It is a bit baffling how the a2 Milk Company's US business opportunity can be given such a low valuation. Yes, it is a money losing business as it invests for heavy growth. But companies here are coming public all the time that are losing money with little prospect for making a profit any time soon and they are valued in the billions of dollars anyway.
But the list of the risks to a2 Milk's US business is considerable. Here are those that I worry about the most:
- The US milk market is highly competitive, with a large number competitors not just in traditional milk but in the premium milk market as well. Plant based "milk" types such as almond and coconut "milk" are much more well known and established. Will a2 Milk have the resources long term to break through an already crowded market?
- Building brand awareness is extremely expensive in the US. The cost will be in the tens of millions to hundreds of millions of dollars. a2 Milk's spending to date has been impressive, but awareness here is probably still somewhere less than 1%. I took a stab at estimating our share of the fresh milk market last year and came up with something like 0.4 - 0.6%.
- The infant formula market has significant structural barriers, via government regulation. You can google this issue, but essentially it is very difficult to enter this market without being a supplier of formula product to the government welfare programs. It's a tightly controlled market. a2 Milk has little chance of entering it any time soon for a variety of reasons.
- Price: a2 Milk competes in the premium milk market, where average prices are in the $6 - $11 per gallon range. The mainstream milk market competes in the $2.50 - $3.50 per gallon range. The premium market is growing, but it's total share of the market is still less than 15%. It's unclear how much market share the premium market will ever be able to command simply based on the fact that consumers will not pay the higher prices.
- US Grocers are very tough business partners. Their margins are very thin and they constantly look to squeeze costs from their suppliers. As volumes grow, the pressure from retailers to reduce costs will increase. If product categories become too attractive, retailers develop their own brand (e.g. Walmart decided not long ago to produce it's own milk). What would happen if Walmart announced they were launching a1-free milk products from their own farm pools? Or if Costco, Kroger or Albertsons announced their own private label a1-free milk?
- There is a portion of the US population who believe animal based products are morally wrong - as they result in animals being mistreated and the theory that animal based farming is more harmful to the environment. They will not switch to an animal based product such as a2 Milk's no matter how nicely the cows are claimed to be treated nor how well they are fed.
- As the evidence of the benefits of a2 milk become more clear, and as dairy farmers see the growth of a2 milk sales, they themselves are breeding their herds toward a2. This is a slow process, but what happens to a2 Milk's ability to differentiate itself if, hypothetically, farmers eventually breed out the a1 protein? At the very least, one can imagine that we're not far off from a brand of a1-free milk priced to compete at traditional milk price levels ($3 - $4 per gallon). And would a2 Milk have enough brand strength to charge a 100% premium at that point? If not, how will the a2 Milk Company respond?
Given the risks and costs for the foreseeable future, and given the overall perception that dairy is a very difficult business to make profitable in the US, it's possible for skeptics to put a low valuation on the opportunity.
Now, having laid out all the doom and gloom, I will note that I own the stock and plan to keep it for the long term. All of the reasons for that probably need to be saved for another post. But in short, I believe that the company is expertly run, has a great plan in place and will remain the world-wide leader in a2 milk products as a2-only milk becomes the gold standard for all dairy products.
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