The a2 Milk Company: Current Nutritional Science Suggests It’s A Long-Term Sell

fcafotodigital/E+ via Getty Images Thesis The a2 Milk Company Limited (OTC:ACOPY, OTCPK:ACOPF) is a company that sells special dairy products. It makes dairy that comes from cows just like other dairy, but a2 Milk’s dairy is slightly different from ordinary dairy. In the past, a2 Milk implicitly claimed that its milk products are healthier than competitors’ products due to a difference in milk protein, and nowadays a2 Milk explicitly states that this protein difference makes its milk products easier to digest. The different proteins in a2 Milk’s products, while possibly beneficial to health and digestion, are not sufficiently beneficial to address the many health issues implicated by dairy protein consumption, based on available nutrition research. For this reason, I think a2 Milk’s growth prospects will become quite limited as consumers and regulators catch up with the science. As these nutritional findings trickle down to the public and trigger wider public action, investors are likely to see higher returns over time by investing their capital in other securities. As a result, I think a2 Milk shares are a sell for the long term. a2 Milk’s Financials Notwithstanding the above thesis, a2 Milk has performed well financially over the past decade, all things considered. Revenues, net income, and operational cash flow (all in millions of dollars) rose handsomely from fiscal years 2014 to 2020, ending in June. But in 2021, all metrics fell significantly. Revenue fell below 2019 levels: Seeking Alpha Net income fell below 2017 levels: Seeking Alpha And operational cash flow fell below 2017 levels: Seeking Alpha The company said that these financial difficulties were due to Covid pandemic shocks. This is understandable, since FY2021 would have been the first full pandemic year for a2 Milk, and sales were likely impacted by supply chain issues coupled with consumer uncertainty and reluctance to spend money on exotic goods during an unstable time. Regardless, the impacted financial metrics largely rebounded over the next 3 years, though less so for operational cash flow. In addition to a2 Milk’s pandemic recovery, the company’s capital structure is also rather encouraging. Seeking Alpha Total debt is far outweighed by cash alone, and with a positive net income, a2 seems to be a very profitable concern with no solvency issues on the horizon. It also pays no dividend and favors stock buybacks as its method of boosting shareholder returns; I greatly prefer both of these traits in companies I analyze, especially if organic profits are already present and relatively abundant, as here. On the surface, a2 Milk seems to be doing very well financially, and in this case, one might confidently judge this book by its cover. My main issue with a2 Milk is not with its current finances but with its growth prospects. a2 Milk’s Valuation For the sake of valuation, a2 Milk has two virtually identical stock offerings, ACOPY and ACOPF. By most valuation metrics, the stocks trade at quite a discount to their 5-year average, though by most metrics they also trade at a significant premium to the consumer staples sector overall. Seeking Alpha This indicates that while investor confidence in the company’s prospects has fallen somewhat in the past few years, a2 Milk is being given significant leeway by investors, and they still seem to have very high hopes for the company’s future. For the reasons given in the next section, I think their hopes are misplaced, and that the assumed growth a2 Milk is targeting may not materialize. Current Nutritional Science Could Cut a2 Milk’s Growth Potential Based on research by multiple market analysts, the global dairy market seems to have a current total addressable market, or TAM, of $400-500 billion, and should have a TAM of $700-800 billion by 2030. I will go by the analysis of Maximize Market Research, which puts the 2023 TAM for the global dairy product industry at ~$550 billion and the estimated 2030 TAM at $700 billion. Long-term investment in a2 Milk should mostly be driven by the assumption that worldwide, people (read: consumers, government food/nutrition regulators, etc.) will eventually adopt not just the company’s products, but will also adopt the theory that a2 milk casein is less harmful for health than a1 casein – that seems to be what the company was founded on, after all. For some background on casein and dairy protein, first, milk protein has two parts – casein protein (80%) and whey protein (20%). Second, casein protein comes in two types – a2 casein and a1 casein. The history of the two casein types can be summarized as follows: “Originally all milk was A2 until a mutation affecting some European cattle occurred some thousands of years ago. Herds in much of Asia, Africa and parts of Southern Europe remain naturally high in A2 cows.” While some research supports the theory that a1 casein products contribute to more inflammation than a2 casein products, the studies comparing a1 and a2 products are often commissioned by a2 Milk itself. To a degree, this alone may call into question the validity and credibility of studies comparing a2 and a1 casein, due to the clear conflicts of interest. Still, even if a2 casein in dairy products is indeed less harmful than a1 casein beyond a shadow of a doubt, the replacement of a1 dairy with a2 dairy would play only a minor role in improving the health profile of dairy products. Based on recently available nutrition research, exposure to regular insulin spikes and chronically raised insulin levels promotes dysregulation of hormones and cellular function. This matters because both dairy casein and dairy whey spike either insulin or an insulin analog called Insulin-like Growth Factor 1. Either way, switching to dairy that has a2 casein does not remove the fundamentally problematic element in most dairy products – dairy protein itself. If, or when, consumers, nutrition experts, and global nutrition regulators put these pieces together and realize dairy protein may be a detriment to human health, they may jointly condemn dairy protein overall, and promote dairy products that have little or no protein, meaning mostly cream/heavy cream, butter, and clarified butters such as ghee. In other words, if or when consumers and regulators realize dairy fat is