Healthy milk and baby formula business a2 Milk Company Ltd (Australia) (ASX: A2M) has been on a tear this year, rising 265% in the last 12 months. What's it got that other companies don't?
Well, there are a few things I like about a2:
- Healthy premise; a2's milk products contain a2 proteins only, compared to normal milk which have both a1 and a2 proteins. a2 milk is thought to be easier to digest and there are several studies that suggest improved digestion and better wellbeing on various measures.
- Brand; In combination with the above health claims, a2 has a strong brand that differentiates it in the hugely competitive dairy market. This lets it charge prices that are well above that of 'normal' milk, although to be fair milk is not the primary driver of a2's earnings.
- Baby formula; powdered gold, a2's baby formula, has hit the jackpot for shareholders as it benefits from booming demand in China. The entire industry is in the midst of a boom with companies like Bellamy's Australia Ltd (ASX: BAL) and Synlait FPO NZX (ASX: SM1) investing heavily in building capacity.
- Strong balance sheet; with no debt, plenty of cash (although an immaterial amount in context of its market capitalisation), and no take-or-pay contracts of the type that nearly blew up Bellamy's, a2 is in about as strong a financial position as you could find.
- Capital-light operating model; a2 Milk outsources the farming and manufacturing aspects of the business to companies like Synlait and Dairy Farmers. This lets it avoid the heavy capital expenditure that is usually required to increase manufacturing capacity. a2's business model is nicely profitable and generates plenty of cash, and should continue doing so.
- Plenty of room for growth; in addition to the ongoing boom in China, a2 is expanding in the UK and the USA and each of these markets alone could be a major growth driver in the future. There are also numerous opportunities to expand the a2 milk range with products like ice cream, flavoured milk, and so on.
While there's a lot to like about a2, I've recently sold a number of my shares on valuation concerns, as I think the company is starting to look fully valued, and at a time when competition is really heating up in the sector and manufacturers are spending millions on adding to capacity. I continue to hold my remaining shares but I think that buyers today need to have a good grasp of the company's value and growth prospects before considering a purchase.
