OCTOBER 3, 2018

Paul McBeth

Paul McBeth is BusinessDesk's chief reporter and has reported on New Zealand financial markets, the economy and business since 2008.

A2 Milk top 10 stock picks

Morningstar Research has added A2 Milk Co to its 10 best stock ideas for Australia and New Zealand as the recent drop in share price created an attractive discount for a strong growth story. 

The research house rates A2 a stock to 'accumulate' with a fair value estimate of $14.60. The shares are currently trading at a 22 percent discount to that estimate, at $11.44. A2 has dropped about 8.6 percent since chief executive Jayne Hrdlicka disclosed a share sale in late September, for which she attracted criticism. The recently appointed chief executive sold 357,232 shares at an average price of $12.02 per share to realise close to $4.3 million, saying she had sold the shares to fund tax and other obligations entered into before she joined A2 in mid-July. The shares immediately fell more than 5 percent in value.

Morningstar analyst Adam Fleck said the milk marketing firm faces risks from its large exposure to China's infant formula market, the potential for unfavourable scientific developments, its small supply pool and competition from larger competitors. However, those risks were mitigated by the large discount the shares are trading at, he said in a note. 

"We forecast strong 20 percent annual earnings growth over the next 10 years, driven by a percentage point of market share gain annually, on average, in Chinese infant formula and further margin expansion," he said.

"Moreover, we expect A2 Milk’s solid brand positioning to support premium pricing for the firm’s products, and the company’s capital-light business model will generate triple-digit ROICs," he said referring to the return on capital invested. 

Research by Armillary Private Capital, which manages the Unlisted market known as USX, shows A2's return on capital employed was 154 percent in 2017 and had generated a three-year average return of 83 percent. Supplier Synlait Milk's return on capital employed was 14 percent in 2017 with a 12 percent three-year average, while Fonterra Cooperative Group's 8.3 percent last year for a three-year 8.1 percent return.