Clover outpaces rivals using niche expertise
Clover, the Australia-based health and nutrition group, is set to benefit from a booming baby formula market in China and the EU, although the gains will not come from supplying formula into this heavily competitive space. Clover's niche expertise is supplying an essential proprietary ingredient to several brands, for which it holds patented rights under licence from CSIRO (Commonwealth Scientific and Industrial Research Organisation), until 2027. If the experience of companies like Bellamy’s Australia Ltd (ASX: BAL) and A2 Milk Company Ltd (ASX: A2M) is taken as an example, this niche could prove profitable for Clover and in fact on a relative basis, it has outperformed these bigger rivals in the past year.
Clover Corporation supplies DHA (docosahexaenoic acid), a key ingredient in infant formula. This is an omega-3 fatty acid that occurs naturally in breast milk and is scientifically proven to support brain development, is critical for optimal brain health, benefits eye health and may guard against heart disease.
Clover Corporation is a leading supplier of DHA in an encapsulated tuna oil or powdered form. Baby formulas use a number oils to maintain fatty acid content, and of these DHA is by far the most important as its replicates natural milk properties most efficiently. Clover maintains a strong position versus rivals in supplying DHA both due to the high quality of its product and its proprietary encapsulation process. This process means the end product doesn’t smell of or taste like fish, but still retains the nutritional benefits, and has a longer two-year shelf life.
Euromonitor estimates that the global infant formula market is worth around $47bn USD and will continue to grow at around 5% per year for the next 5 years. Similarly, Zenith, global food and drink experts, estimates the market is worth over $50bn and will grow at 7% per year for the next 5 years. Of this growth, the most compelling is China, as our head of Equity Strategy Peter Garnry notes, Chinese infant formula demand is driving revenue for key infant formula suppliers.
This growth story is not the only reason that makes Clover a compelling investment, the company is not an end supplier, but provides a key ingredient, and has more than 50 clients so brand specific risks are diversified. Clover supplies a large proportion of baby formulas makers globally, and retains its own intellectual property through the licensed encapsulation process, giving it a competitive edge against rivals.
Clover is also set to benefit from EU regulations that set minimum DHA levels at twice current levels by 2020. This will increase demand for Clover’s product from European clients, but should also spur a knock on as other countries follow Europe’s regulatory lead. Europe only makes up a small portion of Clover’s sales at present, but it is a key focus area for the company going forward.
Clover is growing very quickly with half year revenue up 60% on HY17 due to increasing demand, earnings also grew very quickly, rising by 200%. Increased Chinese demand and regulatory stability has driven increased demand across key clients for Clover. This is expected to continue as three more key customers have secured CFDA approval to market and sell their infant formula brands in China. Another key factor driving earnings growth was the decision to invest in their own production machinery, rather than renting, this lowered the cost of goods and as a result boosted margins for Clover.
The current 12-month trailing EV/EBITDA ratio of 29.5 tells us Clover is expensive compared to 11.7x for global equities. This high valuation premium is naturally a key risk.
Management and risk description
There are several key risks to be aware of before investing in Clover Corporation:
• The benefits of DHA oils may be overstated and could lead to brand damage if findings show no evidence of health effects.
• Increasing competition from other DHA suppliers.
• Slowdown in Chinese expansion where key clients source a lot of their sales.
• High valuation is a key risk as lower-than-expected growth could quickly lead to a sharp revaluation of the company’s shares.
• The market capitalisation is small ($0.2bn USD), small cap stocks tend to be more risky than large cap stocks, however, can offer more growth potential.
Latest Market Insights
Quarterly Outlook Q3 2022: The Runaway Train
- Central banks' attempts to kill inflation is a paradigm shift, which could end in a deep recession.
Tangible assets and profitable growth are the winnersWith US equities officially in a bear market, the big question is where and when is the bottom in the current drawdown?
Understanding the lack of investment appetite among oil majorsThe everything rally seen in recent quarters has become more uneven, as its strength is driven by commodities in short supply.
The pressure is on as the wind leaves the sailsWith cryptocurrencies in sharp decline, are we entering a crypto winter or is the bear market a healthy clean-up of the crypto space?
Why the Fed can never catch up and what turns the US dollar lower?Many other central banks are set to eventually outpace the Fed in hiking rates, taking their real interest rates to levels higher than the Fed will achieve.
Bank of Japan: Swimming against the tideThe Japanese economy has gone from the age of deflation to rapidly rising prices in no time, leaving the Bank of Japan in a pickle.
Green transformation detour and bear market hibernationWith the impending risk of global econonomic derailment, we share the five things investors need to consider in this new half year.
Crisis redux for the eurozone?Whether there's going to be a recession in Europe or not, the path towards a stable economy will be agonizing.
Technical Outlook: Gold, Oil and a remarkable multi-decade perspective on EquitiesThe Nasdaq bubble pattern, USDJPY resistance, crude oil uptrend losing steam and the technical outlook for USD.
China: the train of new development paradigm left the station two years agoChina is transiting to a new development paradigm, as they are hit by deteriorating terms of trade, a slower global economy and an uncertain future while continuing attempts to contain the pandemic.