Readings: Week 19 - 25 Feb 2018

How the A2 deal with Fonterra may reshape the global dairy industry

This week, Fonterra struck a "comprehensive strategic relationship" with the ASX-listed A2 Milk Company (A2M), where Fonterra farmers will supply A1 protein-free milk to A2M and develop herds, sell A2M's fresh milk into the New Zealand market and assist A2M into new international markets where Fonterra has existing operations.The agreement will also explore A2 Milk-branded butter, cheese and China-sourced liquid milk, as well as investing in blending and canning facilities, most likely in Australia.

"The A2 proposition is very real, consumers have voted ... this is a great opportunity and we should be practical and pragmatic about how we create value for farmers and shareholders," said Rene Dedoncker, Fonterra Australia managing director.

"It's big news and it surprised me. My initial thought, it is one of the biggest dairy companies in the world providing support for A2 concept. People are against the science and people are for the science, there's a lot of debate in the market about the validity," he says, noting Fonterra had been among the dairy players pushing back against the concept when it started.

Consultant Keith Woodford describes the Fonterra deal as a "seismic shift" for the global dairy industry, arguing it may now force the other international dairy majors such as Nestle, Danone, Arla, FrieslandCampina, Yili and Mengniu to consider how to respond to the move.

Harris Farm Markets' Tristan Harris says A2 accounts for more of than 9.5 per cent of the group's milk sales by value, noting it has eclipsed jersey milk sales by volume and value. Harris Farm has more than 25 stores around NSW.

The A2 overall sales were flat year on year, and that there was limited competition in differentiated milk products, though he noted cold-pressed raw milk product Made By Cow was doing well in that space with far less marketing support.

In Australia, A2-branded fresh milk accounts for about 9.5 per cent of market share by value, and A2 Platinum is the fastest-growing infant formula brand by value in Australia with market share in mainstream retailers of about 30 per cent.

"The success of A2 is it's a type of milk but also the name of a company that has a very successful brand marketing campaign ... whereas organic is a choice you make around the source, and then there are multiple brands.

a2 Milk: What the market missed

The acceleration of growth in China for A2’s infant milk formula products is very impressive. They now have just over 5% market share of the Chinese infant formula market. Remember the total Chinese infant milk formula market is approximately $20bn in size, with a number of incumbents sitting around the 10% market share level. There is obviously still ample runway for the business to keep growing– most importantly, they are not having any issues on the supply side in meeting that demand via their relationship with Synlait NZ and the capacity expansion they invested in prior years.

The other key piece of information is the announcement of a relationship with Fonterra that will help the business expand into other Asian markets with surety of supply. The willingness for a business like Fonterra to partner with A2 essentially provides further validation around both the IP that sits behind the A2 Milk products and the ongoing strength of the brand through the region.

We like the fact we have multiple growth drivers from here – be it continued growth in China, an untapped SE Asia opportunity and the steady gains in the US fresh milk market. This business can be significantly bigger over time and that is what has likely attracted someone of the calibre of ex-Jetstar CEO Jayne Hrdlicka to head up the business.

Investing in cannabis: who’s growing the good stuff and how to get some

Since Australia opened the market for scientific and medical marijuana cultivation in February last year — and for medicinal consumption in November — a myriad of ASX-listed businesses have jumped on the pot band wagon.

Despite the hype around medical cannabis, share price performance has been mixed.

One, Cann Group, has risen 345 per cent to $1.32 since listing at 30c on May 4. Creso Pharma and Zelda Therapeutics have more than doubled since the start of the year.

The Australian cannabis market is fragmented because it’s so new. Despite a period of share price decline between March and May, ASX analysts still have faith that the cannabis frenzy has a while to run.

There’s a “land grab” for market share because the industry is so new, but Australia is in an excellent position as an exporter given it already supplies half of the world’s legal poppy feedstock for opioid manufacturing, he said.

Canada alone is expected to burn through 600,000 kg of cannabis a year if it legalises recreational marijuana — an issue that’s been pushed back to 2018. That amount of pot exceeds the country’s total growing capacity, estimates Deloitte.

Six of the 17 listed companies have commercial growing operations but only AusCann (ASX: AC8) and Cann Group (ASX:CAN) are set up as commercial growers in Australia.

Jo Patterson, chief of BOD Australia, sees consolidation coming in the market.

A critical element for cannabis operations in Australia is licensing. It’s reasonably simple to get a medicinal or R&D licence from the Office of Drug Control, but manufacturer’s permits are more difficult to come by. Two of the manufacturing and two of the medicinal licences went to market heavyweights AusCann and Cann Group.

The risks for investors are high, although the market in Australia is blue sky right now.

Emerging winners from the electric vehicle megatrend

Australia has a number of companies that participate in the most exciting part of the supply chain where I believe the bulk of value will likely accrue through the cycle. This sector is comprised of the raw material providers to the lithium-ion battery industry, the companies that provide the commodities for not only the electric vehicles we will all drive in the not too distant future, but also the stationery storage devices and all consumer electronics products that are ubiquitous in today’s world.