likely the healthiest part of dairy, and dairy protein is the unhealthiest part, then a2 Milk’s competitive advantage in the dairy industry will mostly disappear. Once this shift occurs, a2 Milk will see a much smaller potential TAM to grow into, restricted to the market for casein-containing dairy products instead of all dairy products. The whey and casein markets are, and will represent, drastically smaller TAMs ($5 billion for casein and $14 billion for whey by the early 2030s) compared to the overall dairy market TAM ($700-800 billion by the early 2030s). Bodybuilders, strength trainers, and certain other insulin-seeking consumers may still want casein and whey for their needs, and will probably opt for the “healthier” a2 casein option over time where possible, but beyond that, for the long term, an industry-wide shift away from selling products with dairy protein would severely dampen a2 Milk’s growth prospects. Worse still, even workout powders don’t require dairy casein or whey for their protein base. Vegan workout powders use combinations of plant proteins like pea, rice, and soy as their complete protein source instead of casein and whey proteins from dairy, so these may also cut into a2 Milk’s casein/whey TAM in the long term. The bottom line is that while a2 Milk is targeting the whole dairy market, emerging nutritional research related to dairy’s effects on health indicates that a2 Milk’s only advantage is in the much smaller market of milk protein, cutting its growth potential in the 2030s from a ~$700 billion opportunity to less than a $20 billion opportunity, a ~97% decrease in a2 Milk’s growth prospects from what many may expect. This $20 billion TAM assumes that a2 Milk has a competitive position in whey protein by association, despite its product only differing in casein protein. A2’s real advantage arguably only extends to the milk casein market, making its early 2030s TAM possibly no larger than $5 billion in size, a decrease of more than 99% compared to the TAM of the global dairy industry. Even if a2 Milk can sell milk fat-based products like its competitors (e.g., a2 Milk brand heavy cream and butter), it will have no competitive advantage selling these compared to well-established mass producers of milk products; a2 Milk’s one distinguishing feature is its milk protein, which will become irrelevant in a dairy industry dominated by products devoid of milk protein. As a result, its market share would become roughly locked in if and when the dairy industry shifts away from protein-containing products. For instance, if a2 Milk manages to 10x its current revenue to $10 billion per year before the dairy industry pivots from protein, then it could, at best, be locked into a 10/700 ratio for market share in the dairy industry long term, for a market share percentage of ~1.4%. That’s assuming that a2 Milk doesn’t end up confined to just the $5 billion TAM for casein, which would decimate a2 Milk’s potential and remove the possibility of earning even $10 billion per year. From a growth perspective, there are far better places to store capital. Relevant Implications Regarding Milk Intolerances and Allergies I will briefly note here that allergies and intolerances to milk are among the reasons the dairy industry might switch away from products containing milk proteins and toward products containing mostly dairy fat. Unlike nearly all other dairy products, cream/heavy cream, butter, and clarified butters pose a reduced allergy risk since they contain almost no milk protein; they also pose no risk of aggravating a milk intolerance, due to the near-absence of protein and milk sugars like lactose in these fatty dairy products. While one should not assume that these considerations will become primary driving factors that might push the dairy industry toward fatty dairy products and away from dairy protein, I think that certain consumers’ desire to avoid allergens and other unwanted dietary issues from dairy might be an underrated market mover over time. After all, rates of food allergies have been increasing worldwide in recent decades, and this possibly includes milk allergies and lactose intolerance. The dairy industry shouldn’t mind putting more of its hypoallergenic, mostly dairy-fat products on shelves if consumers start to prefer them, especially if the TAM for dairy products that don’t aggravate allergies or intolerances expands over time. Risks to Thesis Nutrition research has gone unnoticed or unheeded before. People may not realize that dairy protein on the whole is negatively impacting health, or may not feel a need to act on the information in the long run. It is also possible that dairy protein is vindicated in future research, voiding the need to avoid milk protein at all, or avoid casein and whey proteins in particular. A2 casein may also be proven in future research to be beneficial enough for people’s health to outweigh the harm from dairy protein overall. It is also possible that even if my thesis is correct and the detriments of milk protein do outweigh the benefits of a2 casein, it may take longer than the early 2030s for the dairy industry to shift toward producing mostly milk protein-free products, thus giving a2 Milk more time to expand its market share before shifting to producing milk fat-based products. These and other outcomes may allow a2 Milk to grow as a company and expand into a large-TAM opportunity in providing dairy to the masses. Conclusion Ultimately, a2 Milk seems to be presenting its product (a2 casein) as a full solution to a large problem (indigestible/unhealthy dairy). But its product only tackles part of the problem, and in time, observers and regulators in the health and nutrition spaces are likely to direct the masses to reduce or eliminate dairy protein from the food system, save for some niche areas, leaving a greatly reduced market for a2 Milk to grow into. Nutrition research indicates that a2 Milk’s stated goals would be best achieved by cutting dairy protein altogether, a move that would ironically hurt a2 Milk’s growth. As a result, despite solid finances, the company’s long-term growth prospects seem fairly poor, and investor capital would be better spent elsewhere. I therefore rate ACOPY/ACOPF a sell for the long term. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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