Fund Mgr notes

A2 Milk delivers yet again

ANDREW MITCHELL View the contributor'sprofile page

Ophir Asset Management

Never before has the Australian small and mid-capequity market experienced such a broad variety of Australian and NZ-basedbusinesses achieving stellar success in overseas markets. Where offshoreexpansions have long been an investment graveyard for larger-cap Australianbusinesses desperately looking for growth avenues to supplement mature domesticmarket positions (see National Australia Bank, QBE, AMP, Wesfarmers/Bunningsamongst others), a new cohort of globally-focused emerging Australian companieshave thrived in entering new territories.

Specialist dairy and infant milk formula producerThe A2 Milk Company (A2M) has been one such notable performer, a business thatonly six years ago was a A$210m market cap NZ-based fresh milk producergenerating $48.6m in revenues from the sale of bottled A2-only milk intosupermarket chains in Australia and New Zealand.

Today, the same humble Kiwi milk producer nowcommands a market capitalisation of over A$9.7bn, selling fresh milk and infantmilk formula (IMF) products into Australia, New Zealand, China, the US and UKand will deliver an expected ~A$1.25bn in revenue for the 2019financial year.

The business commands the number one marketposition for infant milk formula sales in Australia, already speaks for 5.7% ofthe $20bn Chinese infant milk formula market and recently announced A2-brandedbottled milk now being sold in over 12,000 stores in the United States. It nowholds more cash on its balance sheet that its entire market capitalisation in2012.

Source: A2 Milk Company Half YearInterim Results FY19 Presentation

Key takeouts fromtoday's result

The recently announced first half result from thecompany again highlights how far the business has come in recent years and themomentum it continues to see across all geographies and product lines.

Group revenues grew +41% on the previouscorresponding period, while earnings before interest, tax, depreciation andamortization (EBITDA) grew +53%. The result was a 8-10% ‘beat’ tounderlying market expectations, with the stock subsequently rising +8% on theday.

Strong performance at the margin line wasparticularly noteworthy at this result, with gross margins across the businesscoming in at a healthy 55.5% as the company benefits from increasing scale,price increases and a continued shift in sales mix towards the more profitableinfant milk formula products. The margin performance provides an excellentexample of the strength of the business given a material increase in recentmonths toward investments in marketing and brand.

Growing footprintin China and US markets

Infant milk formula sales into China continue to bea key driver, with the business now benefiting from landing product into Chinavia a variety of channels. Where initially the company saw enormous growth viathe cross-border e-commerce channel (where individuals would purchase tins ofA2 formula in Australia, take offshore and sell to Chinese parents via onlinemarket places such as Tmall or Taobao), the company now has an in-countrypresence in over 12,250 Mother and Baby stores, resulting in +83%growth in China-label tins from the same period last year.

While still only a small market by current revenuecontribution, the growth the business has experienced this half in the UnitedStates is worthy of mention. Fresh milk sales in the US doubled overthe period, with management noting they are seeing similar parallels to thebrand building experience of their initial Australian roll-out – a pleasinganecdote considering the US milk market is worth in excess of US$13 billion peryear with an underlying consumer already sympathetic to the alternative dairymarket. With further distribution agreements recently signed with national USsupermarket chain Krogers and additional regions with Costco, Walmart andSafeway stores we expect the growth to continue to compound from here.Importantly, it was the success of the fresh milk product in the Australianmarket that ultimately provided the company with the credibility required tounderpin the success of its now immensely popular infant milk formula business– a market opportunity within the US that isn’t yet garnering any attention.

Significant growthopportunities still lay ahead

With a significant amount of runway left for thebusiness in the two largest economies in the world, we continue to maintainconfidence that the company will be a significantly larger one in years tocome. Pleasingly, we entered February with the stock as the second largest heldposition across the Ophir Funds and we very much look forward to continuing tomonitor and enjoy the business’ growth from here.