Buy A2 Milk on infant formula expansion into Asia

Medium Term / Buy

Peter Garnry

Head of Equity Strategy, Saxo Bank Group
Peter Garnry joined Saxo in 2010 and is Head of Equity Strategy. In 2016, he became responsible for the quantitative strategies team, which focuses on how to apply computer models to financial markets. He develops trading strategies and analyses of the equity markets as well as individual company stocks applying statistics and models.

Instrument: A2M:xasx
Price Target: AUD 15
Market Price: AUD 9.93

Background:

a2 Milk expands into Asia

The highest-ranked stock in our global equity factor model is a New Zealand company called a2 Milk. The dairy company sells A2 protein-based milk in primarily Australia, New Zealand, China, the UK, and the US. Its main products are liquid milk and infant formula and it has one of the highest return on invested capital ratios in our global universe of 1,700 stocks.

Additionally, the company has very low leverage on its balance sheet and strong price momentum.

The reversal factor is also very high as the company has underperformed global equities massively in the past month. Disappointing revenue guidance on May 16 drove the share price down by 13%. Overall, the business is still growing fast with 12-month trailing revenue up 55% compared to a year ago.

Competition is heating up for a2 Milk as the fast growing company has seen other dairy firms shift their marketing focus on A2 protein-based milk (there is still a lot of uncertainty over the health benefits of A2 milk, but we will get back to that shortly).

New Zealand's a2 Milk is growing quickly with revenue currently at NZD 728m up from NZD 155m in 2015 (full-year fiscal ends on June 30). The EBITDA margin is at healthy 30.3% and the CAPEX levels are extremely low leading to a very high ROIC and free cash flow generation. Strong business fundamentals usually come with high valuation and a2 Milk is expensive with a 12-month trailing EV/EBITDA ratio of 34.9x compared to 11.7x for global equities.

This high valuation premium is naturally a key risk. In addition, the downward volatility factor is also quite bad indicating significant downside moves on negative surprises. It is important to be aware of these things before investing in a2 Milk.

As the segment table and charts below show, the fastest growing market for a2 Milk is China/Asia but the biggest is still Australia and New Zealand (80% of total revenue). The main growth is coming from infant formula, which is linked to the trend of parents being more aware of health issues related to their kids. According to a2 Milk, A2 protein-based milk is better for the stomach so the marketing campaigns are obviously focused on these benefits towards young families.

Based on the firm's growth rate, the strategy is working and the Chinese market has the potential to become the biggest market for a2 Milk as Chinese consumers have experienced horrible accidents with domestically produced infant formula. The consequent lack of trust in domestic producers will likely become a key driver of growth in China. In addition, a2 Milk announced in April that it is moving into South Korea, thus expanding further into Asia. 

Management And Risk Description:

There are several key risks to be aware of before investing in a2 Milk:

   • The benefits of A2 proteins may be overstated and could lead to brand damage if findings show no evidence of health effects.    • A2 Milk has avoided two lawsuits with the latest being settled in December with its competitor Lion Dairy & Drinks.
   • Increasing competition from other dairy firms expanding into A2 milk production, lower growth rates and operating margins.
   • Slowdown in Chinese expansion because the valuation hinges on massive growth in China.
   • Supply issues from A2 milk producers in New Zealand leading to production constraints and higher prices.
   • High valuation is a key risk as lower-than-expected growth could quickly lead to a sharp revaluation of the company’s shares.

 
Parameters:

Entry: AUD 9.5 to 10.5
Stop: 200-day moving average (currently at AUD 8.56)
Target: AUD 15
Time Horizon: Medium term

We look to buy shares of New Zealand-based a2 Milk on the company's planned expansion into Asia.

-- Edited by

Michael McKenna

Source: Saxo Bank

Source: a2 Milk

Source: Saxo Bank

Access both platforms from your single Saxo account.

A compiled overview of Trade Views provided on Home.saxo can be found here (https://www.home.saxo/en-gb/insights/news-and-research/trade-views/report).

Disclaimer

Any opinions, news, research, analyses, prices or other information contained on this website is provided as general market commentary and does not constitute investment advice or a personal recommendation and does not take into consideration your objectives, financial situation and needs. Saxo Capital Markets UK Limited will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information. We assume no liability for errors, inaccuracies or omissions contained within these materials.

It is important that you understand that with investments, your capital is at risk. We offer leveraged products which carry risk and can result in losses that exceed deposits. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more here.

Additional Key Information Documents are available in our trading platform.

Saxo Capital Markets UK is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871

Please read our full disclaimer - https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer