Should You Buy a2 Milk Shares in 2016?

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China’s slowdown is on everyone’s lips this year. Australian companies who have gotten the worst end of the stick are miners. A contributing factor towards the commodities decline has been lack of demand. And everyone is pointing the finger at China.

China’s slowdown is almost like a sickness. Everything they’re associated with gets caught up in the negativity. However, you should always have a healthy dose of scepticism within the market. Yes, China’s economy is slowing down. But that doesn’t mean everything affiliated with China is doomed.

Last year, Australia’s dairy industry enjoyed huge share price gains thanks to China. The industry benefited largely because of baby formula which was aggressively in demand. Supermarkets could barely keep formula on shelves, that’s how popular it was.

Two stand out winners from the dairy industry were Bellamy’s Australia [ASX:BAL] and a2 Milk [ASX:A2M]. Each company experienced sales and earnings explosions last year. Some analysts believe it could’ve been a one-off. But the evidence is against them.

Yesterday, A2M gave investors a look at their results for the second half of last year. A2M’s overall revenues surged 86% to $128.5 million. Infant formula contributed 53% of A2M’s total revenue. And the party may not be over yet.

China’s demand for infant formula is expected to continue into 2016. A2M’s new product, Platinum Formula, catapulted sales in the second half of last year. And it’s expected to continue into 2016.

A2M CEO, Geoff Babidge, expects baby formula to continue dominating their product portfolio. He explains:

We are still going to have a portfolio of products but clearly, the forecasts and growth projections that we have… in the not too distant future of infant will be beyond 60 percent [of revenue] and heading further north.

The clear growth market will be China, but ‘there is opportunity for us [A2M] to take infant [formula] into new markets,’ Babidge added.

As A2M announced their great start to FY16, shares opened up 21% higher than previous close. However, it seems investors still have fears about China’s future prosperity. It’s also believed some shareholders were just collecting profits by selling out. Regardless, shares proceeded to trade down to $1.925 apiece. Meaning shares only posted a 2.4% gain for the day.

A2 Milk Share Price

Source: Yahoo Finance

Will a2 Milk continue its growth in 2016?

Growth for A2M may not dwarf figures of last year. But the one child policy is over, and further growth will be inevitable. The Chinese government say about 40 million births were prevented because of the policy. Although the number is probably much higher.

With the policy’s recently abolishment, demographics are certainly going to change. Mothers all over China have the chance to have a second child, where they didn’t before. The United Nations has predicted the Chinese population to peak around 2034. This will make an already enormous market even bigger. And what will it need? Baby products and infant formula.

Even travel agencies are trying to get in on the lasting Chinese demand. A&A Travel has been subletting parts of their building to store infant formula. A freighting company is using the extra space to store the precious product. The goods are then shortly shipped over to China, priced up to $100 per tin can.

Everyone is trying to get in on the sustained market. The consensus is for the momentum to continue into the second half of this year. Full-year revenues are expected to climb 125% from previous levels.

Some are saying that regulatory changes will stunt the growth of companies like A2M. The changes strictly state that infant formula must be sold on online Chinese stores. The policymakers are trying to put an end to the infant formula black market. Yet the market is so massive A2M is likely to be fine. The company has upgraded profit guidance for a third time this financial year. Regulatory changes have been included, yet it hasn’t affected A2M.

The market is obviously growing. And who’s to say latest guidance isn’t conservative? An added advantage A2M has over competitors relates to the contents of their products. A2M products only contain A2 proteins. Other dairy products commonly contain both A1 and A2 proteins.

What does this mean? A2 proteins are less likely to cause stomach discomfort. And when we consider demographics, this is very important. Peoples of East Asian decedents commonly experience stomach discomfort when consuming regular dairy products. In fact, 90% of East Asian descendants experience some discomfort.

This means A2M’s products are in high demand for two reasons. Their products cater to the growth of dairy consumption in China. And their products cater to those who experience stomach discomfort. This is why I believe A2M has an advantage in a market that is continuing to grow. But whether investors can get over their fears of China’s slowdown remains to be seen.

Härje Ronngard,

Junior Analyst, Money Morning

PS: Infant formula had a great year in 2015. And it could continue into this year. But there are also other industries and stocks you should be looking out for. According to Money Morning’s Publisher Kris Sayce there are five stocks that will define 2016.

In Kris’s report, ‘The Five Best ASX Stocks for 2016’, he will reveal the hottest stocks to watch out for in 2016. He’ll also let you in a secret, sneaky way to play the Australian property market.

To download your free copy of the report, click here.

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