Today, we will look at why we like The a2 Milk Company (ASX A2M).
We first looked at this stock back on the 19th March 2018 when the price was around $12.50.
We wrote about it again on the 14th May 2019, when the price was around $15.00.
Since then, the stock has traded up to $18.79 and trading close to all-time highs despite the issues around COVID-19.
Milk is perceived as an essential item. In the first three months of 2020, despite the COVID-19 outbreak, A2M reported better than expected revenues because of panic buying by consumers fearing extended lockdowns.
Further, in an April press release, the company posted revenue expectations of NZ$1.7-NZ$1.75 billion for FY20, implying growth of 30%-34% YoY – an admirable performance given the current economic scenario.
In the first half of FY20 (1H20), the company delivered double-digit revenue growth (year-on-year) in all three product segments of liquid milk, infant nutrition businesses, and other nutrition.
Geographically, A2M enjoyed double-digit revenue growth in ANZ and China/other Asia and triple-digit growth in the USA in the same period.
However, its USA business is yet to achieve scale and is EBITDA-negative.
The company has a very strong balance sheet with substantial cash reserves of NZ$620 million as of end-February 20 and no debt whatsoever.
In December 2019, Bloomberg labelled the company as globally the best-performing stock of the decade with a 16150% return.
With effect from June 22, 2020, A2M will be included in the S&P/ASX50 index.
Over the past 5 years, the company has significantly outperformed the ASX200 index by 2620%.
Source – Google Finance
About the a2 Milk Company Limited (ASX A2M)
The a2 Milk Company Limited (ASX A2M) is a specialty milk producer headquartered in New Zealand.
The company specializes in producing milk that only contains the A2 beta casein protein, rather than a mixture of A1 and A2 proteins found in conventional milk.
The company’s infant nutrition line, a2 Platinum, has also been highly successful in China, Australia and New Zealand.
The company mainly has two lines of products, liquid milk, and infant nutrition.
The company was a pioneer in bringing only A2 protein milk to the market and its product has since delivered steady and strong growth for the company.
A2 milk is supposedly easier-to-consume and healthier for people.
As of June 12, A2M’s market cap was NZ$13.81 billion.
The company’s biggest markets are the Australia and New Zealand region, China, and the USA.
A2M Is Highly Successful in Key Markets And Has a Fort Knox Balance Sheet
A2M has been one of the best-performing stocks on the ASX over the past 5 years with over 2,000% return.
This growth has mainly been driven by the success of the company in the Chinese region, where the company’s products have found growing acceptance.
A2M has been successful in China due to several reasons.
Firstly, the Asian region has very high lactose intolerance, which is why the easier-to-consume and healthier A2 milk has sold well.
Secondly, due to the enormity of the Chinese milk scandal which led to baby deaths and 50,000+ hospitalizations in 2008, an increasing number of Chinese nationals have shifted to the consumption of imported dairy and infant nutrition products.
The company’s infant nutrition line, a2 Platinum, has also been a monster hit in China.
Its distribution partnerships with China’s largest sellers such as JD and Alibaba-owned T-mall were instrumental. (In 1H20, a2 Platinum was among the top two selling products of the segment on both JD and T-mall).
Another reason for a2 Platinum’s success is the demand for quality English-label products from an increasingly international population.
A2 Platinum has also been highly successful in the Australia and New Zealand region, where the product is the market leader in infant nutrition across grocery and pharmacy channels in Australia.
The core milk business also continues to grow well. In 1H20, the company reported revenue growth and market share of 11.3% each in the Asia-Pacific region, with 62% revenue growth from the Chinese segment.
The company is also the only brand with distribution agreements with all major supermarket chains in the Australian region.
However, A2M’s operations in the USA are still to achieve scale and are currently EBITDA negative (-NZ$30 million in 1H20).
The company’s Chinese revenues are USD denominated, providing a hedge against depreciation of the NZD/AUD against the USD.
All these factors combined with substantial cash reserves, zero debt, and a solid balance sheet make A2M an exceptionally strong company.
A2M To Benefit From The Huge Opportunity in China
One of A2M’s biggest opportunity is the further development of its market in China.
Over the past 2 years, the company has posted robust growth of infant nutrition products in the Chinese region with sales rocketing about 500%.
In 1H20, the Chinese region generated just 39% of group revenue, compared to nearly 58% for the ANZ region, but this could turn much higher.
Given the massive size of the Chinese population, nearly 50 times the ANZ region, the company has a huge growth opportunity in the country.
A2M has plans to expand Chinese presence through the expansion of its footprint across physical MBS (Mom and Baby Stores) and e-commerce channels.
The company also plans to introduce more China-label products, which grew more than ten-fold from just 2% of product sales to 22% in the Asia Pacific region.
The core milk business is also doing very well in China with a growth of 62% YoY in 1H20.
Source – (A2M 1H20 Report)
Domestic Chinese Competition a Potential Threat
One major threat to the company is increased penetration of the infant nutrition market by domestic Chinese products.
In 2019, the Chinese government pledged to increase the market share of domestically produced infant formula to 60% from the current 40%, an increase of 50%, due to the domination of the segment by international brands such as Nestle, Danone, and A2M.
Although officials did not provide a timeline, this pledge can have an adverse effect on the stock price of A2M over the long term, given the fact that substantial China-driven growth is already priced in its valuation.
However, it should also be noted that some international companies like A2M have a competitive advantage over domestic dairy producers due to the lack of suitable land in China.
Another advantage for international companies is the persistent lack of trust in Chinese infant nutrition products since the 2008 scandal.
a2 Milk’s Strong Financials
We will compare A2M to Fonterra, which is a New Zealand based dairy multinational that accounts for 30% of global dairy exports.
We will also compare A2M to Bubs Australia, an NSW-based producer of baby formula and foods.
Source – WSJ Markets
We will use the price-to-book ratio to compare valuations, gross-margins to compare profitability, and total debt-to-equity to compare leverage of the company to its peers.
We will use gross-profit margin instead of net-profit margin as Fonterra and A2M are New Zealand based while Bubs is Australia based.
In terms of valuation, A2M is significantly overpriced compared to Fonterra and Bubs having a P/B of 13.69 compared to 1.04 and 0.59 respectively, owing to its high growth, robust margins and zero debt.
Fonterra and Bubs have Debt-Equity ratios of 113.2 and 1.89, respectively.
However, A2M has a completely untapped balance sheet that gives the company financial flexibility to raise funds should the need arise.
On profitability, A2M (gross margin of 57.2%) has a significant profit advantage over both Fonterra (14.48%) and Bubs (21%).
However, it should be noted that large operations and scale have higher fixed costs, as in the case of Fonterra, and that Bubs is a much smaller company.
A2M’s Stock Price Reflects Its Strong Fundamentals
The A2M stock has been on a tear in recent times and last traded at A$18.79.
It has shown resilience to the COVID-19 meltdown.
Meanwhile, management continues to be confident about revenue growth and profitability for FY20, and the company is debt-free.
Historically, stocks that outperform in bear markets tend to do even better when the markets recover.
Investors with a long-term perspective may consider accumulating on declines.
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This is general advice only. MF & Co Asset Management has not considered your personal financial needs, objectives or current situation. This information is not an offer, solicitation, or a recommendation for any financial product unless expressly stated. You should seek professional investment advice before making any investment decision.
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Henry is a co-founder of MF & Co. Asset Management with over 15 years of experience as a trader, investor and asset manager. His focus is on quantitative and qualitative stock analytics and advanced options strategies combined with statistical analysis to trade and invest for clients. You can catch him on ausbiz as a regular contributor talking on macroeconomic and trading themes.