A2 Milk Company – Milking The Profits

29 December 2015

Wow, 243% in 5 months… 

Yes, A2 Milk shares have gone up by 243% since we added them to our model portfolio on 31st August.

But what does this mean for you? Is it too late to get in on the action? We’ll let you know what we think in a minute, but first lets take a quick look at the background. 

 

What’s Happened?

Since August A2 management has upgraded its profit guidance for 2016 on multiple occasions which has boosted investor sentiment. The upgrades have primarily reflected better than expected sales of its infant formula in China. Consumers have gone into an infant formula frenzy with fears that supermarket shelves are being emptied of milk formula by customers, often Chinese tourists, migrants or students — removing stock by the pallet-load to sell online at home at inflated prices. The company recently said retail stock shortages were continuing despite production volumes increasing, while demand was continuing to exceed supply.

 

believes this frenzied behaviour will abate over time with either the government putting restrictions in place to ensure the Australian consumer has ample supply or by new or additional product entering the market. This behaviour does however highlight the strong demand from Asia for Australasian dairy and supports ’s core ‘Dining Boom’ thematic.

 

A Feeding Frenzy

On the 18th December A2 Milk’s management advised shareholders that that the company had experienced a significant uplift in sales of its infant formula in the month of November. Management also expects this momentum to continue into December. The company is now forecasting revenue in the range of $300m to $315m, and earnings (EBITDA) in the range of $33 million to $37 million for the 2016 financial year.

 

This upgrade represent a between 50% to 68% increase on A2’s earnings from the prior month’s projections (previously the company had expected revenue of NZ$285m and earnings of NZ$22m). The jump in profit expectations is being driven by its a2 Platinum infant formula products. China's insatiable thirst for infant formula has quadrupled sales for Australasian dairy company.

 

 

A Dining Boom Exposure

Longer term we continue to have large positions in companies such as A2 milk which are leveraged towards the “dining boom”, which we believe is set to be the next big multi-year investment theme for Australasia. Demand for a higher protein diet from a growing middle class in the developing world (in particular Asia) is set to be a multi-year investment theme. Australasia is set to directly benefit from this dynamic, with Australia and New Zealand being exporting nations in close proximity to Asia, in our view.  

 

What to Do?

While there is clearly positive news surrounding A2 everything has a fair value or price. While we still believe in the long term investment case, we also think prices may be stretched at the current juncture (at current share prices A2 is valued at NZ$1.66 billion, with estimated earnings of only NZ$33m – $37m for 2016). Hence we have removed A2 Milk from the portfolio capturing almost 80% of returns.

 

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A2 Milk shares have had an amazing run up 243% since we added it to our model portfolio on 31st August.

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