A2 Milk: A Market Disruptor With 'China Potential'

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About: The a2 Milk Company Limited (ACOPF), Includes: NSRGY
by: WappCap
Summary

The a2 Milk Company is a New Zealand growth stock which produces a unique type of milk.

The company has seen explosive growth since going public five years ago, specifically in the Chinese market.

Important risk factors, like trade war and decreasing Chinese fertility may impact a2 shares, and should be noted.

By Alec Slovenec

(Source: Wikipedia)

The Origin of a2 Milk

The a2 Milk Company (OTCPK:ACOPF), founded in 2000 in New Zealand, has been disrupting the milk industry since its conception. The company prides itself on innovating the way people drink milk, offering a possible alternative for milk-intolerant people who aren't satisfied with soy and nut-based milks. the a2 Milk Company produces milk from cows that exclude A1 proteins, a part of milk the company attributes to causing health issues.

The company was founded by Dr. Corran McLachlan while he was pioneering milk research in college.

"While studying at Cambridge University, Corran learned that proteins in milk affect people differently," reads the a2 Milk Company's website. "He learned that ordinary cows produce milk with different beta-casein proteins, called A1 and A2. He then discovered there was a safe and simple way to identify cows who produced milk that was naturally A1 protein free. From there the a2 Milk Company was born."

The company claims that its type of milk is easier on the stomach than milk from a typical cow. However, its claims have been met with controversy, and the scientific community has disagreed on whether a2 milk actually makes a difference.

"There is no scientific consensus on whether its product actually has a different effect on the human digestive system," reads an article from Timberwolf Equity Research. "But the most important part from a business perspective is whether it actually sells. And the answer to that question is a clear yes."

Regardless of its scientific backing, the a2 Milk Company has tapped into a market that has been drinking it dry.

Performance History

(Source: Ycharts)

The a2 Milk Company IPO'd in 2014 for $0.86 per share. Since then, the company's share prices have risen by well over 1000%. Much of the company's success can be attributed to its success in Asia, specifically China.

a2's largest source of growth is in its Asian market. According to Stock Analyst Richard Lee, about 25% of the company's revenue comes from its sales in Asia, and Asian sales grew by 162% from 2017 to January of 2019.

Many Chinese parents, paranoid about their children's safety due to various health and safety scares from early 2018, looked to premium products, and a2 milk, along with a2 baby formula, fill that demand.

(Source: Ycharts)

Shares peaked up to $10.38 in early 2018, but then dipped to $6.37 in October. Carol Matlack writes in a Bloomberg article that drop was due to "lower birthrates and stepped-up customs enforcement on cross-border sales of formula."

Since October, shares have been in recovery; as of March 2019, the shares are now selling at $10.09 each, and while they have not hit the heights they had been at in the middle of 2018, they are still at roughly a 1100% increase in five years from its entrance into the market. Shares are traded on the Australian Securities Exchange (ASX) and New Zealand Stock Exchange (NZX) and can be purchased in the US as ADRs.

Risk Factors

With the Asian market being one of a2's largest sources of growth, many risks facing China's market also affects a2. The trade war between the U.S. and China is an important risk factor to consider when investing in a2 shares; more tariffs means more expensive imports for China, which means consumption of foreign goods will go down. However, a product like milk, which is more essential than many other imported products, will be hit less hard than some other foreign companies.

"As a2 Milk is more essential to the lives of Chinese citizens and Asia in general, it is much more sheltered from this risk compared to other income intensive related stocks" writes Analyst Richard Lee.

Another risk factor comes from a2 Milk Company's focus on baby formula. According to an article from Reuters, a2 has developed a growing distribution network with approximately 6,700 mother and baby stores. a2's reliance on infants has made the company vulnerable to another growing issue in China: infertility.

A 2018 piece from the Strait Times cites some worrisome statistics:

"According to the National Bureau of Statistics, 17.23 million newborns were added to China's population last year, down 630,000 year-on-year, and the birth rate dropped from 1.295 per cent in 2016 to 1.243 per cent in 2017."

Less babies means less demand for a2 baby formula. Lee recognizes this issue and its effect on a2's performance: "The fertility rate in China is of a concern though, especially with its persistent decline over the years and a projected decrease during 2019. Newborns are a strong demand source for a2 Milk and weak demand means weaker performance for the company."

Competition

Bellamy's Australia performance (Source: Morning Star)

The a2 Milk Company is not alone in the baby formula market; Bellamy's Australia, another premium brand formula producer, is seeping into the Chinese market. The a2 Company's Tasmania-based competitor has seen fierce growth since last year, hitting a high of $23.07 per share. However, the company soon dipped by the end of the year at a low of $6.91 per share, and has yet to come close to its high.

a2 has been edging ahead of Bellamy's Australia in certain areas; for example, when Bellamy's Australia backed out of using daigou, a type of Chinese sales agents, back in 2016, a2 soared ahead of them. "But a2 stuck with daigou and it paid off," reads an article from Reuters. "While a2's revenues rose, those of Bellamy's and Blackmore's tanked." Blackmore's Ltd is infant formula producer and competitor to a2.

Nestle Performance (Source: Google)

Perhaps the biggest competitor to a2 is Nestle (OTCPK:NSRGY). Nestle, the largest baby formula producer in the world, took a page out of the a2 playbook last year and launched its own line of A2-only baby formula. Nestle launched its product in China in early 2018 and in Australia and New Zealand this past November. However, many argue that Nestle's incorporation of a line of A1-free milk has a hidden benefit for The a2 Company: an enormous company like Nestle mimicking a2's mission statement tells the world that there may be a very good reason to drink A2 milk.

"As the pioneers, we stand to be benefit from first-mover advantage and the further validation that competition brings the A1 protein-free proposition," says a2 Executive Peter Nathan in an interview with Dairy Reporter.

Conclusion

The a2 Milk Company is a risky value stock with huge potential. When investing in a2, you must have confidence in China in order to have confidence in a2. China has been a huge portion of a2's success, and unless China can deal with its issues of infertility and trade war, a2 will have to face setbacks in one of its biggest markets.

Since Nestle has begun selling its own A2 milk products in Australia and New Zealand last November, the a2 Milk Company has seen little setback, and has been on a steady increase since late October of last year, according to a Financial Review article. Still, Nestle could prove to be a huge threat to a2 and could spell doom should it take over a2's home country's formula and milk market. Bellamy's Australia, which has been operating and competing with a2 for years, has yet to slow it down.

In its current state, a2 is on the rise and has yet to fully recover to its former heights. Now is an optimal time to buy. But unlike its A1-free milk, this stock is not for those with a weak stomach, and potential investors should be wary of a2's long list of risks.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.