Buffett Test FY2017 Results: Summary
Before I give the Buffett perspective, I want to give an update on my $3 valuation.
Quote:
Originally Posted by
Snoopy
This $3 value is a consequence of supply constraint. Remember a PE of 12-15 still indicates a growth company. It is just that the forward growth picture will be stunted. If last year was maximizing the value of what they have to sell already, and there is no easy way to increase A2 milk supply significantly, then sales in the future have to be limited by supply. Yes they could buy in more A2 cows on behalf of their farmer suppliers. But they might have to discount the revenues from their identification test to do so. They may also have to pay a lot more than the historical premium of 5-7% for A2 milk. All of those factors will have to hurt the bottom line of ATM going forwards. By 'hit the bottom line' I mean a lower margin on incremental sales. I am not saying the company would not continue to grow at all.
Since making this post, Fonterra has stepped up to 'solve the problem'. According to industry commentator Keith Woodford, owners of larger dairy farms will be able to split their herds into 'pure A2' / 'Other' quite quickly. Thus more A2 supply can be brought on board without waiting the ten years it might require a single herd dairy farmer to 'make the transition'. I haven't read anything about banking money from the A2 identification genetic tests for a while. Are A2 now doing this testing 'for free', so they can speed up their search for A2 cows? Anyone know?
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Warren Buffett requires a company with proven cashflows and a track record potential for 'growth' (that covers 'recovery growth' or 'incremental growth'). The issue with ATM is that while it is doing well, it has only two years (soon to be three) of significant profitability. This is insufficient to give insight as to what would happen when market winds blow less favourably. Looking back with the benefit of hindsight, the best decision that ATM made over the last year and a bit was to stick with the Daigou distribution of A2, despite the threat of the Chinese Government cracking down on this channel of distribution. Other Australian infant formula makers chose to focus on more conventional retail store distribution and suffered accordingly. Some will call this good management on behalf of ATM. Others may see that with a weak store presence, a 'challenger brand' such as A2 really had no choice but to stick with the Daigou. So it was really good luck. I mention this now because without the benefit of hindsight, I hope you can see that ATM was taking a huge risk with their stance.
The 'huge risks' are set to continue through into FY2019 (Starting July 1st 2018)
Coming 'huge risk number 1' is the roll out of a more comprehensive retail presence across China via the MBS (Mum and Baby Store) chain. Will these all be incremental sales? Or will ATM be cannibalizing the principal existing Daigou sales channel? And how will the Daigou respond if it is the latter?
ATM has, until FY2017, been a niche supplier into the Chinese baby food market. But now the head is above the parapet will the international giant Nestle (via 'Illuma Atwo') and China's second biggest domestically owned dairy player Mengniu (via 'A1 free Children's Milk') be able to push back against ATM by fighting back with their own A2 milk products {'huge risk number 2')? On the plus side A2 has first mover advantage. On the minus side, these competitors have deeper pockets. And the Chinese government seem to have a policy of arranging more favourable treatment for their own home grown companies!
I am not forecasting doom for ATM. I really don't know what effect 'huge risk number 1' and 'huge risk number 2' will have on ATM. All I will point out is that ATM have not been tested 'head on' in a way that happens when you come out of your niche and are recognised as mainstream. Warren Buffett likes the certainty that the tangible proof of market fighting ability gives. ATM offers promise, but no more than that. The true test of market fighting ability is when you are backed into a corner. And for ATM in China, this hasn't happened yet. Thus I don't believe that Warren would invest in this company. Not because it isn't good. But because it isn't proven,
Up until now I haven't mentioned anything about an updated share price recommendation. I do know that it is possible to model different growth scenarios that can justify any price between $6 and $60. The problem is there are so many unknowns going forwards and there is so little 'track record' under pressure. So I would regard all such scenarios as highly speculative. One rule of thumb I have is that in the 'long term' in a mature market, PE deflation will see the market value of all the suppliers equal the sum total of total market revenue. If ATM has a market capitalization of $NZ10 billion and the total size of the infant formula market in China is $NZ10 billion, this implies an expected 100% market share for ATM infant formula is already priced into the share. This assumes a static overall infant formula market in China. No doubt the overall infant formula market in China will grow over time. But this metric does show just what sort of sales growth will be required to justify anything like todays ATM share price. I assess ATM as being uninvestable, for now. Not because it is no good. But because there is no credible fundamental data than can be used to justify the current share price, or anything close to it. In my assessment conservative sharemarket investors, and that includes those who invest via index funds, should have 0% of their wealth invested in this company.
Give it another couple of years and that data may come through though!.
SNOOPY
discl: Not a holder, not looking to buy.