a2 Milk - the Cream always Rises to the Top
In the space of less than 5 years, a2 has gone from little more than a rounding error in the NZX50 to one of the largest, fastest growing and most profitable companies. At quarter-end a2 accounted for 8.8% of the NZX50 and over the last few years it has had a particularly big impact on the fortunes of the NZ market. Given this company features in many portfolios either through direct investment or equity funds, we wanted to give you an understanding of the company and why it has gathered so much attention.
The performance of the NZX50 over recent years has significantly benefited from the performance of a2. For example, in 2017 a2 was responsible for almost half of the market’s return, increasing the NZX50’s return from 5.3% without a2 to 9.1% with it. The last quarter the reverse was true as a2 dragged the index return down from 5.8% to 4.4%.
Value of $1 invested in a2 and the NZX50 five years ago
Who is a2 Milk?
a2 is a niche dairy operator, who markets and distributes milk and infant formula containing only the A2 protein. For its first decade after listing in 2004, a2 was an unknown penny stock, before quickly gaining success and rising to become the biggest company in the NZ market. The key catalyst has been the company’s successful entry and popularity in the Chinese infant formula market.
The science behind the brand
Without going too deep into the science, the main premise is a2 milk is produced by a specific type of cow that only produces the A2 beta casein protein. The majority of milk providers use a mix of A1 and A2 proteins.
The difference in the protein structures can result in differences in its breakdown during digestion. There has been some scientific research suggesting that milk high in A2 has fewer intolerance-type reactions and it reduces the risk of serious health conditions. This has enabled a2 to pitch itself as a premium product, particularly in the Chinese infant formula market.
Why does a Milk Company get so much Attention?
a2 has seen so much attention in the NZ share market due to its size, rapid growth and potential to grow further. In its most recent earnings report, the company achieved profit growth of 47%. While a result like this is not unheard of, it is uncommon for such a large New Zealand company.
The New Zealand market has been a stellar performer globally over the past 5 years and one of the key drivers of that success was a2. At a time when global markets are dominated by technology giants such as Google, Amazon, Apple, and Microsoft, the NZX’s fastest growing and largest listed company is a dairy producer with less than a 5% of the local milk supply.
In its most recent financial report, a2 announced +41% revenue growth and +47% profit growth. Despite this, its shares fell -12% on the same day and are currently -20% below the price before this report. The main reason for the drop was the company indicated there would be higher spending going forward, particularly on investment in marketing and distribution channels into China.
Revenue Growth Rates - a2 vs NZ Market
The positive take on this is a2 is investing to grow its position in key markets to ensure long-term success. On the other hand, this could be the beginning of lower profit margins if a2 needs to invest even further to defend their market position.
So where does this leave Investors?
a2 is a growth company and as such will exhibit volatility, sometimes significant volatility as we have seen in recent months. Investors with a short investment timeframe or a low risk appetite might be reluctant to hold such an investment but a2 offers a unique growth opportunity, particularly compared to the remainder of the NZ market which is dominated by defensive companies. Growth shares, in moderation, are necessary even in lower risk portfolios to curb the effects of inflation and provide capital growth.
We have included it in portfolios because growth companies such as a2 should be willing to invest for the future and a2 has a great track record of doing this. The company has no debt, and is sitting on a significant amount of cash, lessoning the chance they will need to raise capital anytime soon. Given these circumstances there is the real possibility that a2 continues to grow and bring the NZ share market with it.
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