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China is the second largest market for infant formula in the world. Amazingly, China’s infant formula market size is only 70% of the U.S., with per capita consumption at 30%. With per capita consumption expected to grow strongly as the population increases and as China’s economy expands, China’s market could eventually grow to be three to four times larger than the U.S.’s infant formula industry. With high barriers to entry and considerable growth prospects with China’s birth rate climbing, American Dairy (ADY) is poised for considerable growth in the coming years through its strong Chinese brand, Feihe.

American Dairy has gained market share in the past eight months after 2008’s melamine crisis tarnished other competitors standing with Chinese consumers. ADY’s strong brand and aggressive marketing efforts have paid handsome dividends, allowing the company to reach an important inflection point in its business model. As is often the case with many stocks at inflection points, I had not heard of American Dairy until I noticed their most recent earnings report. It was an amazing quarter:

  • First quarter Sales increased 191% to $113.8 Million vs. $39.1 Million in Q1 of 2008.
  • Income from Continuing Operations Increased 523% to $32 Million vs. $5.1 Million in 1Q08.
  • Net Income was up 282% to $27.8 Million vs. $7.3 Million in 1Q08.
  • EPS blew through analyst estimates, with ADY earning $1.55, 287% above analysts' estimates!

American Dairy redirected its business focus late last year, choosing to dedicate its resources to its formula milk product line, a decision which contributed to the results outlined above and also to the vast improvement in the company’s gross margins for Q1. Gross margins expanded by 2600 bps Y/Y to 65%. This huge expansion in gross margins allowed ADY to report $2.7 per share in Operating Cash Flow in Q1. Please note that the company netted $1.7 Million in Operating Cash Flow for all of 2008!

Not surprisingly, American Dairy’s stock gapped higher on this big earnings beat two weeks ago and its stock has not looked back:

click to enlarge

1 Year Chart of American Dairy

Source: Esignal

A look at ADY’s chart shows an explosion in trading volume as the stock quickly doubled in price during the past two weeks. Note how the stock has hardly pulled back, even after such an incredible move. Sellers appear to be satiated and it should not take much new buying to propel the stock into the $40s.

In short, American Dairy hit a major inflection point last quarter, one that should propel sales and earnings well into 2009 and 2010. Earnings estimates have been ramped up considerably in the past two weeks. Consensus estimates now call for earnings to grow 456% in 2009 to $3.34 a share. Growth will continue into 2010 with earnings poised to grow 34% to $4.49 a share.

Both sets of estimates appear to be too low and I am expecting estimates to move higher as this year progresses. I believe ADY could make $5-6 a share in 2010. If one were to apply a 17 P/E multiple to $6 in earnings, ADY could be a $100 stock some point next year.

The CEO has a 50% stake in the company, owning 8.9 million of the 17.9 million shares outstanding. Strong insider ownership is an important trait many past big winners in the stock market have had, so it is good to see this be the case with ADY also. ADY is being run by someone who is very motivated to get the stock price higher, as opposed to a CEO who does not own much stock in the company he or she is running. Impressively, the CEO has not sold a single share of his stake yet, even with the stock having advanced from $15 to $38. This gives me confidence that the current quarter is also going very well.

While one quarter does not guarantee future returns, American Dairy seems to be firing on all cylinders.

With a limited supply of stock available for purchase, I am expecting a secondary move in ADY in the short term into the 40s. While I plan on selling a small allocation of my ADY on this next push, I also look forward to riding the bulk of this current position to see if the company can continue to build on Q1’s numbers in the coming quarters. If the company can execute, I am expecting big things in the next year from ADY.

Disclosure: Author is long ADY and plans to sell a small part of his stake on the next push in the stock into the 40s in the coming weeks.

Source: American Dairy: If All Goes Right, It's on Its Way to $100