Nestle won't dent a2 Milk's China prospects - Harbour Asset Management

Geoff Babidge, managing director and CEO of a2 Milk. Picture/NZ Herald.

Nestle's incursion into the A1-free beta protein infant formula market in China is unlikely to damage NZX-listed a2 Milk Co's prospects there, Harbour Asset Management senior analyst Oyvinn Rimer said.

In a research note written soon after a recent visit to China, Rimer said the global power-house Nestle had launched an A1-free infant formula series in China, trading under the Illuma brand, which is produced by Nestle's Wyeth.

"This is the first product to be launched by a major global consumer company and is a significant accelerant for the proposition of the category," Rimer said.

"We expect consumer awareness of the A1-free proposition to increase significantly as Nestle and Mengniu (UHT) educate a broader part of the market than what a2 Milk could dream of if going it alone at this point in time," Rimer said.

"While it is fair to ask whether this product should be viewed as competition and potentially erode a2 Milk's margins, our strong view is that the A1-free market is likely to grow and a2 Milk is positioned to disproportionately benefit from this growing category," he said.

"As we have observed for a decade now, both in the traditional A1 market and the organic market, once you are positioned as a premium offering that consumers can relate to, you can grow your sales and margins irrespective of how many competitors enter the market," he said.

"Nestle/Wyeth is perhaps the only company among the Big Four that is currently underperforming the overall market growth in China and they are pushing hard to have customers trade up from their existing Illuma products into their Illuma Organic and Illuma Atwo products, to address the market share losses," he said.

Rimer said it was still early days but that he expected Nestle to have some traction in switching customers onto their new, higher-margin products.

"We do not know what consumers think about Nestle's messaging around their majority A1 business, but we do not expect Nestle to take sales off a2 Milk as most of the customers who buy the a2 Platinum product know which one is the original A2 product," he said.

Harbour Asset has long been a significant shareholder in a2 Milk.

The company, which this year became New Zealand's biggest in terms of market capitalisation, has seen its share price come under pressure since the Herald broke the news in March that Nestle had launched an A2 beta protein infant formula in the People's Republic.

The stock closed on Friday at $12.96, off its recent lows but still down from $13.84 just before the news broke.

Most cows produce the A1 and A2 versions of beta-casein protein, but about 30 per cent of the world's herd produces just the A2 variety.

A2 Milk believes that the A2 beta-casein protein milk is better for people, particularly those who have trouble digesting milk.

In February, dairy co-operative Fonterra said it had formed a strategic alliance with a2 Milk.

Fonterra's opposition on the West Coast, Westland Milk is looking at developing an A1 protein-free product.

In February, a company called Happy Valley Milk was granted resource consent to build a factory near Otorohanga that will focus on making A1-free formula.

Happy Valley is planning a backdoor listing on the ASX via a reverse takeover of the listed shell, Longreach Oil.

As part of the deal, Happy Valley Milk would raise A$2.5 million through convertible notes while Longreach would raise at least A$3m through a prospectus.