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A2 Milk Creaming Market Share In China

Australia | Mar 14 2018

This story features A2 MILK COMPANY LIMITED, and other companies. For more info SHARE ANALYSIS: A2M

Brokers consider now is an opportune time for investors to take advantage of a2 Milk as the business redoubles its momentum.

-Strong growth and further gains in market share highly likely
-Partnership with Fonterra leverages strength of both companies
-Benefits from substantial marketing expenditure expected in FY19

 

By Eva Brocklehurst

Brokers laud a2 Milk Co ((A2M)) for its high-margin, premium-branded products, which have digestive benefits. A2 Milk scored in the last two months of the first half from key selling events in China and its share by value is rapidly rising in a market that is calculated to be worth around US$20bn.

A2 Milk is considered to be in the fortunate position where its balance sheet will allow funding of a blending and canning facility (with Fonterra), new products and global expansion, as well as reward shareholders through dividends.

Morgans forecast strong growth over the coming years and further gains in market share in large geographies such as China, believing the stock deserves a premium rating. Cash flow is extremely strong, providing both growth and capital management opportunities.

Citi considers the current market dynamics are extremely favourable and, while likely to attract more competition, the emergence of any significant competitor is not yet on the horizon. In the meantime, the investors are advised to take advantage of the momentum.

The company did not provide formal FY18 guidance but has stated that its performance in January was pleasing. Morgans believes the market share gains and increased distribution in the first half bode well for a strong surge in revenue, despite infant formula sales being seasonally skewed to the first half.

Morgans initiates coverage on the stock with a Add rating and $14.40 target. The share price has risen strongly this year but the broker considers the upgrade cycle is far from over and the stock will continue to appreciate.

Both Credit Suisse and Deutsche Bank upgraded to Outperform and Buy, respectively, in the wake of the first half results. Credit Suisse expects the company to double its revenue stream in 10 years, while Deutsche Bank suggests the strategic agreement with Fonterra will unlock the global brand potential.

Fonterra

The company recently announced a new partnership with Fonterra for manufacture and supply, with the potential for both geographic and product expansion. Fonterra will manufacture A1 protein-free products for certain markets exclusively for a2 Milk. The two will also explore the potential for a joint blending and canning facility.

Fonterra will license production, distribution, marketing and sales of a2 Milk in New Zealand and manufacture the powder products at its facility in Victoria. Blending and canning will be done at Fonterra's facility in Hamilton, New Zealand. Brokers believe the relationship leverages each company's relative strengths and is a strong endorsement of the a2 Milk brand.

Morgans suggests the strategic relationship with Fonterra should fast track entry of a2 Milk into priority markets in the Middle East and Southeast Asia where Fonterra has strong distribution channels. The company's a2 Platinum product has transformed earnings in recent years and Morgans expects plenty of market share will be gained in both existing and new markets.

Last September, milk supplier Synlait Milk ((SM1)) received registration from China's Food and Drug Administration for a2 Milk's infant formula. This allows the sale of a2 Platinum China-labelled products to stores in China.

The registration requirement has reduced the number of infant formula brands in China, and with fewer brands brokers consider a2 Platinum is well placed to win market share. Additional marketing expenditure should also show benefits in FY19 and the US business is expected to reach break even on a monthly basis by FY20.

Background

A2 Milk is building a global branded dairy nutrition business across Australasia, China, Asia, UK and US. The company differentiates its products as containing exclusively A2 beta casein, derived from certain cows which produce milk that is naturally A1 protein free. Conventional milk supply is a mix of both proteins.

This unique milk product has allowed a2 Milk to price products at a premium to its peers. Research has shown that A1 and A2 proteins are digested differently and the company has been successful in marketing its products to consumers concerned about A1 milk protein intolerance. In this instance, these products are considered well suited to the Chinese market, which has a higher level of dairy intolerance.

FNArena's database shows five Buy ratings and one Hold (UBS). The consensus target is $13.80 suggesting 6.5% upside to the last share price.

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