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 "I always felt that the higher the price, the better the quality,"
said 28-year-old Wei, who lives in Shanghai.
Buyers like Wei have fanned a phenomenal success for New
Zealand-based a2 Milk and its controversial milk powder that is
marketed as easier to digest than conventional milk because it lacks
the A1 caesin protein.
As other dairy makers held back from selling similar milk, skeptical
about its benefits and wary of undermining their regular milk sales,
a2's revenue more than tripled in the three years to June 2017 as
Chinese parents embraced it. The company's share price rocketed
nearly 2,000 percent.
Regular milk contains both A1 and A2 proteins but some cows
naturally produce milk without the A1 protein. Proponents of A2-only
milk say the A1 protein causes indigestion for many people, while
critics say more research is needed to substantiate the claim.
Now, several other companies, including the world's biggest infant
formula maker Nestle SA, have decided to sell their own brand of
A2-only milk powder in China and other countries, which Mark Brown,
chief investment officer at shareholder Devon Funds Management, said
raises a question about the sustainability of a2's success and its
strategy.
"The problem you have is that a2 goes from this unique selling
proposition to a 'me too' brand," said Brown. "I'm... concerned
about a continuance of the same rapid growth we've had and clearly,
then, what you pay for that because the stock is enormously
expensive."
Reflecting high expectations built into the stock price, a2's shares
dropped 20 percent to a three-month low on Wednesday as investors
were disappointed by a company forecast that sales would rise this
year by 63 percent.
A large part of the company's success has come from using unofficial
and unpaid sales agents, or daigou in Chinese, rather than an
established distribution network, or Chinese partner.
There are no official figures, but Brown estimates daigou generate
as much as 80-90 percent of Australia and New Zealand sales, which
would be around 60 percent of a2's total infant formula sales.
Several Australian exporters of infant formula, including Bellamy's
Australia and Blackmores Ltd, turned away from using daigou in 2016,
fearing a crackdown in China on gray-market imports, and shifted to
selling directly or via Chinese partners to distribute their
products.
But a2 stuck with daigou and it paid off. While a2's revenues rose,
those of Bellamy's and Blackmore's tanked.
The daigou buy items in Australia or other countries on behalf of
Chinese buyers because prices for the same item in China can be much
higher. When it comes to milk powder, many customers distrust brands
produced in China following a tainted milk scandal in 2008.
Wei, for example, orders a tin of a2's Platinum brand for $45 from a
daigou to avoid an online price in China of about $70. The daigou
buys the tin in Australia for about $22 and ships it to China.
As competition heats up, the challenge for a2 will be to keep daigou
loyal. They are incredibly influential with Chinese consumers,
marketing products via social media networks.
NESTLE "VALIDATES" A2 MILK'S PROPOSITION
a2 shares rocketed from just NZ0.76 cents in late 2015 to NZ$14.62
earlier this year. After a2's revenue projection on Wednesday, the
shares fell as low as NZ$10.25.
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"Post the big rally, the name simply became too large," said Rod
Gillam, chief investment officer at Anchorage-based McKinley Capital
Management, which has cut its stake in a2 to 0.6 percent from 1.7
percent over the past year.
Three out of the firm's top four shareholders - fund managers
Colonial First State Global Asset Management, Challenger Managed
Investments Ltd and Greencape Capital Pty Ltd have trimmed their
positions, mostly since August.
Stock market filings and Thomson Reuters Eikon data show that
Colonial had kept its stake steady or had increased it since
December 2016, while Greencape and Challenger had been trimming
their holdings since April.
Greencape and Colonial declined to comment. Challenger, which
invests on behalf of several boutique funds, declined comment
"because it's our boutiques who are trading," a spokeswoman said.
"Many of our large shareholders have had to sell down to comply with
their own self-imposed rules," about the size of individual stock
holdings as a percentage of their portfolios, a2 Milk's Asia-Pacific
Chief Executive Peter Nathan told Reuters. He made the comments
before Wednesday's revenue forecast was released.
Nathan said the company's daigou network continued to grow and the
fact that other companies, such as Nestle, are launching their own
A2 products "validates the A2 proposition and the extent to which
further consumer awareness is created, it will strongly advantage
the a2 Milk brand given out first move advantage."
a2's second-largest shareholder agrees Nestle could have a positive
effect.
"I suspect that they're going to assist consumer awareness and I
certainly think that a2 Milk is disproportionately well positioned
to be able to benefit from that," Oyvinn Rimer, director at Harbour
Asset Management, said following a trip to China "to verify that the
thesis is intact".
"EXPENSIVE MILK"
a2 Milk is also developing a growing distribution network in about
6,700 mother-and-baby stores and on major e-commerce platforms,
Nathan said.
On its website, a2 says there is a "growing body" of scientific
evidence supporting the argument milk with the A1 protein causes
digestion problems, but many scientists are skeptical.
"In things like infant formula and toddler milk, there are no
studies in infants and children," said Jane Scott, professor of
public health and nutrition research at Curtin University in Perth,
who has studied a2's claims. "It's milk. It's just expensive milk."
a2’s Nathan said studies in relation to children are at advanced
stages.
So far, Wei said she is satisfied.
"I might only consider switching brand if the nutrition value is the
same and Nestle can offer a better price."
(Reporting by Tom Westbrook in SYDNEY, Charlotte Greenfield in
WELLINGTON and Adam Jourdan in SHANGHAI. Additional reporting by
Shanghai newsroom; Editing by Neil Fullick)
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