MILKING IT - HOW A2 MILK BECAME OUR LARGEST LISTED COMPANY
Research Team, 18 April 2018
What is ‘A2’ anyway?
The difference between conventional milk and A2 milk lies in the make-up of a type of protein called beta-casein. Most cows’ milk sold in the western world contains either the A1 type of the protein or both the A1 and A2 types. However, a2MC’s products contain only the A2 protein type. a2MC claims its products are easier to digest than that of conventional cows’ milk, resulting in less digestive discomfort.
The key to the company’s success has been embracing the ‘Daigou’
Since its products first hit shelves in 2003, a2MC has built close to a 10% share of the Australian fresh milk market, quite a remarkable feat in itself. However, it was the development of its infant formula product, a2 Platinum® in 2013 that really catapulted a2MC into the stratosphere.
The company has gone from delivering operating earnings of under $5m just three years ago, to be on track to do almost $300m this year, becoming the largest listed company in New Zealand in the process - recently overtaking the highly successful Fisher & Paykel Healthcare for that mantle.
The bulk of a2 Platinum® sales are made through what is known as the ‘Daigou’ channel. Daigou, meaning ‘buying on behalf of’ in Mandarin, involves shoppers overseas buying products for customers in mainland China. This channel is often referred to as the ‘grey market.’ Daigou are an important sales channel for the company’s products. We estimate Daigou sales represent around 60% of a2MC’s total infant formula volume.
Some companies have, to their peril, tried to cut the Daigou out of their supply chains, with the aim of boosting margins. The key to a2MC’s success, however, has been to embrace this channel, delivering a rapid ramp-up in infant formula sales by preserving the arbitrage opportunity. a2 Platinum® now has a 5.4% share of the Chinese infant formula market, an astonishing feat.
What does the future hold?
The company has a target to grow its infant formula market share in China from 5% to 10%. To do this, a2MC is targeting growth in more direct sales channels, especially through so called Mother and Baby Specialty Stores.
This is a less-risky and more sustainable form of sales than the Daigou channel in our view, but success in this channel ultimately depends more on the strength of the a2 Platinum® brand. So far the evidence is positive with this Chinese labelled product experiencing strong growth.
However, a2MC can’t ignore the important Daigou channel. Changes to how this channel operates, such as regulatory change, remains the key risk to the very strong earnings outlook for a2MC, though investors can take comfort from the company’s flawless execution in this area to date.
Looking forward a few years, a2MC’s longer-term goal is to be a leading global dairy nutrition brand. This involves the development of new products and expansion into new geographies.
To enable ongoing geographic expansion, a2MC recently signed an important strategic agreement with Fonterra. This deal ensures a2MC has enough milk supply to meet future. It also provides access to Fonterra’s distribution networks, and provides validation of the A2 protein proposition from the world’s largest dairy exporter.
a2MC’s success has, however, brought about new competitors keen to benefit from what has ultimately become a lucrative market niche. This includes Nestlé, who recently introduced an A2 protein infant formula. Although a2MC has a suite of intellectual property, it also has a strong first mover advantage in the category and a brand synonymous with the proposition, a rare feat. This positions it well for the future but increased competition does represent a material risk, the impact of which is difficult to quantify at this early stage.
Past performance is not indicative of future performance and no guarantee of future returns is implied or given.
Please note: This article was first published in the April 2018 edition of News & Views. Craigs Investment Partners clients can view the latest edition of News & Views, which includes the full version of this article, by logging in to Client Portal.