One of the most well-known stocks in the New Zealand market is the dairy company, a2 Milk. Their business? They sell milk of the a2 kind (not kidding) and sell related milk formulas such as infant formula and milk powders.
Why is it called a2 milk? Well, I’m not a milk expert. However, from my understanding, A2 corresponds to the main protein based in the milk of the respective cow it comes from. A2 Milk, not surprisingly, sells milk-related products from cows who produce milk with the A2 protein in it. This is because they initially claimed that milk with A1 proteins in it have health disadvantages. However, the European Food Safety Authority reviewed that the scientific evidence and concluded that this is untrue and that both A1 and A2 proteins harm health.
In the past, A2 Milk’s largest competitors were… its customers.
In 2008, the infamous China Milk Scandal, where milk and milk-related formula (notably, infant formula) were having melamine added to it to pass quality control testing, gave it a higher protein content. There where over 300,000 victims and six babies died from kidney stones. Since then, the trust of milk-related products from China has plummeted, and imports from other countries in China skyrocketed.
A2 milk did not offer its products to China directly until very recently. Therefore “daigou” (Cross border exporting) of the product from New Zealand to China were very prevalent, often charging 50-100% markup on the cost here in New Zealand. This forced supermarkets in New Zealand to restrict the purchase of infant formula to 4 per person at the time.
However, A2 milk has strengthened its foothold in China and has stated that its disruption to the daigou market has started to appear in earnings reports. Furthermore, the Coronavirus has been a tailwind for the company, as the daigou has all but dried up due to travel restrictions.
Many sellers have been attacking the company as of late, especially at its peak around August, when its price to earning’s ratio was above 40, requiring the company to release earnings nothing short of perfection to justify the valuation. However, earnings were down around 6.4%, causing a 29% drop in the stock price.
The risk is that it still trades at a premium, around 30 times earnings. This is relatively high, considering Tech stocks like Apple, Facebook, Google, etc. change around 33 times. A2 Milk at a tech stock valuation, when they are set to see declines in the next couple of quarters?
a2 milk has had a legendary run, one of the best in the NZX. From 2017 to its peak in August this year, the stock has returned an outstanding 833% for shareholders. However, it has traded at a premium for a long time. There is no tolerance for lackluster returns in a fundamentally weak global environment, and a2 milk shows that. This may be a stock that you should keep on your watchlist and wait until global conditions get better before entering this high flying stock position.