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Why A2 Milk Company Ltd (Australia) shares are plunging on Nestle competition

The A2 Milk Company Ltd (ASX: A2M) share price has dipped 6% to $12.25 this morning after the NZ Herald reported that international giant Nestle has entered the fight for the Chinese infant formula market.

Nestle confirmed that it was launching an a2-only product under its Illuma brand in China, called ‘Atwo’, which we assume is pronounced ‘A2’ not ‘at woe’.

A2 milk is based around the perceived health benefits (and growing scientific evidence) of a2 milk protein milk, versus normal milk which contains a1 and a2 proteins. Sadly for a2 shareholders, the company doesn’t have a monopoly on the process and it is possible for competitors to create their own a2 herds and manufacture various products.

Nestle is one of the 100 largest companies in the world and is serious competition. An a2 spokesman was quoted in the NZ Herald as stating “(a2) has been monitoring a number of companies operating in China and considers that new entrants should assist in building credibility and awareness for the A1 protein-free proposition, and hence build the overall category more quickly,” with the argument being that a2 will be the primary beneficiary of growing product awareness.

That may be so but it’s also prudent for shareholders to consider the impact of growing competition on volumes and margins. I don’t see any incentive to compete on these quite yet, with Chinese demand still immature and growing rapidly, but as the market matures, differentiators like brand and price will become more important.

The potential for increased competition is something I have written about before, and with the entry of Nestle I think it is important for shareholders – and more importantly, today’s buyers – to keep one big truth in mind:

Trees don’t grow to the sky.

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Motley Fool contributor Sean O'Neill owns shares of A2 Milk. The Motley Fool Australia owns shares of A2 Milk. 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 Scott Phillips.