16 Sep 2021

The yo-yoing fortunes of the darling of the stock market

From The Detail, 5:00 am on 16 September 2021
Spoon with infant formula

Photo: 123rf

It used to be the darling of the share market, racing from 75 cents before sales of its infant milk powder took off, peaking at more than $21 last year.

But the a2 Milk Company’s meteoric rise is now tumbling, struck by complications by Covid.

Today on The Detail Emile Donovan talks to Sam Dickie, a senior portfolio manager at Fisher Funds, to talk about the company’s roller coaster ride, and how one of its greatest strengths – its unusual distribution channel – has become its greatest weakness.

Between 2017 and 2020, a2 Milk’s share price rose more than 900 percent. But over the past 13 months it has fallen by nearly 75 percent.

It turns out that firms that hitch their wagons to a single product in a single market – in this case, China – have fragile fortunes.

A2 started off in 2000 as a bio-tech company licensing their a2 technology and selling liquid milk. But the company really took off after 2012/13 when it launched infant formula for the Chinese market.

A2 milk contains a type of casein protein that some scientific studies suggest is easier for humans to digest – and importantly, it doesn’t contain the A1 beta casein that is present in everyday milk. The company uses specially selected cows – in New Zealand, Jersey cows – and licences the farms providing it.

Dickie describes the science as “interesting and varied” but says what’s probably more important here is that the company morphed from becoming one driven by science, to one driven by brand – particularly when it launched in China.

In late 2015 sales really took off and the company nearly doubled its earnings forecast.

“In 2014 it basically had no revenue from a2 Platinum infant formula – and six years later it was generating about $1.5 billion in infant formula revenue,” he says.

By July 2017 the share price was at $4; by July 2018 it was at $11; by July 2020 it was more than $21.

The interesting aspect of a2’s marketing in China was its ‘daigou’ distribution method. The translation of daigou is ‘buying on behalf of’, and it was largely worked through Chinese students living abroad, buying formula in bulk, and funnelling it back into China to be sold through channels such as WeChat.

“That’s an extremely powerful channel if managed well,” says Dickie. “Because it is largely free-marketing. So think about it, you’ve got tens of thousands of ambassadors running around pushing your brand, so your marketing costs are very low, so the profitability of the product is very, very, high.”

The brand was on fire, and the pricing structure was managed carefully so that the daigou got a good margin per tin of formula.

It’s become more corporatised in recent years as China cracked down on tax dodgers operating this way.

But then a global pandemic came along, and the supply chain dried up.

Dickie says “a series of events and missteps” meant “this powerful, profitable channel became its greatest weakness”.

The problems, perversely, were triggered by strong demand as covid hit China and millions of Chinese mothers began panic buying. But as it became obvious that they didn’t need to stockpile the product, they stopped buying it at all – because they needed to use up their stash.

A massive rise in demand was followed by a huge fall, but the links in the distribution chain didn’t pick up quickly enough on that fall, and the company was slow to diagnose what was happening.

In today’s podcast Dickie explains how the subsequent uncertainty has played havoc with a2’s earning forecasts, and talks about the other factors that have contributed.

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