Stock Takes: Questions raised over CEO's a2 Milk share sale

Sharemarket watchers will be familiar with the announcements that come out from time to time from company directors and top management regarding their own shareholdings.

When companies are on the ropes and facing difficult times, it is common to see company insiders buy shares as a gesture of good faith.

And when things are going gangbusters, investors like to see insiders getting into the swim of things and taking on more stock.

Furthermore, they see it is natural when insiders — perhaps after a long stint — pare back their holdings as they prepare to exit.

So when a2 Milk chief executive Jayne Hrdlicka sold her all her head shares in a2 Milk just two months into the job, it caused a backlash.

The trades were declared after the market closed in New Zealand on Friday.

When trade resumed on Monday, the stock was sold down by $450 million on the back of the news.

Hrdlicka's remaining time-based rights and performance rights still leave her with plenty of skin in the game, but the sale raises a few issues.

There are some funds that focus exclusively on the buying and selling patterns of market insiders, and there's academic research to back the idea that they can be an indicator of things to come.

The sale also came at a time when there is some uncertainty emerging about the regulatory environment in China's cross-border e-commerce channel, which as been a big part of a2 Milk's success to date.

Four star

Morningstar has undertaken coverage of a2 Milk, rating it four stars out of a possible five.

In a report, the investment research company said while a2 Milk's highest-growth days were behind it, the company still expected to see solid future gains, with market share opportunities in Chinese infant formula, US fresh milk, and global follow-on dairy products supporting its outlook for nearly 20 per cent of annual earnings growth over the next decade.

"And with minimal capital investment needs, a2 is set to enjoy stellar returns on invested capital and strong free cash flow," it said.

"However, the future success of the firm relies mostly upon developments in the Chinese infant formula market, where we estimate a2 generates nearly 90 per cent of its earnings through both direct sales and third parties," it said.

Morningstar said it expected market share of China's infant formula market to climb to 15 per cent of over the next 10 years from 5 per cent in fiscal 2018, "but continued competition and scientific developments regarding a2 Milk present sizeable risks," it said.

A good look?

Morningstar, which as a "fair value" estimate of $14.60, said a2 Milk looked undervalued.

Adam Fleck, Morningstar's director of equity research for Australia and New Zealand, said the CEO's share sale was a surprise.

"Any time you see insiders, particularly executives who have a significant control over the company's future strategy, selling down shares, you have to ask a lot of questions," he told Stock Takes.

But he said management had done a "terrific job" for shareholders and "we would expect that to continue a lot of that same trajectory".

On the regulatory front, he said a2 Milk and partner Synlait Milk had, in the past, done a good job dealing with the vagaries of Chinese environment.

"For us, it is about the long-term story, and the long-term story is one of Chinese consumers really flocking to high quality premium priced international formula brands will continue," Fleck said. "And we think a2 will be an increasing part of that story."

Morningstar has a three level "stewardship" rating system, and in a2 Milk's case, it rated as management as "standard".

"She (Hrdlicka) is still strongly incentivised to see success in a2 Milk and a one-time transaction like this does not dissuade us from that standard stewardship rating," Fleck said.

"One data point does not a trend make, but we will be keeping an eye on that going forward."