Wednesday 27th March 2019
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Nikko Asset Management New Zealand’s head of equities Stuart Williams says he dreads waking up to the news that some global giant has launched a takeover offer for A2 Milk.
That’s because the fund manager’s stake in A2, currently just 0.8 percent or 6.2 million shares, added 90 basis points to his team’s performance in 2018 and 35 basis points year to date.
The company was overweight in A2 by 3-4 percent through most of 2018.
Williams’ statement that “A2 is very important to us” was clearly an understatement at his company’s investment conference in Wellington on Monday.
"It's really self-serving - we would prefer that the New Zealand capital markets remain vibrant. I really don't want a company as good as A2 that's still at the start of its process to be taken out," Williams said. "This thing's growing earnings at 55 percent."
Clearly a takeover offer can’t be ruled out because A2's register is wide open – the annual report listed Commonwealth Bank of Australia as the sole substantial shareholder at Aug. 1 last year with a 7.3 percent stake – and there have been rumours of global interest for years now.
What is equally clear is that any takeover would have to be very well priced, given A2's performance to date and promise for the future.
Nikko first started investing in A2 back in 2012 when the stock was barely out of the penny dreadful category and not obviously on track to become one of New Zealand’s largest listed companies.
But former chief executive Geoff Babidge, who oversaw A2’s transformation, was already at the helm from August 2010 and the company’s launch into China’s infant formula market, the key product and country in its transformation, came in October 2012.
Stuart told the conference hardly a day goes by without new information about A2 coming to light, witness Monday’s announcement of Li Xiao as its chief executive for greater China. Li Xiao has previously worked in China for a diverse range of multinational companies including Mars, Nike and Burger King.
But investing in A2 clearly involves risk. In the past 12 months the stock has traded down as low as $8.67 and up as high as $15; it was trading at $14.01 a short time ago.
Not least of its hurdles for A2 is the changing regulatory environment in China. A2 claimed a 5.7 percent share of the infant formula market for 2018, up from 5.1 percent in June 2018, and infant nutrition accounted for 81 percent of sales in the six months ended December, most of that in China.
A2 has had to get China Food and Drug Administration approval for direct sales in China, change its packaging for its “China” label and apply for State Authority for Market Regulation approval.
Nikko’s A2 analyst Michael De Cesare had warned last year about regulatory changes impacting products that find their way to China from Australia via the daigou trade. The daigou are people and organisations that buy products in Australia for sale in China.
So the Nikko team were prepared to see the share price decline. However, when the shares did fall in September last year it was actually because newly-appointed chief executive Jayne Hrdlicka had sold $4.3 million worth of shares she had only just been awarded as part of her salary package.
Nevertheless, because Nikko still had a positive view of the company’s outlook long term, it had reduced its stake to neutral ahead of that rather than moving to an underweight position.
That was before another regulatory change whereby the daigou will have to be registered, agree to be monitored by the authorities and to pay tax. The change is set for Jan. 1 this year, although the Chinese authority provided a grace period through to April 1, covering the daigou trade and e-commerce sales. A2 also uses e-commerce channels such as TMall.
“We don’t know how hard that legislation will be regulated but we do know that the predominant trade goes through four main daigou, all of which are already compliant with the new legislation,” Williams said.
Nikko is now about 2 percent overweight with A2 Milk and is currently debating whether to go further overweight, he said.
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