After Crashing In December, Will a2 Milk Company Ltd (Australia) (ASX:A2M) Shares Fall Further?

More volatility for The A2 Milk Company Ltd (ASX:A2M)?

After reaching a high of $2.48 on 1 December 2016, a2 Milk’s share price plummeted the following day by as much as 13.7% on a shock announcement by Bellamy’s Organic (ASX:BAL) regarding the impact of China’s regulatory risks it had on its financial results.

Bellamy’s announcement resulted in a trading halt, which led to a voluntary suspension as the management attempts to negotiate better terms with suppliers to reorganise its inventory levels and stave off any potential future cash flow problems in the face of discount wars of infant formula manufacturers.

In an attempt to distance itself, a2 Milk (ASX:A2M) released an announcement on 21 December 2016, which resulted in an initial upswing; however, the share price once again took a small tumble the next day. Perhaps, indicating that the potential successes of a2 Milk are not worth the current associated risks, which had caused the share prices of several other high profile “China growth” companies such as Blackmore Ltd (ASX:BKL), Crown Ltd (ASX:CWN), Capilano Honey Ltd (ASX:CZZ), Bega Cheese Ltd (ASX:BGA) and BWX Ltd (ASX:BWX) fall substantially in 2016.

Still Overvalued?

At $2.48, a2 Milk (ASX:A2M) was priced to perfection; however, given the dramatic fall to around $2.00, the market has taken a wait and see approach to the much-anticipated update by Bellamy’s Organic on the coming Friday (13/01).

Could a2 Milk fall further? Ever since Bellamy’s Organic (ASX:BAL) announced the trading halt and the extension to voluntary suspension, short-sellers have targeted a2 Milk (ASX:A2M) on the belief its run of success may be short-lived for the remaining 2017 due to the ongoing price-war in the infant formula market; uncertainty related to Chinese regulations; and Lion’s cross-claim against a2 Milk’s health claims of its products. There will be a case management hearing in February and full hearing in November 2017.

Speculation is rife that the news announcement on Friday (13/01) by Bellamy’s Organic will result in further substantial falls, potentially dragging down a2 Milk’s share price as it did in December 2016. Believing that there are further falls to come, investors have opened short positions at around 3.07% of all capital shorted from early December 2016 to just over 5.09% – a 66% increase.

Observers have noted Bellamy’s Organic is more of a marketing company: without hard assets like plant equipment and property which could provide a base value. This is not too different to a2 Milk’s business model whereby much of its value lies in its intellectual property, brand recognition and distribution network. If a2 Milk’s share price is to fall, would it fall back to be in line with Food and Beverage industry averages?

Based on our price based on past earnings and on the value of assets, a2 Milk appears to be overvalued compared to industry averages; however, in the long-term, it could be quite an opportunity.

A2 Milk PE

Wil Liam Lim holds no positions in any  of the above mentioned companies