a2 Milk: What the market missed
The acceleration of growth in China for A2’s infant milk formula products is very impressive. They now have just over 5% market share of the Chinese infant formula market. Remember the total Chinese infant milk formula market is approximately $20bn in size, with a number of incumbents sitting around the 10% market share level. There is obviously still ample runway for the business to keep growing– most importantly, they are not having any issues on the supply side in meeting that demand via their relationship with Synlait NZ and the capacity expansion they invested in prior years.
The other key piece of information is the announcement of a relationship with Fonterra that will help the business expand into other Asian markets with surety of supply. The willingness for a business like Fonterra to partner with A2 essentially provides further validation around both the IP that sits behind the A2 Milk products and the ongoing strength of the brand through the region.
Future growth opportunities remain attractive
We’re obviously still very positive on the stock. The runway for future growth remains extensive and the growth rate is accelerating. We like the fact we have multiple growth drivers from here – be it continued growth in China, an untapped SE Asia opportunity and the steady gains in the US fresh milk market. This business can be significantly bigger over time and that is what has likely attracted someone of the calibre of ex-Jetstar CEO Jayne Hrdlicka to head up the business. Management have done an excellent job in investing ahead of the curve and shareholders are seeing the results of that investment now. We have been owners of the stock since it listed on the ASX and that won’t change near term – today’s result confirms the extensive due diligence we had conducted over the past six months that suggested the company was performing ahead of market expectations.
What the market is missing
What is interesting about A2 here is that despite margins being relative strong as is, there is still a fairly significant amount of margin leakage to various intermediaries that the business can likely claw back over time. Whether that is through taking back some of the fairly generous manufacturing margin (they are now flagging the potential to build their own manufacturing facility in Australia) or through lifting prices, there are a number of levers for management to pull to increase margin from here. We really like that flexibility for future added margin gains.
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Andrew has over 15 years’ experience in portfolio management of listed companies, stockbroking and economic analysis. Prior to co-founding Ophir, Andrew worked from 2007 to 2011 as a portfolio manager at Paradice Investment Management.