“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.
Note: Forager has subsequently sold its investment in Ausnutria. See the August 2019 Monthly Report for further details.
Thanks for sharing this article. Two questions
1. Where would NZX stocks sit in that chart, some comment that NZ is one of the most expensive markets.
2. If you look at PE/RoE, or PE/profit margin, in fact A2 looks cheaper, Is market paying more for higher profitability? Is it sustainable for A2 to maintain these higher margins?
Read an article on ABC News this morning on the importance of the daigou channel to sales of products by A2 milk, Bellamys and other companies that are currently in vogue among China’s emerging middle class. It appears that the daigou channel is incredibly influential on sales revenues and, in turn, the share prices of these companies. It was interesting to read that attempts by these companies to by-pass the daigou channel fell flat as they were unable to replicate the personalised marketing/trust/rapport that Chinese customers value when using the services of a daigou. Take home message: ‘Having a quality product is not enough. It also helps to have a (decentralised) horde of daigou actively marketing and trading your product to Chinese consumers.’
Just curious to know if Ausnutria products have clout among the daigou in Australia and elsewhere?
https://www.abc.net.au/news/2019-07-31/chinese-daigou-changing-influencing-australian-business/11221498
Hi Yong, it’s a different distribution model for Ausnutria (which we think is a good thing). They have their own established distribution into China and aren’t dependent on the Daigou channel. That means a lot more inventory but, hopefully, a much more resilient business model.
Fair enough. Also thanks for presenting at the Brisbane Roadshow yesterday. I wanted to say hello but had to scoot for another appointment. Looking forward to seeing how the investment theses for each of the portfolio stocks work out. Keep up the hard work and here’s hoping for improved fund performance moving forward.
Hi Steve
Does the announcement by Blue Ocra Capital on their new short position on Ausnutria change your view or holdings of them?
Thanks
Jim
Sorry – name of the fund shorting is Blue Orca Capital. They have had successful shorts on ASX listed stocks including Blue Sky and Quintis, as well as other international stocks.
Hi Steve,
Interesting to see your view after Blue Orca released the short report on Ausnutria Milks?
Thoughts on the recent short report?
I’m also interested to learn Forager’s view on the shorting of Ausnutria ?
Blue Orca’s rebuttal of Austutria’s response looks like a crushing blow.
Perhaps Forager has a different view ?