A2 Corporation chief executive Geoff Babidge expects some slowdown after the Fonterra scare.
Sasha Woolley
The rise of milk group A2 Corporation in an industry that has been reshaped by low-cost generic milk from big supermarkets Coles and Woolworths provides a powerful lesson about the importance of brand differentiation in a highly competitive market.
Having claimed a strong foothold in the domestic milk market, A2 is eyeing lucrative opportunities overseas but recent events in the Chinese infant formula market highlight the difficulties of entering new territories.
A2, which is listed on the New Zealand sharemarket, is 26 per cent-owned by health food company Freedom Foods, one of the best performers on the ASX in the last 12 months. In the year to August 5, Freedom Foods’s share price rose from 56¢ to $1.98 – a 230 per cent increase.
Few listed companies can lay claim to such a big rise, which has lifted Freedom Foods’s market capitalisation to $230 million.
The biggest beneficiaries of the strong growth are the Perich family, the majority owners of Freedom who have build a fortune on property and dairy farming. Tony Perich appears on this year’s BRW Rich 200 fortune in 42nd position with an $875 million fortune. Share price growth since the Rich 200 was published in May has added an extra $40 million to his net wealth.
Belinda Moore, a senior analyst from RBS Morgans, says Freedom Foods is benefiting from its strong balance sheet and stands to get a good return from its expansion into the US and China.
“Food stocks are defensive but [Freedom Foods] is in high growth niche sectors,” says Moore. “There are huge market opportunities.”
A2 is similar to standard cow milk except it contains A2 protein instead of the more common A1. It is marketed as being a healthier alterative to normal milk and better for people with sensitivities to dairy. Its main customers are high-income earners who are prepared to pay a 150 per cent premium compared to low-cost alternatives.
Food allergies are on the rise worldwide. The US gluten-free market is worth $3.7 billion and growing at 15 per cent a year, according to Moore. Freedom Foods has been selling into the US market since 2011.
China push
In a move that has the potential to help maintain the strong growth, A2 has begun shipping to China where it plans to enter that country’s rampant infant formula market.
Geoff Babidge, the chief executive of A2 Corporation and a former chief executive of Freedom Foods, says the infant market in China will double in size by 2020.
“The infant formula opportunity was in part influenced by the importance of providing the best nutrition to young infants,” he says.
“Hence the product benefits of A2 are highly relevant.”
Health scares attributed to local infant formula providers in China have led to high demand for foreign-made products. Chinese media reports suggest imported formula is frequently sold out in Chinese supermarkets and consumers have a strong preference for formula made in “safe” countries like Australia and New Zealand.
That status was threatened when New Zealand’s biggest dairy company Fonterra was forced to recall some infant formula available for sale in China after a product it used to make the formula was contaminated with a bacteria that can cause botulism in humans. Fonterra exports to dozens of countries globally, including China and Australia. It is believed no formula available for sale in Australia was affected.
But China, the world’s biggest market for baby formula, placed a temporary ban on some products from Fonterra, the world’s biggest dairy exporter.
Babidge says while his company is not directly affected, the botulism scare may result in a “minor slowdown” to A2’s push into China.
“These things are not helpful. They make you reflect on your own supply arrangement and processes. We hope and expect the New Zealand government will act to address any potential implications,” Babidge says. A2 has already shipped its first batch of formula to China and it is due to be available for sale by November. Annual sales of $NZ60 million ($52.7 million) were expected by 2016 prior to the Fonterra ban.
While it also plans to start selling into the Australian and New Zealand markets later this year, A2 has been focusing much of its effort on China due to the strong demand. Of the 20 million babies born in China each year, about 5 million are breast fed.
According to Babidge, A2 sources its milk powder from Synlait Milk, a rival to Fonterra in New Zealand. Synlait released a statement on August 5 that said all its products are safe and that it has not used any of the whey protein concentrate recalled by Fonterra.
The power of differentiation
A2 is one of several brands within Freedom Food’s stable of health-conscious and allergen-free products, including Crunchola, Australia’s Own and So Natural.
Sales have risen strongly over the past year. The latest available sales results show a 57 per cent increase in revenue to $44.3 million for the six months to December 2012.
A2’s success goes some way to show the importance of differentiation in a market crowded by similar products. While generic branded fresh milk at the big supermarkets sells for as little as $2 for a two-litre bottle, A2 sells for $5 for a two-litre bottle.
Babidge says A2’s success is due to the unique product offering, strong business structure and a management team that was willing to back the strategy over the long term.
“The business has identified a product which has substantial potential,” Babidge says. “There is a very strong trend towards wellness and that goes to the fundamental issue of differentiation.
“And it has to have a demonstrable benefit to consumers.”
Despite its success in marketing A2 to customers, not everyone is convinced that A2 is a superior product to standard milk.
“There is no evidence to suggest that A2 milk has any additional benefits to health than other types of milk,” says Eithne Cahill, a nutritionist for Dairy Australia.
“It is great that people have a choice, but what is most important is that they consume more milk, yoghurt and cheese.”
It’s not just the health of consumers that stand to benefit from more consumption of dairy products.
Growth rates like those reported by A2 are rare in the dairy industry, which is struggling to find ways to increase in size.
According to Dairy Australia, growth expectations are at a 10-year low – just 29 per cent of dairy farmers plan to have a larger output in three years.
“The Australian dairy industry sits at a crossroads,” reads the Horizon 2020 report for Dairy Australia. “It hasn’t grown as an industry over the past decade and has a diminished global standing and reputation.”
Babidge says his product is sufficiently differentiated from the broader industry to set its own growth trajectory. Overseas expansion, such as infant formula in China and a fresh milk joint venture in the UK, are critical to further growth, he says.