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Should you worry about A2 MILK FPO NZ and Bellamy’s Australia Ltd crashing?

Credit: Bellamy's

Shares of A2 MILK FPO NZ (ASX: A2M) and Bellamy’s Australia Ltd (ASX: BAL) begun yesterday in the same way they’ve spent most of 2015. Both shares soared, each touching new all-time highs and giving shareholders yet another reason to smile going into the New Year.

But then something out of the ordinary happened: both companies’ shares fell, hard.

The A2 Milk share price soared as much as 9.8% to a new high of $2.36, but ended the day 12.8% lower than its previous close at just $1.875. Similarly, Bellamy’s share price peaked at $16.50 (after debuting on the ASX at just $1 per share in August 2014), but ended the session 9.4% lower than its previous closing price at $14.02.

A2 Milk is down another 6.1% early in today’s session, while Bellamy’s shares have fallen 5.1% to $13.30.

What does this mean?

The 2015 calendar year has been a bumper year for essentially anything milk or baby-related, especially thanks to the red-hot demand from countries such as China. A2 Milk and Bellamy’s have been the most notable beneficiaries but shares of Bega Cheese Ltd (ASX: BGA), Blackmores Limited (ASX: BKL), Baby Bunting Group Ltd (ASX: BBN) and, more recently, Australian Dairy Farms Group (ASX: AHF), have also rocketed in price.

The returns have been truly incredible for shareholders – especially those who bought in early – but it has also led to speculation that shares may have become overpriced. The sudden plunge in A2 Milk’s and Bellamy’s share prices yesterday and this morning will no doubt have some investors feeling anxious about what happens next.

What happens next?

Unlike some of the speculative tech stocks of the past which have soared for no apparent reason, there is a legitimate reason behind A2 Milk’s and Bellamy’s spectacular returns. Demand for their products has skyrocketed – so much so that they have struggled to keep supermarket shelves stocked – which has led to surging sales and profits.

A2 Milk, for instance, upgraded its EBITDA (earnings before interest, tax, depreciation and amortisation) guidance for the 2016 financial year from $12 million to $22 million in November, and then from $22 million to roughly $35 million a week before Christmas – a total guidance increase of 192% in just over a month.

Meanwhile, Bellamy’s is expected to announce another bumper result when it reports its half-year earnings in February after it reported a 617% increase in net profit after tax (NPAT) for the 2015 financial year.

The incredible share price gains for both companies indicate that they are well and truly on the radar of investors by now, and the early profits have clearly already been made.

In other words, the shares are by no means ‘cheap’ anymore, at least not by conventional standards. But yesterday’s sharp pull-back in price doesn’t necessarily mean their strong run is over, either, especially if they can keep boosting supplies and growing their earnings.

For the sake of full disclosure, I’ll note that I recently reduced my stake in Bellamy’s based on the fact that it had skyrocketed in price and become, in my opinion, an overly large position in my own portfolio, but I am still holding a decent amount of shares. If the shares pull back much more, they could certainly be worth a closer look for investors.

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Motley Fool contributor Ryan Newman owns shares of Bellamy's Australia. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. You can follow Ryan on Twitter @ASXvalueinvest.

The Motley Fool Australia owns shares of Bellamy's Australia. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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