As the newly inked initial trade deal between the US and China appears set to roll back some tariffs, we look at how these China-exposed Australian companies have fared recently.

The signing of the phase-one agreement by US President Donald Trump and Chinese Vice Premier Liu He in Washington on Wednesday marks a thaw in the 18-month row between the world's two largest economies.

But scepticism remains because the deal doesn't fully eliminate the tariffs that have slowed the global economy and sets hard-to-achieve purchase targets.

Looking some of the large Australian companies with the greatest China exposure – outside of mining conglomerates – three companies stand out. Each of these companies count sales into China as a considerable driver of revenue.

At the height of the trade tensions last year, Morningstar Australia's director of equity research Adam Fleck didn't anticipate any long-term negative effects.

He conceded that any company deriving a lot of money from Chinese consumers was likely to be hurt by a slowdown in China's economy.

Conversely, Fleck said that if tariffs applied to goods from the US it would be good news for Australian companies.

China’s economy is expected to have grown 6 per cent in October-December from a year earlier, according to analysts polled by Reuters, unchanged from the previous quarter’s pace, which was the slowest since 1992 - the earliest quarterly data on record.

Treasury’s China sales on track

Treasury Wine Estates, a global wine company that increasingly targets high-end consumers, benefited from a drop in the tariffs China imposed on Australian winemakers in the first half of 2019 – at the same time as US wine exports to the country fell sharply.

Fleck sees continued growth in Treasury's Asian business, which comprises 26 per cent of sales and 31 per cent of operating income. This is largely because of the company's "premiumisation" drive in boosting its high-end brands and reducing sales of lower-end wine.

His outlook for double-digit average annual volume gains in Treasury's sales in China remains on track, forecasting 14 per cent annual volume growth over the next several years.

"Chinese wine consumption has climbed off a low base, averaging 16 per cent annual volume gains since 2011, as the region’s climbing consumer wealth has driven demand for upmarket brands," says Fleck.

He expects volume gains will remain "tough to come by" but believes Treasury's focus on the premium end of the market and continued growth in China and other Asian countries positions it favourably.

Treasury Wine's fair value estimate of $12.80 was lifted from $12.30 in August, on an expectation of higher margins over the long term.

But Fleck also sounds a note of caution, given the company currently trades at $17.24, some 35 per cent above what Morningstar thinks it is worth.

A2 Milk

New Zealand-based milk and infant formula company A2 Milk has long been linked with Chinese consumers, especially in connection with professional "daigou" shoppers who legally buy the milk powder to sell overseas.

But Fleck viewed A2 as largely immune to fallout from the trade tariffs, even while highlighting sales of infant formula into China as the company's key medium-term growth avenue.

"We forecast rising prices, new products, and a continued consumer shift toward foreign brands to drive higher revenue per volume, and high-single-digit growth for overall value in the market," Fleck said in late 2019.

"We see A2 increasing revenue in this geography at a 16% annual clip through fiscal 2029, with Chinese infant formula climbing to about 90 per cent of the company’s consolidated earnings before interest, tax, depreciation and amortisation."

He notes that A2's premium pricing gives it an advantage over other dairy producers, which has seen its operating margins top 30 per cent from less than 1 per cent in fiscal 2015.
"We see a ceiling to A2's profitability upside…but the company's business strategy supports sky-high returns on invested capital," Fleck says.

He believes ROIC will average more than 230 per cent over the next five years. This, combined with a debt-free balance sheet and strong free cash flow, underpins the narrow moat of competitive advantage attributed to A2 Milk.

The company's fair value estimate of $14.50 as of August last year was lifted from $13.60, on the back of solid financial results for fiscal 2019. A2 shares closed at $14.23 on Thursday and are considered fairly valued.

Blackmores fairly valued

Vitamin maker Blackmores, which relies on Asia for around 40 per cent of total group revenue, is also trading in line with Morningstar's fair value estimate.

Equity analyst Nicolette Quinn highlights China as a large opportunity for narrow-moat Blackmores, anticipating around 10 per cent annual growth in the market from fiscal 2021.

She notes China is the second-largest global market for vitamins and dietary supplements, behind the US.

"However, the company has struggled to get across the regulatory environment, and changes in distribution channels has caused volatility," Quinn says.

Alongside the daigou channel, two key distribution methods for Blackmores are cross-border online sales and shopfront sales from supermarkets and pharmacies.

The lack of formal Chinese regulatory approval to sell from these physical storefronts continues to elude Blackmores, despite having been in the application process for more than five years.

"We understand this is a key point of focus for the new management team," Quinn says. She lifted the company's fair value estimate to $81 a share in October, following the appointment of CEO Alastair Symington and management's outline of a sustainable growth framework at its annual general meeting.

"We attribute recent disappointing performance to execution and regulatory issues, and not a changed regard for the Blackmores brand by the customer.

"Blackmores commands a price premium and its reputation for quality is its source of competitive advantage."