Australia | Aug 28 2018
Is a2 Milk a disruptor deserved of a high multiple, or a high risk, one trick pony reliant on a volatile supply chain?
-a2 Milk thrives on demand from China, especially for infant formula
-First mover advantage establishes company as leader in a global market
-Expiring patents, emerging competitors, shortage of scientific evidence cloud future
By Nicki Bourlioufas
The a2 Milk Company ((A2M)) on August 22 announced an FY18 profit of $283m on revenue of $922.7m (up 68%). Just over 75% of revenue came from sales of infant milk formula, mostly to China, with the rest coming from liquid milk and other nutritional products.
A2M sells fresh milk and processed milk products that contain the A2 beta-casein protein but do not contain any A1 protein, which the company says is harder to digest. The company is already well established in Australia and New Zealand, and is expanding into the US and UK.
The stock closed at $10.80 the day after the result. While this was down on its peak of $13.17 in March 2018, the stock’s trajectory represents a spectacular rise from $2.00 in early 2017.
Analysts are divided on the company’s prospects. As Henry Hill from CLSA put it: “A2M is an increasingly polarising stock: is it a scalable, high margin, premium priced consumer good company disrupting a large and lucrative market and thus deserving of a high multiple? Or, is it a one-product company reliant on an opaque, volatile supply chain that has boosted margins while increasing risk?”
Hill is sceptical, rating the company a Sell with a price target of $10.40. Citi is even more negative, rating it a Sell with a target of $9.65.
At the other end of the spectrum, Bell Potter maintains a Buy rating, having raised its target price to $12.95. Macquarie is equally optimistic, rating the stock Outperform with a target of $12.50. Morgans rates the stocks Add with a target of $12.35, while Deutsche Bank has a Buy with a target of $12.30.
Between the two extremes, Credit Suisse and UBS both rate the stock Neutral, with price targets of $11.81 and $11.80 respectively.
Informal Chinese importers of baby formula move to local product in local stores
The optimists at Macquarie reiterate their supportive stance: “We continue to see a positive medium- to long-term opportunity for A2M to build its first-mover advantage as a disrupter in dairy and continue to become synonymous with a category that is seeing growing interest globally.”
Deutsche Bank agrees, saying A2M is the only business that is globally recognised in this space. Nestle’s recently launched competing brand, Illuma ATwo, has had no impact yet, according to A2M.
According to Bell Potter: “A2M continues to achieve strong levels of earnings growth while generating high levels of operating cash realisation. Looking forward we see the scope for continued success in the brand gaining traction in China, US and UK, the potential launch of IMF [infant milk formula] products in other regions and an acceleration in demand for IMF products in China as levers to create further value for shareholders.”
The Bell Potter analysts predict further growth in sales of baby formula in China as the number of distribution points increases and local sales of Chinese-label products replace sales through cross-border e-commerce platforms.
These informal channels include daigou, the “personal shoppers” who operate as unofficial agents for Chinese consumers, buying a2 products in Australian supermarkets and shipping them, often through the post, direct to the ultimate buyers’ homes in China.
Morgans believes “growth will be underpinned primarily by further market share gains across all markets and channels, a positive impact from its recent price rises, incremental growth from new products and increased distribution” through China’s mother and baby stores.
Regulation and reputation in China are key to future growth
Credit Suisse explains its valuation is “highly dependent on continued success in China, with a change in consumer perception regarding product quality or safety at the top of the list of items that could disrupt performance”.
Other items on that list of dangers include supply-chain risks, both in its concentrated exposure to the daigou channel, and its supply/manufacturing arrangement with milk processor Synlait Milk ((SM1)).
Credit Suisse notes: “Other China-specific issues include regulatory changes including tariffs, quotas, price controls, taxes and barriers that may be applied. Rules around standards and registration of manufacturing facilities and products are also of interest, with compliance to these in the hands of the manufacturer.”
Outside China, Credit Suisse points out, risks include heavy investment in the US, expansion into Southeast Asia, competition from companies such as Nestle, and potential threats to the company’s intellectual property rights.
Credit Suisse also pinpointed the risk of “the emergence of science that disproves or casts doubt regarding the efficacy of A1 beta-casein free products in delivering health benefits”.
Post the release of FY18 financials, the six stockbrokers in FNArena's database that cover a2 Milk rate the stock as a Buy (or equivalent) three times, with two others on Neutral/Hold, leaving Citi on Sell.
Note: CLSA and Bell Potter are not included in the brokers monitored daily by FNArena.
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