Jumping out of the street corner Infant Milk Formula (IMF) Bar on Monday morning and looking a little less morose for the first time in ages, is that former symbol of our once monster-truck trade with China, the a2Milk Co (ASX:A2M).

A2M shares are up sharply in morning trade on a mixed first half that disappointed on earnings, topped consensus and offered a second half outlook that Barrenjoey analysts are calling “positive.”

Canada: Don’t let A2M pasteurise

To be fair, reports are coming in that Saputo, the Canadian dairy giant is the latest of a number of consolidating dairy giants thinking what a tasty meal the infant formula maker would make.

Along with the analyst beat, there’s also speculation about takeover activity in the industry.

That marks a possible ray of light for a company such as A2M.

FY21 was a spoonful of distilled pain and COVID-19 carnage. NPAT did an 80% plank walk and inventories became write offs.

Strong, and improving first half EBITDA margins up 15% have helped reboot A2M after a long and seemingly endless run of hits and missteps.

Analyst view

Barrenjoey says the result is ahead of consensus and was a beat on its analyst expectations.

Perhaps most importantly — and possibly what’s behind the rising share price – the second half revenue outlook has also improved with growth expected to continue above 1H22 levels.

However, it comes with this rider — that incremental profits will be reinvested into what is set to be record marketing levels and rising ‘capability’ costs.

In a note this morning, Barrenjoey analysts say FY22 was, “always going to be a ‘trough’ year for earnings,” as A2M reset inventory levels and set about reviving the battered state of its once unbesmirched brand.

“There are signs of greenshoots with inventory rebalanced and pricing restored and A2M’s MBS marketshare reaching 3.2% in December (vs. 2.6% MAT). And while that’ll be some rare pleasing news for long-suffering investors, the cold hard fact remains – the China IMF market is still a very, very challenging place to be leveraging your business,” the analysts said.

Once upon a time, when trade was friendly and the Australian brand untarnished,  A2M set a fascinating precedent. There was an almost effortless grace to the way the dairy specialist stepped into a massive niche market which had been left totally vacant by domestic scandals that read more like horror movie scripts.

(Google melatonin – it’ll all chillingly come back to you pretty fast).

So while we’re seeing a lift of the back of these numbers, it’s a long road back and the jury is still out on whether it ever returns to the valley of that Shangri-la.

First up – domestic and global competition have stepped into the regulatory vacuum, since A2 was so publicly squashed by belligerent Chinese regulators.

A2M’s downfall has been part structural, part political. All the eggs were in the one basket when Chinese officials began turning them away.

But China’s demographic trap is also tightening. There are fast-falling birth rates which have catastrophic implications right across the Chinese economy.

And finally, there’s increasing global competition and A2 is losing on many fronts; critically it’s getting whacked in the comatose Daigou markets.

A2M 1H22 key takeaways:

– Revenues broadly in line with Barrenjoey estimates, excluding MVM contribution.

– EBITDA ~$20m ahead of Barrenjoey and consensus, driven by stronger-than-expected margins in ANZ and China/Other Asia.

– 2H22 revenue outlook improved, A2M now expects growth in 2H22 revenue on 1H22 levels.

– Improved revenue outlook to be offset by record FY22 marketing guidance (up from~$195m to ~$220m).

– Corporate capability (particularly in China) and incentive costs are also expected to rise.

Barrenjoey: “In our view, FY22 earnings are largely irrelevant given the rebasing of the business required. The improved 2H22 revenue outlook and rebased inventory and pricing levels are positives.”