By Marcus Tuck

Head of Research
The Super Investor

8 am – 11 August 2020

Is Bubs the next A2M?

Bubs Australia – BUB

A2 Milk Co managed to convert the global trend of consumers wanting easier to digest A2-protein based milk products into $14 billion of market capitalisation. Goat milk is even easier to digest. Is it possible that Bubs Australia (ASX:BUB), with a market capitalisation of only $510 million, is at a similar point to where A2 Milk Co was years ago, and is well positioned to experience a similar trajectory?

Bubs is Australia’s leading producer of goat dairy products, particularly infant milk formula (IMF), supplying 65% of Australia’s goat milk requirements from the largest milking goat herd in the country. Bubs runs a total herd of 23,000 goats, supplying in excess of 20 million litres of goat milk per annum. Bubs has plans to grow its herd to 50,000 milking goats.

Bubs’ product range is sold in over 2,000 points of sale in Australia including Coles, Woolworths, Costco, Chemist Warehouse and Baby Bunting. Bubs also exports to China and South East Asia.

The global IMF market has grown at a rate of 5-6% per annum over recent years, driven by strong Chinese demand. Chinese consumption of IMF has grown at a higher rate of 8-9%, lifting China’s share of the global market from 41% to 44%. These trends are expected to continue over the next five years, lifting China’s market share to over 50%.

Goat IMF growing faster than cow IMF

Global production of goat milk is approximately 20 million tonnes. However, only 23,000 tonnes (less than 1%) of this is converted to milk powder, with the majority consumed as cheese and other fresh product. Bubs’ current production of goat milk powder (1,750 tonnes) represents about 7.5% of global output.

The global market for goat IMF is expanding as a share of the total IMF market, increasing to 5% in recent years. It is expected to double again by 2023. In China, goat IMF accounts for about 12% of the total China IMF market. That share is rising, with goat IMF sales in China expected to achieve an annual growth rate of 20-25% over the next few years.

While IMF accounts for over half of Bubs’ sales, goat milk powder for adults accounts for 27% of revenue. Organic baby food, fresh dairy and children’s vitamins are other smaller segments.

An established, transparent supply chain

The IMF market in China became more tightly regulated after a scandal in 2008 where melamine-laced formula resulted in the deaths of six infants and the hospitalisation of over 54,000 infants.

Since its 2017 listing, Bubs has completed two significant acquisitions and entered into a number of strategic partnerships that have allowed it to develop a complete and transparent supply chain.

Significantly, the 2019 acquisition of Australia Deloraine Dairy secured one of only 15 Australian canning facilities licenced for importation into China. The acquisition of Deloraine delivered capacity to produce 10 million tins of product per annum through a state-of-the-art, purpose-built facility, with the ability to invest to double that capacity in the future if required. It completes the production supply chain from herd to tin for Bubs.

China distribution channels in place

Besides targeting Chinese “daigou” networks, direct sales to China are achieved through a number of significant partnerships and supply agreements with key Chinese retailers. In 2018, Bubs entered a merchant service agreement with Alibaba, the largest e-commerce platform in China, where Mother & Baby products are the second-largest category. Notably, Bubs’ largest shareholder with a 13.6% stake, C2 Capital Partners, includes Alibaba as an anchor investor.

Bubs has also established a joint venture with Beingmate, one of China’s largest enterprises in the infant and maternal nutrition industry with a distribution network covering 30,000 Mother & Baby stores throughout China. The joint venture subsequently announced a strategic channel partnership with Kidswant, the market leader in infant and child-related retail in China by market share.

Investor update and outlook

On 27 July 2020 Bubs provided an investor update giving some preliminary results for the 12 months ended 30 June 2020.

Gross revenue rose 32% to $62m, representing continued growth since Bubs listed at the start of 2017 (see chart). Strong growth was achieved despite COVID-19 impacting normal quarterly phasing in the second half. The sequential run-rate dropped off markedly in the final quarter, mainly because of a COVID-related inventory build-up in China in the March quarter.

Source: Bubs investor presentation, 27 July 2020

IMF sales rose 69% in FY20 and accounted for 55% of group gross revenue. IMF is Bubs’ most profitable segment and is becoming a bigger share of total revenue (two years ago it was only 30% of revenue).

China direct sales rose 37% in FY20, representing 21% of group revenue. Exports are becoming more diversified. Exports ex-China now account for 9% of group revenue, driven by a recent launch into Vietnam, along with Singapore, Hong Kong and shortly Malaysia. Bubs operates in these markets via distribution agreements with established local players. Australia is still Bubs’ biggest market though, accounting for 70% of revenue.

Profit disclosure was more limited during the briefing. Bubs indicated that preliminary, unaudited normalised group gross profit (which excludes inventories written off and one-off discounts) improved 3 basis points compared to a year ago.

The 2H20 saw a net operating cash outflow of $5m, with a $26m cash position at 30 June 2020, down from $36.4m at 31 March 2020. At the end of March 2020 Bubs had drawn only $2m of its $5m financing facility.

In terms of outlook commentary the CEO indicated that, “Bubs expects continued strong growth in FY21 through accelerated revenue streams. Group margin will be further enhanced by optimised product mix, highest and best use of milk pool allocation, and value chain.

Excluding any residual COVID-19 adverse impacts, Bubs Australia expects to achieve profitability at normalised EBITDA level in FY21. With strong market demand and fully integrated supply chain, Bubs is well positioned to execute strategic goals towards delivering long-term sustainable and profitable growth.”

Bubs’ founder CEO Kristy Carr has a strong background in marketing, having previously been responsible for the global brand communications, advertising and media for Cathay Pacific Airways. She owns 2.43% of Bubs (after divesting 0.56% in May to pay a tax bill), providing good alignment with other shareholders.

Valuation and risks

Bubs is not a widely covered stock. However, the few analysts who cover it generally expect the company to break even in FY21 and become profitable in FY22. Earnings forecasts have been downgraded a little in recent months. The current consensus forecasts are for EBITDA of $17.3m and NPAT of $9.9m in FY22.

Analysts were a little concerned by Bubs’ higher than expected cash burn in the June quarter, and wonder whether another capital raising might be needed if that persists. They were also concerned by the COVID-related deceleration in sales in the June quarter.

At the current share price of $0.90, BUB trades at a FY22 PE ratio of 52.5x and an EV/EBITDA multiple of 28.6x based on the consensus forecasts. Although not particularly meaningful, it does show that some expectation has already been built into Bubs’ share price. The consensus analyst recommendation is Outperform based on Bubs’ longer-term prospects.

Overall, Bubs has some strong brands in a fast-growing niche of the IMF market. It also has some important partnerships that position the company well in the key China market.

Bubs is a potential takeover target for a larger IMF player wanting exposure to the higher-growth goat milk segment. The challenge for Bubs’ management is to translate the company’s strong sales growth into profitability and free cash flow generation. There’s a long way to go to reach anything like A2M’s scale but so far Bubs is heading in the right direction.

Bubs is expected to release its FY20 results towards the end of August.

Disclosure: The author does NOT own BUB shares.

Neither The Super Investor nor the author has received [or will receive] any benefit whatsoever from any party at all for the publication of this article.

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