a2 milk in China: Analysts divided on brand’s long-term growth potential amid Nestle takeover rumours

There are differing views on how China consumers perceive a2 milk and the value that it brings to its buyer in the event of being acquired.

The Australian​ reported on August 15 that Nestle ‘has been keeping a close eye’ on The a2 Milk Company which is currently listed on both ASX and NZEX, citing unspecified industry sources. Both companies did not acknowledge the claims.

Founded in New Zealand by scientist Dr Corrie McLachlan and his business partner Howard Paterson in 2000, The a2 Milk Company claims that its products are different from conventional cows’ milk, as it comes from cows selected to naturally produce only the A2 protein type.

Conventional cow’s milk contains both A2 protein and A1 protein. The company claims that individuals who experience digestive issues drinking conventional cows’ milk may experience benefits when they switch to drinking A2 protein only dairy products.

The firm also owns the trademark ‘a2 Milk’ in several countries, such as Japan, Singapore, and The Philippines. 

Due to COVID-19 disruptions, sales from daigou and cross-border e-commerce, which The a2 Milk Company heavily relies on, have plummeted.

Its revenue for FY2020 H2 declined 16 per cent to NZD$677.4m (US$467.2m) and profit down to NZD$120m (US$82.8m) as a result. Growth was seen in Australia and the US, where sales were up 16.3 per cent and 22 per cent respectively, while sales from its China label infant nutrition products sold within China was also up 45.2 per cent.

However, in the recent months, the company has posted a less than positive financial outlook and had downgraded its FY2021 revenue and EBITDA three times between September 2020 and May this year.

Speaking to NutraIngredients-Asia, ​four regional experts expressed differing views on the long-term growth potential of a2 milk in China, as well as whether it is an attractive acquisition target.

Beijing-based independent dairy analyst Song Liang told us that in the case of Nestle, the company has a reason to acquire a firm such as The a2 Milk Company, as it fits the organisation’s ongoing restructuring projects.

“There are three factors as to why a company such as Nestle would want to acquire The a2 Milk Company. First, Nestle has been restructuring its operations in APAC in recent years, it is making a big adjustment from making FMCG products to include specialised nutrition and the concept of a2 milk fits the bill. ​

“Second, The a2 Milk Company holds the largest market share in China’s A2 milk segment. ​

“Third, birth rates in China will hit a new high in 2023. Infant formula is an industry with good gross margin and a2 milk is well-liked by Chinese,” ​he said, believing that the Chinese government’s three-child policy would yield results.

“Although China’s birth rate has been low in recent years, it is still a very big market with huge sales volume. The a2 Milk Company’s recent decline is largely due to disruptions arising from COVID-19, but since the Chinese government supports cross-border e-commerce greatly, I believe that infant formula imports would continue to grow,” ​he added.

Brad Gordon, director at New Zealand-based Hobson Wealth said that The a2 Milk Company's ownership of patents was another reason for acquisition. 

"It may come down to their patents as The a2 Milk Company has fiercely protected these. It [the company initiating acquisition] could be looking to double up, given The a2 Milk Company's stock weakness and take it over to leverage the know-how technology beyond infant formula – maybe into other consumer related products targeted at sensitive digestive systems. But this is a stretch given they could do the same with their own brands,"​ he said. 

Not ‘the trend’ anymore?  ​

On the other hand, Jane Li, founder and principal consultant at New Zealand-based firm Li, Page & Co, also an expert specialising in the infant formula market, held a different view.

With other companies such as Danone and Nestle producing A2 milk in China, she said that consumers were beginning to feel fatigue about the category.

“A2 milk is no longer the Hermes of infant milk and has lost its premium exclusivity status. China consumers are starting to get ‘tired’ of A2 milk. ​

“Some people are thinking, even my peasant neighbours are able to buy A2 milk [from either The a2 Milk Company or other companies] now, it is no longer something that is exclusive, something that one can buy only via overseas connections such as daigou.​

“A2 milk is still in trend, but not the trend, like how it was a few years ago,” ​she said.

Then again, due to a lack of innovation in the infant milk industry, she thinks that big MNCs such as Nestle will still be interested in acquiring the firm.

She explained that this could be because its own A2 milk products might not be performing up to expectation and also because The a2 milk company has the reputation of producing the “original”​ A2 milk.

Financial gains? ​

Michael Norris, research and strategy manager at AgencyChina, on the other hand, believes that Nestle’s acquirement of The a2 Milk Company would not make financial sense.

“At this time, we do not believe the reports [of Nestle intending to acquire ​The a2 Milk Company​] are credible. An acquisition today would complicate and even cannibalise Nestle's current super-premium product and portfolio mix in China. ​

“However, we find some support to the claims Nestle may have considered an acquisition years ago,” ​he said.

Nestle China currently has its own range of A2 milk for infants, pregnant mothers, and the entire family.​

"We don’t believe a bid is likely, but with The a2 Milk Company fiercely defending its patents, having supply chains and market access, production agreements, it may be seen as gaining scale quickly and reducing competition. Ultimately, we believe that the company is still too expensive for a takeover based on a current earnings,"​ Gordon added. 

A report by Financial Review ​on August 19, on the other hand, said that The a2 Milk Company has been escalating its battle against Nestle to Australia’s Federal Court over the latter’s registration of a trademark of its baby formula branding for NAN a2.

The a2 Milk Company will be announcing its annual results on this Thursday (August 26).

Brand loyalty ​

The experts also differed on whether The a2 Milk Company has managed to amass its loyal consumers in China.

Song said that the firm has loyal supporters in the tier 1, 2, and some tier 3 cities, as they understand that the firm’s products were different from others.

“Products by The a2 Milk Company are produced by the third-generation of A2 milk producing cows, whereas products by other companies in China are made via cows from gene selection. ​

“This means that the cows might not have parents or grandparents that produce A2 milk. In other words, the A2 milk that these cows are not as ‘pure’ as the third-gen A2 milk producing cows,” ​he said.

Due to daigou disruptions, he said that The a2 Milk Company has been ramping up its offline China sales to make up for its daigou channel loss. The products sold offline are also cheaper and he is optimistic of the company’s long-term growth in China.

Li, however, pointed out that Chinese consumers tend to follow what’s in trend, instead of making purchase based on scientific evidence. This also means that the A2 milk could be replaced by another product that manages to become a big hit. 

“China consumers don’t care about the science of the product, they only care about what’s trendy.​

“From Karicare, to Bellamy’s to a2 milk, Chinese consumers are always chasing something novel, premium, exclusive,”​ she said.

“Also, local Chinese brands are up-and-coming, it is now ‘socially acceptable’ to buy Chinese made infant formulas, as with the rise of other Chinese goods, such as cosmetics,” ​she said.

This is not the first time The a2 Milk Company has come on the radar as an acquisition target. In the past, Freedom foods and Dean Foods had expressed interest​ in acquiring the firm.