This is the second part in our analysis of A2 Milk, part 1 can be found here.
Growth Opportunities in New Markets
A2 Milk is currently expanding to other Asian markets with their recent launch in Singapore and Korea. The expansion into the Singapore market late last year is seen as a logical first step to drive expansion for A2 Milk into Asia as a whole.
Furthermore, the areas in which they are targeting now, including the release of platinum infant formula in Hong Kong, tend to be areas with higher educational and income levels. These are generally the areas in which A2 Milk would do well in as the general population would be able to better comprehend the health benefits present in A2 protein. Furthermore, the expatriate population is higher in these countries where many are Australians and New Zealanders and are already aware of the brand and its benefits. This would make breaking into the Asian markets even easier.
A2 Milk is also releasing a pregnancy product in 2H18. The product has had good feedback from presentation to trade and it fits well into their existing product offering and distribution channels. Sales for the pregnancy product is expected to do well due to the brand image that A2 Milk has managed to build up. Their brand image relates to their premium product and being a better/healthier option as compared to their counterparts. These are the ‘key terms’ in which one would be looking for in terms of purchasing during the pregnancy period. This also explains why A2 Milk is constantly investing their profits in medical research as to the benefits of A2 protein.
A2 Milk’s Strategic Relationship with Fonterra
A2 Milk has entered into a comprehensive strategic relation with Fonterra through a nutritional products manufacturing and supply agreement. Fonterra will then supply A1 protein-free nutritional products in bulk and consumer packaged formats exclusively to A2 Milk. A2 Milk is also granted strategic customer rights with committed capacity arrangements with offtake flexibility while Fonterra is granted specific supply rights for specific new priority markets in SEA and Middle East to a specified volume. As part of the partnership, Fonterra will begin sourcing an A2 milk pool for A2 Milk’s products in New Zealand which is intended to significantly expand over time to help meet the growing demand for its products.
The strategic relationship will benefit both parties where A2 Milk is able to leverage on Fonterra’s high-quality milk pools, global supply chain, manufacturing capabilities. Combining Fonterra’s distribution expertise with A2 Milk’s brand strength would enable them to unlock new opportunities in a wide range of international markets. This will facilitate further growth for A2 Milk’s products and allows for an acceleration of strategy of their strategy. This includes the roll out of their products into the SEA market. It serves as a defensive move through increased speed to market should there be any threats of other companies trying to launch an A2 free product similar to what Nestle did in China.
A2 Milk’s intellectual property portfolio consists of a number of rights in trademarks, patents, proprietary processes and know-how which together interlock and provide protection to a2 branded products and processes. A2 Milk has brand and trademark registrations or applications across 57 territories. In addition, A2 Milk has 14 families of patents which cover a number of activities including herd testing, herd formation, beneficial uses and physical properties associated with A2 products. The table below details all publicly disclosed patents by A2 Milk. My understanding is that these patents are largely focused around the benefits of A1 protein free products.
The most important patent has already been expired in Nov 15 which is the method for testing milk for the presence of A1 Protein. In practice the patent was co-owned with Fonterra and the fact that Fonterra had never pursued an A1 protein free product range suggests that there is more protection in place for the a2 range than simply one patent. I suspect that the more important element of the protection is likely around the herd testing and selection protections, with one of these patents lasting through to 2023.
Nestle has recently rolled out an A2 baby formula in China under its Illuma brand posing a direct challenge to A2 Milk in one of its most significant markets. The stock dropped 6.5% in New Zealand after news of Nestle’s launch emerged. The new product is currently being offered on e-commerce platforms at a similar price point to A2 Milk.
Source: Euromonitor International
As seen from the graph above, Illuma has a strong brand share in the China market and the increase competition would have an impact on A2 Milk’s business.
