Thursday 22nd February 2018
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A2 Milk Co is now more valuable than Fonterra, even though the milk marketer's sales amount to less than 3 percent of the dairy giant's, as investors bet it will continue to beat expectations.
A2 shares jumped 18 percent to $13.87 on the NZX and are trading at more than 50 times forecast per-share earnings - the highest price-to-earnings (PE ratio) of any company on the NZX 50 Index. The market capitalisation of a2 has jumped to $10.1 billion, exceeding the $9.76 billion value of Fonterra based on the $6.06 price of the shares that trade in a farmer-only market on the NZX.
Shares of a2 surged yesterday after the company posted a 150 percent gain in first-half profit and announced a strategic partnership with Fonterra for the supply of A1 protein-free milk products in bulk powder and consumer packaged forms, in exchange for an exclusive licensing agreement to produce, sell and market a2 branded fresh milk for end sale in the New Zealand market. A2 sees a similar trading performance for the second half but expects to increase spending on marketing.
Its stratospheric performance comes from being able to tell a good story with its infant formula and milk products said to be beneficial for people who suffer gastrointestinal discomfort from regular milk which contains the more common A1 protein variant, investors say.
"Yes, it's a good story. Everyone can see the attractive dynamics of the product they are producing, which is why it's been heavily embraced by the market," said Angus Gluskie, managing director at Sydney-based White Funds Management, which manages about A$600 million and has "a small holding" of the stock, putting it at "neutral weight".
"I think it's a riskier proposition investing in it from the current time, given the high price, relative to forecasts," Gluskie told BusinessDesk. While a2 has been "very smart" in establishing a niche the question is whether there is anything to challenge that, given the stock is expensive on the back of expected growth. There were signs of competitors emerging, in the US in particular, he said.
"Should that occur and should that impact on the growth outlook the stock would have the potential to pull back," he said. "The risk occurs if people get too extravagant in what they are extrapolating into the future," he said, noting that future growth projections are now quite high.
The shares have soared 509 percent in the past 12 months on the NZX. Its manufacturing partner Synlait Milk hasn't been able to keep up, despite a stellar 115 percent 12-month rally.
Matt Goodson, managing director at Salt Funds Management, attributes this week's gains to "the market reacting to the future potential of the Fonterra deal."
"At the end of the day, a2 has found a niche in a vast market and they keep delivering. They keep beating the market's expectations both in volume and price terms and the deal yesterday with Fonterra raised the possibility that could be leveraged into something larger," he said.
Goodson said the key risks in the space are any regulatory change as well as food safety issues. While both are unlikely and unforecastable they can have a devastating impact. He agreed, however, "obviously the risk further out is competition."
Synlait shares rose 2.6 percent to $6.82, having fallen yesterday on the announcement of the a2-Fonterra tie-up, which made no mention of Synlait. Late in the day, though, a2 and Synlait put out a joint statement says a2's Fonterra partnership didn't change Synlait’s exclusive infant formula supply arrangements with a2.
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