Portfolio Specialist, NAB Asset Management
Since listing on the ASX in March last year the A2 Milk Company share price has risen 200%.1 Since launching its main product – A2 Milk – it has taken nearly 10% of the grocery store fresh milk market. More recently, sales of the company's A2 Platinum baby formula have exploded in the Australian market. The brand is also growing in the Chinese market for baby formula and adult milk, and has just entered the UK and US markets.
Historically milk has been an entirely homogenous product. For the last 15 years there has been no legislative control in Australia over the price that milk processing companies must pay farmers for their milk.2 While there are over 80 different brands of milk available in Australia, the homogeneity of the product combined with the power of processers and supermarkets, has driven down prices for consumers.3
One litre of plain milk is currently sold in supermarkets for A$1; yet A2 Milk sells alongside it for A$2.35 per litre.4 While this is an impressive premium that consumers are willing to pay, the path to achieving it has not been easy.
How could this brand grabbing market share happen to one of the most boring products in the world – plain white milk?
Back in the 1990s, a scientist from New Zealand discovered that cows naturally produce two types of beta-casein proteins in their milk – A1 and A2. Further research suggested that many people who experienced 'discomfort' after drinking milk were not affected in the same way if the milk they drank was made from cows that produced only the A2 protein. They built a company and a simple genetic process to determine if a cow was only going to produce the A2 protein in its milk.
The opportunity opened to innovate and differentiate a brand of milk based on this discovery. First, they needed to find supply – and that meant convincing dairy farmers to selectively breed those cows with only the A2 protein milk; and pay for the genetic testing of the herds in order to achieve this. In addition, the dairy farmers would need to pay to have their milk supply regularly tested to ensure that it contained only the A2 protein.
In early 2000, deregulation was unleashed on Australian dairy and farm gate milk prices fell. Paying for significantly higher input costs via this testing and the time to selectively breed an appropriate herd was going to be a hard sell.
But the A2 Milk Company did manage to convince some early adopters that it was worth the upfront effort and ongoing costs. The company made arrangements to pay a higher price for this specific type of milk – approximately 11 cents a litre more than for normal milk – and a handful of dairy farmers came on board. From there, the A2 Milk Company milk supply started to increase.
In March 2003, a Jersey cow herd near Lismore in NSW was the first in the world to have its milk bottled and sold purely as A2.5
But there was a problem. Part of the developing marketing strategy was aimed squarely at undermining the existing quality and dietary impact of regular milk. This did not sit well with Dairy Australia – the dairy industry body – nor the Queensland Health Department, who fined the A2 Dairy Marketers in Australia (who had bought the rights from the A2 Milk Company in New Zealand) for making false and misleading claims about the health benefits of A2 milk. Shortly after being fined, the Australian A2 Dairy Marketers went into liquidation, owing farmers and processers tens of thousands of dollars. A Federal Government grant of A$1.3 million that had been awarded to the company in August 2004 as part of the Regional Partnerships Programme was cancelled.6 The future looked bleak for the early adopting producers, with no one interested in buying what they were supplying.
Resilience pays off
But they persevered. The patents, brand and marketing rights were sold to a company in Singapore and the A2 milk supply and distribution was rebuilt, with the A2 milk available in 600 supermarkets in four states in Australia. But three years after first being sold, A2 milk was a tiny share of the overall market in Australia. In March 2006, the patents, brands and marketing rights were bought back by the A2 Milk Company in New Zealand. Just prior to this transaction, shareholders in the A2 Milk Company were told not to expect any profit for three years.
Since that time, the A2 Milk Company changed the way it marketed its milk. It concentrated more on the benefit it provided to consumers rather than discussing any negative side effects from other dairy products. The company focused on increasing its supply – it only had six farmers producing 13 million litres a year in 2006 – and increasing its range of product.
By 2010, 40 million litres of A2 milk was produced by 12,000 A2 certified cows across Australia; and yoghurt made with A2 milk first appeared in April 2010.
In February 2011, A2 Corporation announced that it had made a profit for the first time. In the six months ending December 2010, it announced it had made slightly less than A$900,000. In December 2012, it announced that it would list on the New Zealand stock exchange in an attempt to raise A$20 million to expand its business in China and the UK. The company listed on the ASX in March 2015.
There are now 44,000 A2-tested cows providing milk for the A2 Milk Company. With the company holding 10% market share in Australia, and pushing hard into global markets, shareholders will be delighted with the company's performance over the last year. Even competitors, who do not necessarily agree with the science of the proteins, are now labelling their milk 'contains naturally occurring A2'.7
These curious cows show that while companies can be disruptive and innovative the path to success is not always clear. The patents for A2 gene testing start to expire in 16 years. It will be fascinating to see how the dairy industry develops and innovates into the future.
This is not a recommendation to purchase A2 Milk Company shares, nor to change your diet, nor does it try to suggest that the science regarding the A2 proteins impact on digestion is clear!
1. Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market. ASX and New Zealand Stock Exchange. A2 Milk (stock code ATM) has been listed on the New Zealand Stock exchange since 20 April 2004 and the ASX (code A2M) since 30 March 2015. 2. Industry achieved full deregulation on 1 July 2000. Source: Dairy Australia as at 3 February 2016 - www.dairyaustralia.com.au/Industry-information/About-the-industry/Deregulation.aspx. 3. Choice August 2014 - https://www.choice.com.au/food-and-drink/dairy/milk/buying-guides/milk. 4. Coles online shopping as at 3 February 2016 - http://shop.coles.com.au/online/national/dairy--eggs-meals/dairy-eggs/milk. 5. ABC Landline 2006. 6. Australian Finance and public administration references committee report on regional partnerships and Sustainable Regions Programme, October 2005. 7. The Lion owned Pura and Dairy Farmers milk products have used this labelling on some of their milk since August 2014.
This document is issued by nabInvest Capital Partners Pty Limited (NCP) ABN 44 106 427 472, a subsidiary of NAB Asset Management Limited ABN 16 134 158 517. NAB Asset Management is the investment management business of the National Australia Bank Limited ABN 12 004 044 937 (NAB) group of companies (NAB Group). An investment in any financial product referred to in this communication is not a deposit with or liability of, and is not guaranteed by NAB or any of its subsidiaries. This information is directed to and prepared for Australian residents only.
This information may constitute general advice. It has been prepared without taking account of individual objectives, financial situation or needs and because of that you should, before acting on the advice, consider the appropriateness of the advice having regard to your personal objectives, financial situation and needs. We believe that the information contained in this communication is correct and that any estimates, opinions, conclusions or recommendations are reasonably held or made as at the time of compilation. However, no warranty is made as to the accuracy or reliability of this information (which may change without notice).
Any forecast or forward looking statement in this document is provided for information purposes only. No representation is made as to the accuracy or reasonableness of any such forecast or statement or that it will be met. Actual events may vary materially. While NCP have taken all reasonable care in producing this communication, subsequent changes in circumstances may occur and impact on its accuracy. NCP relies on third parties to provide certain information and is not responsible for its accuracy. NCP is not liable for any loss arising from any person relying on information provided by third parties. NCP may use the services of NAB Group companies where it makes good business sense to do so and will benefit customers. Amounts paid for these services are always negotiated on an arm's length basis.
Any opinions or analysis expressed should not be considered a recommendation or solicitation to purchase or sell any stocks. It should not be assumed that any investment in any stocks was, or will be, profitable. Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market.