Hong Kong's cheaper alternative to A2 Milk

“Our growth stocks are the world’s most expensive” screams the headline in a recent Australian Financial Review article. That’s not hyperbole. Goldman Sachs has crunched the numbers and, of the world’s 13 largest stock markets—the ASX has the world’s most expensive growth stocks.

That should be ringing alarm bells for Australian investors. For those with a global focus, though, there is something on the far right of that chart that is even more interesting. It suggests that the median Hong Kong growth stock trades at just 17 times earnings.

We love companies that are likely to grow. We just don’t like paying up for them. Thanks to Trump’s trade wars, widespread pessimism about the Chinese economy and a headlong rush for perceived safe havens, on the Hong Kong stock exchange you can have your cake and eat it too.

There is no better example than a recent addition to the International Fund, Ausnutria Dairy Corporation (HKSE:1717).

Foreign nutritional products preferred

China’s insatiable demand for quality nutritional products has seen Australasian company A2 Milk (ASX:A2M) hitch its wagon to the world’s most populous nation. With around three quarters of its revenues sourced from China, directly and indirectly via the daigou channel, the company saw its share price rise almost eightfold in the last three years, backed by strong revenue growth and earnings acceleration.

Back in 2014, A2 was a sleepy New Zealand company generating roughly NZ$100m of revenue a year and not making any profit. This year it is expected to make NZ$285m profit on almost NZ$1bn of revenue. It has been an amazing success story, largely thanks to growth in China.

The only problem is that you are being asked to pay NZ$10.8bn for the privilege of owning it (that’s A2’s market capitalisation at the time of writing).

Up in Hong Kong, you can buy a business with prospects at least as good for roughly half the price.

The winning formula

Ausnutria sources, produces and packages infant milk formula and other nutritional products in the Netherlands and Australia and sells it into the Chinese market.

Despite being listed in Hong Kong, the majority of its production comes from Holland, as does its CEO Bartle van der Meer. Like A2, being foreign sourced is an advantage in the Chinese market where consumers are wary of locally sourced product.

Both A2 and Ausnutria occupy a fast-growing niche in the premium Chinese infant milk formula market. While half its sales are traditional cow-milk powder, Ausnutria has a dominant position in the rapidly growing goat’s milk segment. Again like A2, the benefits of goat’s milk over cow’s milk can be debated (while A2 claims its milk is easier to digest, there doesn’t seem to be much scientific evidence supporting its claims). The fact is consumers lap it up.

From just 2% market share in 2012, goat’s milk formula was 6% of the Chinese market in 2018 and should keep growing. With one third of the goat’s milk market by volume and 60% of the premium product, Ausnutria is likely to keep taking market share.

For all of that, Ausnutria trades at a multiple almost a third less than A2. It’s an attractive proposition in it’s own right.

Barriers to entry

The barriers to entry are increasing. In recent years the Chinese government has cracked down on misleading marketing in the sector and has introduced a licencing regime that should strongly favour the incumbents. More recently, authorities have also been attempting to restore the fortunes of local Chinese producers of infant milk.

State owned investment fund Citic Agri Fund owns 24% of Ausnutria which has its own local distribution force. We’re not sure consumers will buy the made in China argument. In any case, Ausnutria is better placed than its 100% foreign competitors.

Owning 8% of the company’s outstanding shares, van der Meer has more than $300m invested alongside us and is the founder of the Dutch business that today makes up the majority of Ausnutria. He is 73 years old, so succession is going to be important. For now the company is in a safe pair of hands.

Point of difference

All the usual risks around doing business in China still remain. But, we’re confident this business will grow at a healthy clip for some time yet. We have it pencilled in for 25% revenue growth this year. Thanks to operating leverage, that should mean profit growth of almost 50%. With reported first quarter growth rates of 29% and 89% for those two metrics respectively, we are hopefully being conservative.

All of that sounds exciting but, of course, it comes down to price. And this is where Ausnutria looks substantially different to A2. The two companies generate roughly the same revenue as each other. We expect Ausnutria to grow at least as quickly. We like the local ownership. While its profit margins are currently lower, we think that is part of the upside. Ausnutria growth translates to higher margins in future.

For all of that, Ausnutria trades at a multiple almost a third less than A2. It’s an attractive proposition in its own right. Relative to the world’s most expensive growth stocks, it looks like a steal.