Sales success makes A2 Milk a takeover target

Sales success and surging share price make A2 Milk a takeover target


New Zealand nutritional powder processor Synlait Milk, A2's sole supplier for infant formula, said is ramping up production after reports of retail outlets running out of stock.

New Zealand nutritional powder processor Synlait Milk, A2's sole supplier for infant formula, said is ramping up production after reports of retail outlets running out of stock.

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A major shareholder believes the A2 Milk Company is performing so well it is now a possible takeover target for multinationals

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The A2 Milk Company appears poised for an earnings upgrade after a strong start to the second half, while a major shareholder believes the trans-Tasman company is a possible takeover target from multinationals looking for growth.

According to Tmall/Taobao data, A2 is winning share in China, while maintaining its premium pricing position.

While the largest proportion of sales in 2016 was within the Australian grocery and pharmacy channels, direct sales into China increased significantly and are expected to continue to rise.

NZ dairy processor Synlait Milk, A2's sole supplier for infant formula, said is ramping up production after reports of retail outlets running out of stock.

Goldman Sachs recently upgraded its earnings per share expectations by nine per cent to 12pc for the next three financial years.

"Its relationship with Synlait also means it is well placed to obtain CFDA registration [in China] to grow further offline," analyst Andrea Chong said.

"Supply of product is the main near-term constraint to earnings growth, with second-half growth likely skewed to fourth quarter."

News of A2's bumper half is not what troubled rival Bellamy's Australia wants to hear as it tries to secure a new canning line after losing its slot at Bega Cheese's Derrimut site, leaving it out in the cold for its China CFDA certification from 2018.

It also has a stressed balance sheet, ageing inventory and onerous take-or-pay contracts with suppliers.

One of A2's biggest investors brushed off any stock issues and believes it could be a takeover target as large multinationals look for global growth.

Nestle and Danone have articulated strategies to grow in Asia and beyond by acquiring brands that move them towards the health and wellness categories.

Greencape Capital portfolio manager Matthew Ryland said following the recent $US16.6 billion ($22b) deal by UK's Reckitt Benckiser to buy US-based Mead Johnson Nutrition, in which Nestle was also interested, A2 would be on suitors' radar.

"Nestle have shown ... they want brands that extend them further into the wellness category," said Mr Ryland, who controls a 7.22pc stake, making Greencape the second biggest shareholder.

"Next in line after Mead Johnson is A2.

“You would have to say it's a target, it's clearly on radar. It's an attractive growing brand in a consolidating sector."

Mr Ryland said while A2 was trading on a price-earnings ratio of 22 times, with net cash and a valuable yet loss-making US operation, the Mead Johnson/Reckitt deal was 27-times P/E.

He believed A2 was a different proposition to Bellamy's, which has faltered in reading demand in China resulting in the former chief executive officer being fired and the majority of the board spilled.

He said A2's main issue is managing its growth.

"Bellamy's has regulatory issues in China, has complete opaqueness where they source products from and their organic brand is not differentiated from others around the world," he said.

"Consumers have worked this out. A2 has got IP and a lot of differentiation.

“A2 can also expand globally and multi-generationally [beyond formula] thus having a much larger potential market."

A2 promotes its products by highlighting they are free of the A1 protein, which it claims can cause gastrointestinal issues for some people.

Its products contain only the A2 beta casein protein.

In February, A2 flagged first-half profit nearly quadrupled to $NZ39.4 million ($36.8 million) on surging sales in Australia and China.

A2 stock is trading at an all-time high, and has risen 81pc cent in the past 12 months to $2.95.

Citi analyst, Sam Teeger, said while A2's share price has had a good run higher, he remained sceptical, noting risks around rising costs over the medium term.

Mr Teeger, who has a "neutral" rating on A2, said while there are risks, management has done an "excellent job to date".

He also agreed that Synlait's guiding towards infant formula volumes ticking up towards the end of this half was positive over the medium term.

He added there was potential for a resurgence at Bellamy's this year.

"[CEO] Andrew Cohen is doing a good job," he said.

"He has a tough task ahead of him, but the new strategies he is pursuing are sensible."

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