With its shares down over 50% year to date has The a2 Milk Company become of interest for value investors

The a2 Milk Company (a2) has always been an interesting business, especially so in the past 5 years. From 2015 to 2020 the business delivered explosive growth. Revenues grew from $154 million in the 12 months to June 2015, to $1.73 billion in the 12 months to June 2020. Similarly impressive growth occurred at the bottom line, with profits increasing from $2.4 million to $388 million in the same corresponding periods, an increase of 16,000%! Scant wonder the share price rose from 70c to $20 over those 5 years of remarkable growth, as the company became a significant player in the global infant milk powder industry.

It is understandable then that by 2020 a2 had become a firm favourite with growth investors across Australasia and beyond. Indeed, it is highly unlikely that value investors have ever seriously looked at a2. Even back in 2015 when it was trading around 70c, it was not cheap on historic or current earnings, having been loss-making before carding a modest $2.4 million profit.

And then, in August last year, shortly after reporting its record $388 million profit, it became apparent to management that 2021 was going to be a tough year as Chinese demand for its infant milk formula collapsed amid increased competition. Just how tough 2021 was going to be has been consistently underestimated by management, which has resulted in a series of guidance downgrades as the 2021 financial year has progressed. The most recent announcement was perhaps the worst of all, a horrid update that indicated the current run rate was now loss making and that aging tins of infant milk formula were being literally dumped down the drain. At the time of writing this, a2 shares have fallen from a high last year of $21.70 to around $6.00, a drop of over 70%.

So, it makes sense to review the investment case of a2 milk via the lens of a value investor, to see if they might be getting excited. Before doing that I wanted to give some context to the discussion and in doing so reference this graphic that I have borrowed from Dundas Global Investors, a very experienced global equity investor based in my hometown of Edinburgh. It looks to show, in a simplified way, the relationship between growth and value investors. At their extremes, value and growth investors will generally not own the same company. The cardigan (with leather elbow pads) wearing value investor and the European sports car driving growth investor are not often sighted on the same company’s share registry. But as Dundas point out, there is sometimes a handing over of the baton as value investors sell their winners to growth investors. Sometimes the baton is passed in a different direction as growth investors sell their losers to value investors.