Why A2 Milk and Bega shares are looking so tasty now: analyst

The coronavirus can rage as much as it wants, but Australians still have to eat. So are these 2 dairy companies wise investments?
The post Why A2 Milk and Bega shares are looking so tasty now: analyst appeared first on The Motley Fool Australia. –

Regardless of what COVID-19 and lockdowns do, people still have to eat.

So if you run with that thesis, Bell Potter this week nominated 2 dairy-related ASX shares as ‘buys’ for investors to consider.

Senior industrial analyst Jonathan Snape did give a caveat though.

“Investments in the agricultural and FMCG [fast-moving consumer goods] sector should be considered high risk and come with volatility,” he said in a memo to clients.

“For this reason, we tend to focus on stocks where we see either: a structural uplift in ROIC [return on invested capital] through the cycle, cyclical growth stories, or counter-seasonal crop exposures.”

With that in mind, here are the two ASX shares:

A winning acquisition

Bega Cheese Ltd (ASX: BGA) won many fans after its acquisition of Lion Dairy & Drinks (LDD), which completed in January.

“LDD is considered a good strategic fit for Bega, as it diversifies Bega’s dairy exposure, increases scale, and accelerates the shift towards branded products,” said Fairmont Equities managing director Michael Gable last month.

Snape agreed in his Bell Potter memo.

“The acquisition of Lion Dairy & Drinks (LDD) and the targeted synergy base is expected to drive a material step change in returns for BGA over the next 3 years.”

The Bell Potter analyst also thought Bega would be more competitive at the farm gate because of “operational issues” at its rivals.

Bega shares have only gained 3.84% so far this year, to trade at $5.40 on Friday morning.

Bell Potter sees a 36% upside, slapping on a price target of $7.35.

“In the medium term, we see the potential for additional LDD synergies to be realised as seasonal milk flows are better utilised,” said Snape.

Current earnings don’t reflect future potential

A2 Milk Company Ltd (ASX: A2M) shareholders have watched in horror as their investment tumbled 63% in the past year.

An almost overnight elimination of their daigou sales channel into China forced a series of financial downgrades in the past 12 months.

But with a business that was flying high before the coronavirus struck the globe, Snape reckons A2 Milk could be a recovery bet.

“While not without near-term risks as supply chains stabilise, at its core we see A2M as a business that, once [margin] is consolidated, has baseline revenue of ~NZ$1.4 to $1.5 billion and EBITDA of ~NZ$300m.”

If the risks are well-managed, Snape can see the dairy producer reaching NZ$1.7 billion in revenue with NZ$445 million EBITDA.

“We do not see FY21 earnings as reflective of the returns the business can generate in the medium term, but acknowledge the high level of risk involved in timing the inflection point at which destocking activity concludes.”

Watermark Funds has recently bought into A2 Milk for similar reasons.

“The a2 Platinum brand continues to resonate strongly with Chinese mothers,” Watermark portfolio manager Daniel Broeren posted on Livewire.

“While there are some risks around market size (declining birth rate), and recovery timeline for Chinese travellers (daigou), these are palatable risks when the stock is trading at such a significant discount to prior valuations.” 

A2 Milk shares were trading at $7.18 on Friday morning. Bell Potter has put on a price target of $8.50, which would be an 18% return from now.

The post Why A2 Milk and Bega shares are looking so tasty now: analyst appeared first on The Motley Fool Australia.

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More reading

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Motley Fool contributor Tony Yoo owns shares of A2 Milk. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended A2 Milk. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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