A fact-finding mission to China has prompted Citigroup to nominate two stocks that are better placed to outperform the market than market darling A2 Milk Company Ltd (ASX: A2M).
The share price of A2 Milk has more than doubled in the past year as it's seen as the best placed company to capitalise on the insatiable Chinese demand for Australian dairy products.
The rally is understandable as Citigroup noted on its latest trip to the Chinese city of Shenzen that A2 Milk's products are selling better than rival Bellamy's Australia Ltd (ASX: BAL), whose share price is only up 11% for the year which is a little ahead of the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index.
The broker looked at the manufacturing dates on the tins to work out turnover of the various products and this indicated little change for Bellamy's since Citigroup's last visit in early June 2018.
"This is unsurprising given Bellamy's limited ability to invest in China marketing without CFDA registration but also not alarming given China label sales represent ~10% of group sales," said Citigroup.
Foreign companies selling infant formula in the Chinese market require approval from the China Food and Drug Administration (CFDA). A2 Milk has received CFDA's blessing but Bellamy's is still working to secure certification.
However, the broker doesn't think investors should be put off by this as Bellamy's is in a better position to increase pricing for its products.
A tin of Stage 3 infant formula from Bellamy's sells for RMB350 (or around $69) while one from A2 Milk retails for RMB428. What's more, Bellamy's products are also cheaper than other premium brands like Wyeth, Abbott and Arla, which all sell for over RMB400.
Once Bellamy's receives approval from the CFDA, probably at the end of this calendar year, it is likely to raise prices. This, coupled with its attractive valuation with the stock trading on a price-earnings (P/E) multiple of around 18 times, makes the stock a "buy" in Citigroup's book.
In contrast, the broker has a "sell" rating on A2 Milk with a target price of $9.50 even though the company continues to do well in China. The problem is valuation as the stock is on a 33 times P/E and the broker has concerns about whether FY19 consensus expectations are too high.
There is another stock that also makes a good alternative to A2 Milk. Citigroup is urging investors to buy Freedom Foods Group Ltd (ASX: FNP) as well because its joint venture, Australian Owned (AO), appears to be gaining traction in China.
Freedom Foods owns 10% of the JV but has the option to increase that by another 20% over the next three years.
Citigroup has a target price of $19.70 on Bellamy's and $6.90 on Freedom Foods.
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