US fund Ruane, Cunniff & Goldfarb stands by A2 strategy

A2 Milk chief executive Jayne Hrdlicka Picture: Stuart McEvoy

• EXCLUSIVE

  DAMON KITNEY

  VICTORIAN BUSINESS EDITOR

  
• 12:00AM NOVEMBER 19, 2019
• NO COMMENTS

A top US investment house founded by a long-time friend of Warren Buffett has publicly backed the strategy of A2 Milk chief executive Jayne Hrdlicka amid growing concerns about the company’s increasing cost base, as pricing in the booming China market comes under pressure.

The New York-based value manager Ruane, Cunniff & Goldfarb, which for just over a year has held about 11 million A2 shares in a 50-year-old global portfolio known as the Sequoia Fund, said it was willing to “sit tight” with its A2 holding as long “as the underlying business continued to grow in value”.

Since A2’s inaugural investor day on September 17, when Ms Hrdlicka hosted a large group of analysts and investors in Shanghai, the company’s shares have fallen from $13.10 to as low as $11.31 early this month. They are now trading at about $12. They were trading above $16 before A2’s annual results in August, when Ms Hrdlicka revealed that the company’s earnings margin was likely to fall slightly this year because of its investments in growth and a growing marketing spend.

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New York-based Sequoia Fund portfolio manager Will Pan, who attended the September investor day, said he was “impressed by the management team and team dynamic”. “They came across as sharp, hard-working and high-integrity,’’ Mr Pan told The Australian ahead of A2’s annual general meeting in Auckland today, when the company traditionally updates its year-to-date financial performance.

“We think Jayne has communicated well. We also appreciate that, to maximise the value of the business, Jayne cannot always show all of her cards.”

A2 spent about $NZ20m on consultants last year, contributing to its marketing costs nearly doubling to $NZ135m, and they are likely to approach $NZ200m ($188m) this year.

“We believe the investments in marketing are necessary for the company to reach its full potential,” Mr Pan said. “We think there are right and wrong ways to utilise consultants. We trust Jayne — an ex-consultant herself — to know the difference.” Ms Hrdlicka previously worked for Bain & Co.

“We love frugal, scrappy businesses and have been fortunate to invest in many over the years, but we are also aware of companies that miss opportunities because they run too lean. We trust the team to strike the right balance.”

There is a growing view among some local investors that A2 may be building up a cost base that may become a drag on earnings if it is unable to hold pricing for its core infant formula product in the highly competitive China market.

Morgan Stanley said in a report last week that pricing of A2 infant formula on Alibaba’s Tmall platform had deteriorated since February. It noted A2’s international peer, listed US healthcare giant Abbott, explicitly noted pricing and promotional pressure in the third quarter at its latest quarterly results, as did other big multinationals Nestle, Reckitt Benckiser, Danone and Beingmate.

Morgan Stanley also said its own recent channel checks had pointed to discounting in the offline channel, escalating in September and continuing into October.

“They highlighted: 1) Increased discounting from small local brands in the offline channel in lower-tier cities; and 2) International brands began to increase discounting in September and this has continued into October,’’ the broker told clients.

It also noted Neilson data showed pricing was softer and said the lower birth rate in China in 2018 would flow through to A2’s Stage 3 infant formula products next year.