13 October 2021
Within the Australian Equities component of investor portfolios we have bought A2 Milk (ASX: A2M), a global milk company, domiciled in New Zealand, that sells A2 protein type milk, infant formula and related products.
We view A2 as a good-quality high growth business. They are the leading provider of A2 fresh milk in Australia, A2 infant formula in China and an emerging speciality milk provider in the US with the launch of the A2 brand.
Historically their success in building the business was based upon being an early mover in the A2 niche, investment in marketing, and strong management. As a result, A2 enjoys strong brand recognition, good customer retention and premium pricing in both new and mature markets.
Looking forward, we believe that A2 can continue to exhibit strong top line growth through the combination of the US fresh milk business gaining scale and further market share gains in the China infant formula business. In order to maintain the growth, heavy reinvestment back into the business will be required – primarily in marketing and distribution. This reinvestment will have the effect of capping margins at levels slightly below where they currently sit.
Like all investments, A2 is not risk free. There are several priority challenges that management have to work through including increased competition from global and domestic China brands, disruption to their Chinese distribution channels resulting from covid and changing product mix having a negative impact on margins.
At current pricing, we believe that there is an adequate margin for safety that accounts for the risks and should still provide strong returns over the medium to long term.
To fund the purchase of A2 we are removing Seek Limited (ASX: SEK) from the portfolio. Following the partial divestment of Zhaopin and Andrew Basset stepping down as CEO, we believe that longer term earnings growth is insufficient to justify their lofty valuation.
If you have any questions or would like more information, please contact your Elston representative.