August 20, 2019 / 9:01 PM / 2 months ago

UPDATE 2-New Zealand's a2 Milk flags higher marketing spend as 'daigou' sales dry up

* Shares fall nearly 15% after annual profit misses expectations

* a2 Milk sees 12% of revenue in FY20 to be used for marketing

* Looking to build brick-and-mortar store presence in China (Recasts throughout, adds background on China and marketing spend)

By Nikhil Nainan

Aug 21 (Reuters) - New Zealand’s a2 Milk missed expectations for annual profit on Wednesday on the back of higher marketing costs which ate into gains from robust Chinese sales, sending its shares plummeting nearly 15%.

The company has been pushing into smaller Chinese cities as demand for foreign milk and infant formula grows in response to health scares around Chinese milk products, a strategy that helped drive a 41% leap in revenue for the year.

But marketing spending soared about 84% to NZ$135.3 million ($86.73 million) - or 10.4% of sales - and the company said it expected to invest about 12% of sales in the 2020 financial year as it opened physical mother-and-baby stores in China.

“Margins are key for a company that is priced for perfection. They need to beat expectations and this was a slight miss, but only a slight miss,” said Jeremy Sullivan, an investment adviser at Hamilton Hindin Greene.

a2 Milk said it was prioritising physical stores in China in a shift from its reliance on so-called “daigou” shoppers, who purchase products in bulk from stores outside China and import them informally to the mainland.

If a2 were to push heavily into brick-and-mortar stores then that would be a sign they are worried that the grey channels are slowing, Sullivan said.

“There’s a lot of costs involved in running those stores,” he said.

A Chinese crackdown on such informal importers has impacted firms which had used them to avoid the higher costs of marketing their products directly in China.

Australian vitamin maker Blackmores Ltd last week flagged lower first-half profit and said it would begin investing directly in China, citing the impact of regulatory change on the daigou network.

SALES UP

a2 said net profit after tax for the year to June 30 was NZ$287.7 million, missing a forecast of NZ$296.7 million according to Refinitiv data. This year’s number compared with NZ$195.7 million it reported last year.

Total revenue for the year rose 41.4% to NZ$1.30 billion.

While China’s slowing economic growth has troubled many other consumer goods companies, a2 Milk managed to grow its share of the infant formula market in China to 6.4% over the year. Its a2 milk product is marketed as easier to digest than conventional milk because it lacks the A1 caesin protein.

a2 shares were trading at NZ$14.35 in morning trade, its lowest level since the start of July, while the broader market was down 0.8%.

a2 Milk also said it planned to exit its British liquid milk business in the first half of 2020 to focus on its core markets.

$1 = 1.5588 New Zealand dollars Reporting by Nikhil Kurian Nainan, additional reporting by Ambar Warrick in Bengaluru; Editing by Bernard Orr and Stephen Coates

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