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Liang Chen
Steven Chen
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A2 Milk: Not All Milks Are Equal

Australian company attempts to premiumize the once-commoditized product

Australia-based The a2 Milk Co. Ltd. (ASX:A2M) engages in the commercialization of A1 protein-free milk and related products.

For a bit of scientific background – conventional milk contains two main types of beta-casein protein, A1 and A2; the former is believed by many consumers and health care professionals to affect digestive health and possibly cause heart diseases and diabetes. This is where a2 Milk attempts to premiumize its brand. The business claims that all its products contain only the A2 protein. In order to do so, the company starts with specially selected cow that are not affected by the natural genetic mutation leading to the production of milk containing A1 proteins. As you can imagine, this production process requires a high degree of quality assurance (e.g., testing), which a2 Milk has its proprietary technology and know-how for.

Over the past three years, a2 Milk increased its top line at a compounded annual growth rate of more than 50%, while nearly doubling its operating income on average every year. International expansion and line extension played a critical role in driving growth. As of fiscal 2019, infant formula accounted for over 80% of the total sales, compared to liquid milk’s 13.4%. Therefore, the company has gone far beyond the typical milk commodity business. Instead, we consider it as a superior branding, testing and innovating venture, reflected by its outperforming operating margin compared to Swiss food conglomerate Nestle (XSWX:NESN), Chinese dairy leader Yili Group (SHSE:600887) and its domestic competitor in the baby formula space, Bubs Australia (ASX:BUBS). The company is smart to brand its products under the name “a2,” leveraging its first-mover advantage and making its rivals' later entry into the niche the “endorsement” for its own brand.

According to management, a2 Milk captures the leading value share of 6.4% in the fast-growing Chinese infant nutrition market. It is easily understood that when it comes to price-inelastic baby food, a reputation for safety and quality matters considerably. At the same time, a2 Milk has become the top premium milk brand in Australia with an 11.2% value share. Management is working on building its brand recognition and distribution in the U.S. as well. As of fiscal 2019, the company had approximately 16,000 stores (up 64% year over year) for distribution in China and 13,000 (up 161% year over year) in the U.S. Clearly, the company intends to take advantage of the growing consumer demand for health and wellness products, increasing its focus on food safety, as well as the rise of the middle class in Asia. We also observed that the management team does a decent job of embracing digitalization, especially in terms of engaging digital-savvy consumers in China.

Additionally, it should be to shareholders’ delight that management concentrates on meaningful metrics such as the return on capital employed, the percentage of revenue invested in marketing, research and development and intellectual property.

Of course, swift expansion inevitably raises concerns around the sustainability of the growth rate. For instance, it is even challenging to gauge whether the product is purely riding a fad or a game-changer that can last a while in the industry. Also adding to the short-to-medium-term internal risk is the recent departure of the CEO.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own any securities mentioned in the article.

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About the author:

Steven Chen
Steven CHEN is a quality-focused investor (with bottom-up opportunistic approaches), an ex-hedge fund analyst on Wall Street, a serial entrepreneur, computer scientist, and free-market capitalist.

Steven is the Managing Partner of Urbem Partnership, a value/quality-focused investment partnership fund (www.urbem.capital).

Steven can be reached at [email protected] or through LinkedIn.

Visit Steven Chen's Website


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