Small Caps | Jun 23 2015
-Unique dairy products
-Expansion in US accelerates
-Planned equity raising
By Eva Brocklehurst
Why wouldn't a strong brand with unique products like a2 Milk Co ((ATM.NZ)) receive a takeover proposition? UBS makes the observation after two associated parties signalled their interest. The company's board does not consider the offer is a firm bid, or that it is imminent. The expression of interest is conditional on due diligence and the company refraining from undertaking an equity raising at this juncture. Still, the news has revitalised interest in the stock.
A2 Milk has created some unique dairy products with perceived health benefits which open up the market to new consumers. The company's market share in milk in Australia is around 3.1%, and in infant formula around 5.0%, so it is far from mature. UBS also observes the UK business is nearing profitability, with second half volumes likely to be double the first half. The company has recently launched its brand in California while sales of infant formula in China are ramping up.
A2 Milk is considering raising equity capital. To UBS this suggests the rollout of its product in the US is moving faster than expected. UBS increases earnings forecasts and valuation as a result of the earlier-than-expected start of sales in California. UBS has a Buy rating and NZ95c target, valuing the Australasian component of the business at NZ55c.
The consortium includes one known company, Freedom Foods, a shareholder of a2 Milk with around 17%, and an international liquid dairy. The expression of interest may flush out competing parties to reveal their interests, or push a2 Milk into proceeding with the equity raising to accelerate its expansion plans, Credit Suisse suspects. The broker believes that just as the organic market developed in terms of food production and created a marketing platform for price differentiation, so too does the a2 Milk digestive benefit claims generate opportunities.
The broker downgrades earnings estimates for FY15-17 to reflect a higher cash-burn rate for the expansion into the UK and US. Credit Suisse believe a successful execution of the company's strategy could justify a spot valuation of NZ$1.17. The broker considers, with or without a bid, the stock is undervalued. Credit Suisse has a NZ76c target and Outperform rating.
Deutsche Bank regards an assessment of the underlying value in the stock as difficult to make, given the early stages of its expansion and the level of risk in operating in highly competitive end markets. Hence the broker has a more prudent Hold rating with a NZ73c target. Still, Deutsche Bank has revised earnings forecast to include a stronger outlook from the US opportunity and the recent fall in the NZ dollar, albeit retaining a view of weaker near-term operating margins.
In total, the broker estimates the growth strategy targets an addressable retail market value of NZ$4.5bn. To fund US and infant formula growth the broker estimates the company needs to raise NZ$50m in equity, which is now included in FY16 as a base case. With the stock now trading in line with a discounted cash flow valuation, Deutsche Bank believes investors should start to bank profits on a risk adjusted view. To obtain material value uplift and reach a bull case valuation of NZ$1.17 would require another trade player to enter the bidding stage, in the broker's view. If no bid emerges, Deutsche Bank estimates the Australasian business, without the other growth options, is worth NZ50c.
A2 Milk has transformed from an intellectual property company when listed on NZX in 2004 to now control its own brand marketing and development in all regions outside New Zealand, where it remains under licence until 2017. It relies mainly on third parties for processing. The company's brand development strategy is based on the digestive benefits of its type of milk.
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