The first is: the world is urbanising. While there are many ramifications of this, one of the worst consequences is an increase in pollution. As well as being quieter and significantly more powerful, one of the most important features of EV engines is their superior efficiency. EV engines appear to be an elegant solution to the transportation problem, as well as being a much cleaner and environmentally friendly option.

One of the big impediments to EV penetration in the past has been that the prohibitive cost of the battery. Half to a third of the cost of an EV is in the battery, and bringing the price of the battery down will make the vehicles more affordable for the end users. The real mover and shaker is without a doubt, China, which is bringing on the largest addition of new battery capacity globally.

The battery industry has seen what is coming, and this has emboldened the global auto-makers to follow suit. We've basically seen every global auto manufacturer, in addition to a raft of new auto companies, commit tens of billions of dollars on new facilities that can only manufacture electric vehicles.

China is not only the driving force in battery manufacturing, they have also sold half of all global EVs in the past year.

The expected increase in demand in the cobalt, lithium and graphite markets is staggering and worthy of more work and analysis.

We Forget That Everything Is Relative

Ron Johnson’s JCPenney offered products at more honest prices and was rejected in favor of sales gimmicks. Aunt Susan still hates him. Think about that: JCPenney’s customers voted with their wallets and they elected to be manipulated. They wanted deals, bargains, and sales, even if it meant bringing back inflated regular prices—which is exactly what JCPenney eventually did.

JCPenney—and Ron Johnson—paid a high price for failing to understand the psychology of pricing. But the company ultimately learned that it could build a business based upon our inability to assess value rationally. Or, as H. L. Mencken once said, “No one ever went broke underestimating the intelligence of the American public.”

The story of Aunt Susan and JCPenney shows some of the many effects of relativity, one of the most powerful forces that make us assess value in ways that have little to do with actual value. At JCPenney, Aunt Susan assessed value based upon relative value, but relative to what? Relative to the original posted price. JCPenney helped her make the comparison by posting the discount as a percentage and adding notes like “sale” and “special” to help focus her attention on the amazing relative price they offered.

When it is hard to measure directly the value of something, we compare it to other things, like a competing product or other versions of the same product. When we compare items, we create relative values.

The problem isn’t with the concept of relativity itself, but with the way we apply it. If we compared everything to all other things, we would consider our opportunity costs and all would be well. But we don’t. We compare the item to only one other (sometimes two) . This is when relativity can fool us.

Life Lessons from a Self-Made Billionaire: My Conversation with Ray Dalio

15 cracking quotes from Kerr Neilson

  1. “We’re reluctant to chase the market leaders because it’s just not how we invest.”

  2. “We simply do not believe that one can systematically add value by being with the in-crowd.”

  3. “The arbitrage lies in complexity and uncertainty not the other way around!”

  4. “It is not enough simply to be contrary… If the stock is cheap you must presume generally the market gets it right and an intelligent investor will start by trying to assess where he or she has got the wrong end of the stick.”

  5. “Dividends play a very important part in rewarding shareholders for the risks they take.”

  6. “The behaviour of the crowds invariably results in imperfect pricing.”

  7. “There is a natural predisposition towards extrapolating the present situation far into the future.”

  8. “Give your investment thesis time to work out but be decisive when the facts change.”

  9. “We have made some good money… by ignoring the noise.”

  10. “We tend to hold our value and build wealth by avoiding the downturns, so we give away some of the upside in boom times. If we lose money, our clients aged 55-70 are not going to get it back. This is the product of their life's work. That's our attitude it's other people's money. And the market is your ultimate judge.”

  11. “As investors, the paradox is you have to listen to the market and yet form an independent opinion. You cannot ever be in a cocoon of isolation where you pay no heed. At times you will be at total disagreement and that's where you need a lot of character. That sense of independence is rare as there's a tendency to benchmark hug ... We think that's a silly way to run money.”

  12. “Some are good at telling the story but forget to pull the trigger.”

  13. “Being thankful for the abilities one has been given and not wasting them.”

  14. “Hold your poise, do your work, remain independent in thoughts and action, and wealth will accrue.”

  15. “The stock market owes you nothing”

Your First Thought Is Rarely Your Best Thought: Lessons on Thinking

“Shane, most people don't actually think. They just take their first thought and go.” What my CEO friend meant was that people are losing the ability to think through a problem.

The problem with not having time to think is nailed by William Deresiewicz, who said:I find for myself that my first thought is never my best thought. My first thought is always someone else's; it's always what I've already heard about the subject, always the conventional wisdom.

Thinking time is non-linear. The time you spend thinking – walking around a problem in a three-dimensional way and exploring all of the various perspectives and mental models – pays you back tenfold in the end. The problem for those who are shortsighted is that this time will appear as a negative for a while because it looks like nothing is getting done.

A lot of things in life are first-order positive and second-order negative. Heroin is an obvious one, sugar less so. We have trouble delaying gratification, so we do a lot of things that are first-order positive, second-order negative. We buy bigger houses than we need, only to find that rising interest rates make the mortgage payment untenable. We buy the sexy car only to discover later that it depreciates faster than the commuter car.

Intuitively we know the value of delayed gratification. We tell our kids that they need to get an education, which is nothing more than preparation for life. And yet once we get out of school and start working full time, we are conditioned to think in terms of today and tomorrow, rather than months or years ahead.

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