Can A2 Milk And Blackmores Just Keep Going?

This story features A2 MILK COMPANY LIMITED, and other companies. For more info SHARE ANALYSIS: A2M

– Surging share prices
– Surging Chinese demand
– Overvalued or not?

By Greg Peel

It was Singles Day in China, so called because it falls on 11/11, that really lit a fire under the Chinese-demand-for-infant-formula story. Singles Day was created by Chinese eBay lookalike Alibaba a few years ago and has now taken on a life of its own as a rival to America’s Cyber Monday online shopping bonanza.

Aussie mums were apoplectic and shopkeepers perplexed when in the lead-up to Singles Day, Chinese tourists wiped the shelves of premium infant formula. The reason became apparent when Singles Day 2015 sales more than doubled those of 2014, and high on the list of most sought after items were premium milk products made downunder, manufactured by the likes of Bellamy’s ((BAL)) in Australia and The a2 Milk Company ((A2M)) in New Zealand.

The rise and rise of Chinese demand for Australasian dairy products follows in the footsteps of the rise and rise of demand for Australian dietary supplements, as evidenced by the long surging price of Blackmores ((BKL)). Ironic, really, that more and more Australian doctors are suggesting Chinese herbal remedies for patients while the Chinese can’t get enough of pills in a tub which most local doctors suggest are unnecessary unless you actually have some sort of deficiency.

Whatever the case, the cat is now out of the bag. Early investors can currently be found on the ski slopes of Aspen or cruising the Caribbean but for those who’ve only recently woken up to the “New Poseidon” story, the question is one of just how far can these share prices go? Typically the smart money gets in first and begins to push a share price, then the momentum traders jump onto the bandwagon, and finally a FIMO stage begins (fear of missing out) which portends the top of the market. Where are we?

Credit Suisse notes a2 Milk’s share price rallied 26% in a week having rallied 32% the week prior. The broker calculates that in order to validate a2 Milk’s share price, the company would need to sell 15,500 tonnes of infant formula here and in China in FY16, when 6,100 tonnes is the current projection.

Credit Suisse had rated a2 Outperform on the premise the company could successfully execute growth in A2-type fresh milk products in Australasia, the UK and US and infant formula in Australasia and China. Just as the advent of an organic approach to food production, including dairy, created a marketing platform for products and price differentiation, the A1-A2-type milk hypothesis and digestive benefit claims are similarly generating opportunities for a2 Milk, the broker notes.

But while Credit Suisse hails management’s “exceptional execution” to date downunder, confidence in the ability to duplicate such success requires further progress in other markets as far as the broker is concerned.

The bottom line is that 15,500t in sales when 6,100t is projected is a bit of a stretch. Credit Suisse maintains its valuation of a2 and a target price of NZ$1.18 but has downgraded to Underperform straight from Outperform.

Blackmores shares opened 2015 at around $35 and are currently trading above $180. How many tonnes of vitamin B and Echinacea does the company have to sell to justify that share price?

Goldman Sachs has not provided such a calculation but the broker admits a 29x price/earnings on FY16 forecast earnings, as implied by the current share price, is a considerable premium. However another popular valuation measure is PEG, or price divided by forecast earnings growth. Here Goldman calculates a PEG of 0.44x when other high growth peers are currently trading on 0.7x.

Goldman believes Chinese demand through the cross-border channel will continue to deliver significant growth for Blackmores. The December quarter and March quarter should deliver strong results for the company thanks to demand arising from Singles Day, now passed, and Chinese New Year, yet to pass. Importantly, the broker notes strong growth from Blackmores’ direct sales into China, which supports a more sustainable model of growth.

The risk, however, is one of possible regulatory change. As always, legislation follows and never pre-empts, and the sudden burst of Chinese demand is likely to bring stricter registration requirements for the cross-border channel lest any old snake oil salesman decides the opportunity is too good to pass up. The industry is expecting stricter requirements to soon be implemented.

This would actually be a positive for brand owners like Blackmores in the longer term, Goldman believes, notwithstanding the company’s direct sales channel.

The bottom line is that while Credit Suisse feels the a2 story has run away too far, Goldman Sachs does not believe the same is true for Blackmores. The broker already had a Buy rating on the stock but rather than downgrade, has added the stock to its Conviction List, that is, Buy With Conviction.

Goldman has lifted its target price to $220 from $185.

To put that into perspective, the FNArena broker database shows a consensus target of $125. Goldman Sachs is not a database broker and only two database brokers cover the stock, being JP Morgan (Overweight) and Morgans (Hold).

Three database brokers cover a2 Milk, one being Credit Suisse (Underperform), with UBS on Buy and Deutsche Bank on Hold. The consensus target is NZ$1.14.
 

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