASX 200 index +1.3%) rose strongly as economic data points to the Australian economy is making a V shaped recovery.

A rally in commodity prices helped benefit major miners and energy stocks, Fortescue Metals (+7.9%), Rio Tinto (+4.6%) and BHP (+3.1%), iron ore prices surging higher amid stock piling by Chinese buyers. Most of the major banks also traded higher following their solid results last week as the Aussie economy recovers with the nature of their business able to handle any potential increase in interest rates and CBA hitting multi-year highs after announcing a new tech partnership. 

Crown shares rose +7.25% after announcing it received two more takeover bids, Blackstone increasing its initial bid by $0.50 per share to $12.35 per share, and Star Entertainment made a cash offer of $12.50 per share or an exchange of 2.68 Star entertainment shares for 1 crown share, which implies a value of $14 per share.  

New Zealand’s main share index fell (NZX 50 index -0.6%) weighed down by A2 Milk's earnings downgrade which dragged down its supplier Synlait (-5.9%), as well as Fonterra being down another -4.7% following its potential capital structure changes. 

Heartland group rose +1.6% after upgrading its earnings guidance by +2% as economic conditions improve and on the back of modest receivable loan growth. 

3 Things Markets will be Watching this Week

  1. COVID, lockdown, and vaccine related news-flow globally continues to dominate headlines.
  2. Economic data highlights this week include inflation prints in the US and China along with the latest retail sales data in the US.
  3. Closer to home, retail sales in Australia are due on Monday while a number of earnings reports will be released including Pendal, AusNet, CSR, Pushpay, Graincorp, Xero, Orica, Goodman Property and Tilt Renewables. CBA will round out the bank reporting season with its Q3 update while Meridian Energy will host an Investor Day on Tuesday.
Global markets were mostly lower overnight (S&P 500 index -1.0%) as US technology stocks led the market lower, against the backdrop of inflation fears with key industrial commodity prices stretching higher.

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