A2 Milk (ASX: A2M) Is A Fast Growing & Leading Chinese Infant Formula Brand

This article was originally published at MF & Co. Asset Management.

Today we’ll look at why we like A2 Milk Shares (ASX A2M).

We first posted about A2 Milk on 19th March 2018, when the A2M share price was around $12.50.

Like most stocks that rely heavily on exports to China, the stock suffered declines down to sub $9.

However, A2 Milk has rallied back to over $15.30 since then with a lot of clear skies ahead.

Now let’s get into why we think A2 Milk is a good stock to buy.

About A2 Milk (ASX A2M)

The A2 Milk company was founded back in 2000 by Dr Corran McLachlan in New Zealand. Whilst studying at Cambridge University, he discovered that the proteins in milk affected people differently.

He then discovered that ordinary cows produced two types of beta-casein proteins called A1 and A2. He then found a way to identify cows that produced milk without the A2 protein.

With that, the A2 Milk company was born.

The main selling point of A2 Milk is that the A1 protein has demonstrated through research to cause some people digestive discomfort.

By producing a product which doesn’t have the A1 protein, A2 Milk has a specialised product that some consumers will find easier to digest.

Since then, the A2 Milk company has expanded to Australia, New Zealand, China, the US and UK. They have also moved into some emerging markets in Asia.

Synlait Receives CFDA Approval of A2M shares Infant Formula

Since moving into the infant formula business, A2 Milk partnered with Synlait Milk Limited (ASX SM1) in 2010 to produce infant formula.

Based in New Zealand, Synlait Milk is a dairy processing company focusing on New Zealand, Australia, and China.

Their business goal is to manufacture the world’s first infant formula containing only A2 beta-casein protein type, without the A1 protein type.

Starting from 1st January 2018, manufactures of infant formula are required to register brands and recipes at the China Food and Drug Administration (CFDA).

China has a strong appetite for Australian imports as these products are view as high quality and trustworthy.

Synlait submitted an application of A2M stock’s infant formula to CFDA in May 2017 and was approved in September 2017.

In addition, Synlait Milk’s CNCA application for its Dunsandel facilities was approved in January 2019.

CNCA registration is required where Chinese authorities certify production facilities, to allow export to China.

Since Synlait Milk’s facility was approved, A2 Milk share price has been on a tear with strong momentum.

Having both certifications was a game changer for A2 Milk, allowing them to export to the worlds largest consumer market.

As it takes months to get these licenses, A2 Milk is well ahead of most of its competitors.

Chinese Market Tailwind and Exceptional Growth

A2M has gained huge success in China, and there is significant growth expected in the future.

Sales in China and other Asia area has skyrocketed.

Even though Australia & New Zealand growing by 68.8% is nothing to be sneezed at, the Asian countries grew at an astonishing 162.9% in FY18.

With the CFDA approval for infant formula, it was obvious that this was a massive tailwind for A2 Milk.

Some key growth metrics:

  • Revenue rose from 88.9m to 233.6m or 162.9%
  • EBITDA rose from 32.7m to 81.3m or 148.2%
  • Group Revenue rose 67.9% and EBITDA rose 100.5%
  • Infant formula revenue rose 83.8%

Source: FY18 Annual Report

In China, A2 Milk is now stocked at 12,250+ stores – a lot of this driven by Mother Baby Stores (MBS) as if 1H19.

In addition, there is another important reason behind the growth. This is due to the growth in China’s burgeoning middle class.

According to McKinsey Consulting, approximately 76% of China’s urban population will reach middle-class status by 2022. The Chinese middle class will reach at least 550 million people.

Furthermore, the one-child policy is withdrawn in China since 2015. Because of this, we can only expect the demand for infant formula to skyrocket as families bear more than one child.

The combination of CFDA approval, growing Chinese middle class and a one-child policy boom will see demand skyrocket in the coming years.

A2 Milk Shares Strong First Half 2019 Performance

Looking at the 1HY18 results for A2 Milk, the company continues to grow at a dizzying pace.

Half-year on half-year, A2 Milk across all segments grew revenue by 41% with Net Profit After Tax (NPAT) growing by 55%.

Source: 1h19 Results

Looking at each segment, we can see that the Asian segment has slowed down.

However, slow down is only relative, at a 50.1% growth in revenue, this is still the strongest segment for A2 Milk.

This was not surprising. The initial bump in revenue in the last financial year would have been from initial market penetration as the CFDA was approved.

Some key growth metrics

  • Chinese Revenue growth at 50.1%, EBITDA growth at 41.6%
  • Australia & New Zealand revenue growth at 37.5%, with EBITDA growing at 64.9%

What’s also important to consider as well is that the China & other Asia segment is still less than half the size of Australia & New Zealand.

Considering the size of the Chinese market, A2 Milk has probably only just scratched the surface.

US Market Gaining Traction

Even though there has being a lot of focus on the Chinese market, A2 Milk is also making headway in the US.

In the US & UK market segment, A2 Milk grew revenue by 43.1%.

A2 Milk’s growth comes from increasing the distribution of its products from 6,000 stores in June 2018 to over 12,400 by January 2019.

The growth in distribution was due to national distribution to large supermarket chains.

This includes chains such as Kroger, Costco, Vons, Safeway and Walmart.

In addition, A2 Milk is running a national branding campaign to create awareness for their products.

A2 Milk expects the US & UK market segment to be EBITDA positive during 2021.

Fonterra Co-Operative Group

In February 2018, A2 Milk announced a comprehensive agreement with Fonterra.

Fonterra has multiple Australian and New Zealand manufacturing sites.

A2 Milk’s deal with Fonterra is that they will exclusively supply new emerging markets (other Asia, Middle East).

There is also the potential for Fonterra to develop non-infant formula products for worldwide distribution.

Fonterra joining forces with A2 Milk is a very strong positive for the company. This will allow A2 Milk to expand production and product lines with less investment in infrastructure.

A2 Milk Supply Challenges

A2M shares are different from other dairy product shares.

As the demand for A2 Milk’s products rose quickly, A2M has encountered problems in the supply chain.

Since the company needs special cows to produce A2 Milk, it takes a lot more time time to increase the number and volume to meet the demand.

Some suppliers have even completely switched over to supplying A2 Milk, by converting to an A2 protein only herd.

A2 Milk continues to look for farmers to provide A2 only milk and will pay a good premium for it.

Another method of increasing supply is through feed efficiency. This is because simply growing more animals on the farm is no longer sufficient.

Farmers need to tackle the small amount of forage on farms, limited utilisation low efficient use of supplements.

Even though A2 Milk will have supply challenges, it seems at this point they are able to meet demand.

However, supply challenges are something to keep in mind if A2 Milk grows too fast and supply becomes a problem.

A2 Milk Continues To Grow Strongly

Taking into consideration growing demand, especially from the Chinese market, A2 Milk shares are poised for continual stronger growth.

Even though there was a setback in terms of the A2 Milk share price during 2018, this has been short-lived. The stock continues to perform strongly and ha rallied non-stop since late 2018.

A combination of exceptional financial performance, CFDA and CNCA certifications, great market penetration and strong demand, we see a lot of upside for the A2 Milk share price.

Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia.

Categories: Australian Stocks, Featured, New Zealand Stocks

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