However, they have reported that their sales have still been strong and there was not much of an impact. This could be because of brand loyalty which is prevalent in the packaged foods sector. Furthermore, a recent industry feedback suggests that the ‘a2’ brand is the top purchase driver of a2 Platinum and not the A2 protein proposition. The demand originated out of the brand’s reputation as a high-quality product leveraged to their clean & green image. Hence there would be limited situations where consumers select between the two products based on containing A2 protein. This bodes well for A2 Milk where they are able to defend against potential competition.
Given that the China market occupies ¼ of the total revenue, it is definitely good news that they are able to defend their position in the market. However, more time is needed to truly observe the impact by the increased competition. Given the strong market share by Illuma, they are most likely going to increase distribution and marketing efforts for the new product.
Share Price Analysis
Using the ASX 200 and NZX 50 as a benchmark, the returns from investing in ATM/A2M far exceeds the market index in the last 6 months. There have been a few major movements in A2 Milk’s share price with the notable ones being in Feb and Mar 2018.
In Feb 2018, A2 Milk released the 1H18 financial results and investors overreacted slightly to the stock resulting in the large increase in share price. In addition, Citi has also released a market report during that period stating a buy rating with a target price of 14. This has also contributed to the sharp increase in ATM’s price with an increase in investors’ confidence.
In Mar 2018, Nestle launched an infant formula product that uses the A2 beta-caesin protein similar to the ones produced by A2 Milk. This is seen as a direct competition towards A2 Milk and is reflected by the dip in their share price. The price for A2 Milk went down from 14 to 12.4 and has rallied to the current price of 12.76. The company’s shares still remain 316% higher than a year ago.
Growth Potential Factored in the Share Price
From the recent news released, there isn’t much information on the results from the growth/expansion of A2 Milk. Looking at the price chart, the market did not react much to the news of A2 Milk entering the Korea market. This would indicate that investors are either holding on to observe the operational performance or that they are losing confidence due to increasing competition. More time is needed to observe A2 Milk’s success in the SEA market and in Korea which would largely affect the price of the company given that the headwind is currently stronger for A2 Milk. However, the returns from investing in A2 Milk is still better than investing in the different market indexes which has a return close to 0.
A2 Milk as a Potential Takeover Target
A2 Milk’s earnings, as mentioned previously, has remained solid after a strong start to 2018. Furthermore, they are looking to enter into new markets in SEA along with winning market share in China while maintaining its premium pricing position. Although their main market now is still within Australia and New Zealand, A2 Milk’s direct sales into China has increased significantly and are expected to rise even more.
All these factors actually make A2 Milk a perfect takeover target with its strong market position and potential for growth. They are in a niche market where their premium pricing and brand image is unrivalled in the industry. Furthermore, their balance sheet is as good as it gets with minimum debt and high current assets. Multinationals looking for global growth could see A2 Milk as a potential target. Large companies like Nestle and Danone have articulated strategies to grow in Asia and beyond by acquiring brands that move them towards the health and wellness categories. In addition, with A2 Milk’s differentiation in the market, they will allow companies to expand globally and multi-generationally thus having a much larger potential market.
However, while the acquisition of A2 Milk is indefinitely beneficial to any firm, they would need to issue a large cheque and that is highly unlikely. Their stock price is highly valued at NZD $12 per share. This can be compared to its competitors which are trading at a much lower price. ATM’s 52 week range is at 3.11 – 13.78 and it would make no sense for potential buyers to pay at a price close to their 52 week high. Furthermore, the premium that would be paid to A2 Milk in an acquisition would be rather large given the potential synergies and growth potential that they possess.
A2 Milk remains a good investment opportunity for investors. The only risk that they have currently would be the increasing competition. Even though the share price of A2 Milk has been trading relatively close to its 52-week high, it is still a BUY with their growth in the SEA market and launch of new products. A2 Milk’s management is focused on expansion and it seems to be working so far. They are in a good position to increase market share in both China and SEA with different strategic partnerships which in turn would lead to high returns for investors. Why stay safe and invest in market indexes when the potential returns of A2 Milk is just right there calling for you.