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Why Freedom Foods Group Ltd and A2 MILK FPO NZ shares are soaring today

A2 milk shares
Credit: Benjamin Horn

Shares in dairy and allergen free food specialists A2 MILK FPO NZ (ASX: FNP) and Freedom Foods Group Ltd (ASX: FNP) are up around 16% and 22% today as both businesses continue to ride a wave of excitement over their potential to grow sales into China.

Freedom Foods is a gluten and allergy free food specialist that has been largely focused on expanding sales of its food range into North American markets until recently, although in February 2015 the company launched its branded ‘Australia’s Own Kid’s Milk’ into China which is the first Australian milk product marketed specifically to the post-infant-formula toddler market in China.

Back in June of this year I suggested both Freedom Foods and a2 Milk had some potential to follow baby formula business Bellamy’s Australia Ltd (ASX: BAL) in selling infant formula products to Chinese consumers. Since then Freedom Foods shares are up 55%, while a2 Milk is up 236% largely after it upgraded profit guidance on the strength of strong sales for its a2 Platinum infant formula in China.

Notably, Freedom Foods also sold a large ownership stake in a2Milk just over a month ago for 85 cents per share to raise around $64 million. At the time the managing director justified the decision to sell by saying the funds could be better employed elsewhere. However, since the decision to sell on 17 November, a2 Milk shares have climbed more than 150% to leave Freedom Foods management and shareholders to mull over some unfortunate timing.

The rocketing a2 Milk Company now expects full year operating EBITDA in the range of $33 million to $37 million for the 2016 financial year which using the mid-point of that guidance means it’s now valued at around 38x estimated forward EBITDA when selling for $2.17 this afternoon.

That’s expensive when you consider that I was recently able to purchase shares in a hot ASX tech stock growing globally at around 16x trailing EBITDA around $17 million, with more strong growth forecast.

Moreover, the success of Australian baby formula businesses like a2 Milk and Bellamy’s will not have escaped the attention of large multinationals like French conglomerate Danone and US operator Mead Johnson Nutrition. Both these powerful operators already supply baby formula in China and could be expected to ramp up their sales efforts to meet the growing demand.

Indeed, investors in the iron ore space and students of free markets will know that supply will eventually catch up with demand and when it does the tables can turn for businesses that were previously considered sure bets on booming Chinese demand.

Investors then bidding up stocks like Bellamy’s and a2 Milk need to make sure they are comfortable with the valuations of these businesses relative to their potential to keep growing at gangbusters rates, otherwise they could find themselves deep underwater.

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Motley Fool contributor Tom Richardson owns shares of Bellamy's Australia.

You can find Tom on Twitter @tommyr345

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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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