2 reasons to buy shares in the A2 Milk Company Ltd this week

Shares in The A2 Milk Company Ltd (ASX:A2M) have nearly tripled in price over the last 12 months, which might lead many investors to conclude that the opportunity for big gains has passed them by. However, after a recent dip in the share price, now might be a good time to look at two reasons why A2 Milk is still worth adding to your portfolio. 

New Zealand-based dairy and infant formula producer The A2 Milk Company Ltd (ASX:A2M) has been one of the top performers out of the ASX200 over the last 12 months. It’s hard to believe that a company now trading at $10.29 per share was valued at under $4 this time last year. Here are two reasons why a2 might still represent a great investment, even at current prices. 

  1. a2 makes baby formula (and it exports it to China) 

The Chinese market for baby formula is incredibly lucrative. This is particularly true for foreign companies, since the 2008 milk scandal resulted in such a massive loss in consumer confidence in local Chinese brands. China also now represents a potentially growing market, given the recent phasing out of its longstanding one-child policy. 

The promise of riches has led plenty of Australian companies to try to tap into the Chinese market. Just two weeks ago, the price of shares in small cap infant formula company Wattle Health Australia Ltd (ASX:WHA) surged 22% higher in a single day, after it announced it had inked a $34 million deal to supply its baby and toddler milk formulas to Chinese state-owned company Shandong Weihai Port International.  

Blackmores Limited (ASX:BKL) and Bega Cheese Limited (ASX:BGA) attempted a joint venture to sell infant formula in China, but the business was eventually scrapped after disappointing sales levels.  

But a2 Milk is fast becoming an established player in the Chinese market. According to a presentation the company gave to investors in New York in March, a2 now commands an infant formula consumption market share of 5.4% in China.  

Looking at the company’s financials, it’s easy to see how integral Chinese sales are to the company’s recent success. First half FY18 revenues from its Asian operations was NZ$114 million, which represented a 203% increase on first half FY17. Of the total 1H18 Group revenues of NZ$435 million, NZ$341 million came from infant formula.  

  1. Science 

Not all milk is created equal. Most of the milk you buy from your local supermarket will contain, amongst other types of protein, both the A1 beta-casein protein and the A2 beta-casein protein.

According to the a2 Milk website, domesticated cows typically only ever produced milk containing the A2 beta-casein protein. But, due to natural mutations which were then spread globally through modern farming practices, cows began producing milk that also contained the A1 protein. Research has suggested that this form of the protein can be more difficult for some people to digest.  

The a2 Milk Company works with local farmers to select cows that naturally produce milk free from the A1 beta-casein protein. Only milk from these specially selected cows is used in the company’s products. This means that the milk itself is not chemically altered and the dairy cows aren’t genetically engineered in any way. The company is therefore able to sell fresh milk and dairy formulas that are still naturally differentiated from its competitors’ products.   

Foolish takeaway

In a trading update released on the 12 July, a2 Milk announced unaudited revenues for FY18 of approximately $922 million. This exceeded the upper bound of the revenue guidance it had given in May by $2 million, which is a great result.

The company’s share price still dropped about 3% after the announcement, probably because of the fact a2 also flagged higher marketing and overhead costs for FY19 due to its continuing expansion into China and the US, plus additional costs associated with a transition to a new CEO.  

Despite the dip in its share price, a2 Milk still trades at a multiple of almost 54x earnings. This could imply that the company’s shares are still overpriced, especially when viewed alongside the shares of fellow New Zealand-based dairy company Synlait Milk Limited (ASX: SM1), which trades at a little under 30x earnings.

However, if you believe in the longer-term prospects of the company, now might be a good time to add A2 to your watch list. 

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Motley Fool contributor Rhys Brock has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Blackmores Limited. 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.

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