The road to riches in selling food produce to China’s masses does have the odd pothole, after all.
There have been several reminders of that this year, the most recent being this month’s very disappointing trading update from infant formula specialist Bellamy’s Australia Limited.
Market darling Bellamy’s second-quarter is not going to be anywhere near as strong as the first-quarter was, and it downgraded its full-year FY17 earnings guidance significantly. Bellamy’s said sales in China would not meet its expectations, and that it was being hurt by recent Chinese import regulation changes – despite appearing to be managing that situation well.
The reaction was savage, with the share price falling 43%, erasing more than $500 million from the company’s share price in a matter of minutes. Brokers quickly slashed their earnings estimates and their consensus target prices for Bellamy’s – in most cases, by more than half.
Given that Bellamy’s annual general meeting was held just two months ago, and there was no bad news announced then, the stock market simply wasn’t expecting lower revenue guidance and declining margins.
The slump also washed over into similar companies that export into China, such as A2 Milk Company (A2M), which was down 11%; vitamins giant Blackmores (BKL), which fell 8.6%; and Bega Cheese, (BGA), which gave up 6.2%. Bega, which has a joint venture with Blackmores selling infant formula in China, had already felt the wrath of the market at the end of October, when it plunged 32% in a fortnight after reporting that the China JV had not performed to expectations.
China is a big opportunity for many Australian products, but the infant formula and vitamins sectors have been particularly strong in recent years, as they cash in on Chinese consumers’ perceptions of clean, high-quality Australian produce. Given China’s strict family planning policies, children are a huge commitment for Chinese couples, and the choice of infant formula for their child holds an importance even beyond what it does here. A 2008 tainted-milk scandal in China that killed six babies led to a panicked search for baby formula products that were the highest quality possible: Australian products are widely seen as fitting that bill.
Australian infant formula companies don’t even have to export: their products walk off the shelves of Australian supermarkets and pharmacies into the hands of the “daigou,” or personal shoppers, who either courier them directly to customers in China or send them to bonded warehouses in China and on-sell them online. The daigou even buy the goods from wholesalers or straight from the manufacturer.
It’s been a great business for the likes of Blackmores, Bellamy’s and A2, but they have not had it all their own way.
In April last year, China changed its importing regulations to crack down on the grey channel: in future, only registered manufacturers in certain categories will be able to export into China, and each of these will be allowed to bring in only a certain number of brands.
For example, in infant formula, broker Morgans says the current range of about 2,000 brands being imported into China will fall to about 300.
The announcement of these changes had already hammered the share prices of the Australian exporters, but one by one, they had largely responded to investor concerns by outlining their progress in registration with the Chinese authorities. Beijing gave foreign companies a “year of grace” to help them get their affairs in order: the new regulations will come into force on 1 January 2018.
However, the disruption in the market has been significant: there has been severe over-supply of the affected goods categories in the short term, as supplies of brands that are unlikely to gain registration with the China Food and Drug Administration have been heavily discounted to clear inventories.
The Australian brands have been caught up in this. As broker Ord Minnett puts it, share price volatility will continue in the near term, as the industry adjusts to regulatory changes. but the “longer-term thematic of foreign consumer demand for Australian products will continue.”
This is a common view among broking analysts, because the Australian brands are highly valued by Chinese consumers. But for another perspective on this market, a fascinating article [1] from Fairfax Media at the weekend is required reading for investors.
Let’s look at the main participants in this market.
Bellamy’s Australia Limited (BAL, $6.68 – trading halted pending announcement)
Market Capitalisation: $648 million
FY17 forecast yield: 1.6%
Analysts’ consensus target price: $6.94
After its belting this month, Bellamy’s has seen everything downgraded: its own guidance, brokers’ earnings expectations and target prices, recommendations – as well as stock market credibility. No broker has a buy rating on Bellamy’s anymore, and they will be a bit wary of assigning one to the company, for some time.
Everything about the company, from its business model, in which Bellamy’s outsources processing and manufacturing to its long-term partner, operations, Tatura Milk Industries (which is owned by Bega Cheese), to its Launceston head office location, is now being questioned by the market. (Not so long ago, analysts were praising this “capital-light” model that saw Bellamy’s focusing on building the brand.)
As broker Morgans puts it, China remains a huge opportunity for Bellamy’s, as the reduction in brands actually creates barriers to entry into the market, and it expects the company’s earnings to resume growing in 2018. But it will be quite some time before this stock could be bought with confidence.
A2 Milk Company Limited (A2M, $2.30)
Market Capitalisation: $1.6 billion
FY17 forecast yield: 0.3%
Analysts’ consensus target price: $2.45
New Zealand-based specialist milk and baby formula company A2 Milk sells its specialist milk, dairy and infant formula products across Australia, New Zealand, North America and Asia. All A2 branded products contain only the A2 beta-casein protein type rather than both A1 protein and A2 protein found in conventional cows’ milk products: there is some evidence that A2 products have health benefits and enable people who have problems with conventional dairy products to use milk products in their diet.
Infant formula accounts for more than 60% of total revenue. The flagship A2 Platinum infant formula brand is a big seller in China.
A2 has been distancing itself from Bellamy’s through performance updates. In June A2 revised full year revenue and earnings guidance upwards in the region of 4.5% and 12% respectively. A2 said it now expected full year revenues between $350 million to $360 million, with operating EBITDA (earnings before interest, tax, depreciation and amortisation) of between $52 million to $54 million for the financial year ending June 30 2016.
That was warmly received, and so were two trading updates given last month, the second at the annual general meeting. A2 said Chinese demand was growing as consumers became more aware of its flagship A2 Platinum infant formula and A2 Milk brands and that it was progressing towards registering its infant formula product in China. Importantly, there were no shock downgrades; A2 said first-quarter revenue was in line with expectations at $NZ112.5 million, up 40% on a year ago.
A2 Milk has been a strong performer – it has more than doubled in the last 12 months – and on Thomson Reuters’ compilation, the analysts’ consensus target price of $2.45 sees a bit of value left in the stock.
Blackmores (BKL, $110.27)
Market Capitalisation: $1.9 billion
FY17 forecast yield: 2.8%
Analysts’ consensus target price: $118.33
Blackmores’ share price has almost halved this year on the back of the concerns about the Chinese market. Blackmores’ vitamin business is directly affected, and in January this year the company launched an infant formula joint venture with Bega Cheese, which has had a disappointing first year, failing to meet sales targets in China.
In particular, a surprise profit warning in August – delivered with the FY16 result – sent the share price crashing 20%, taking the gloss off record sales and profits in FY16.
In the first quarter, Blackmores’ Chinese business generated $31 million in revenue, up 220% on the prior corresponding period, and just over 20% of total revenue. Brokers generally believe the longer-term outlook for Blackmores in China is strong, based on continuing strong demand for its products: on FN Arena’s collation, analysts see about 7% upside in the stock.
Bega Cheese (BGA, $4.71)
Market Capitalisation: $719 million
FY17 forecast yield: 2.2%
Analysts’ consensus target price: $5.70
Bega Cheese disappointed shareholders at its annual general meeting in October when it admitted that Bemore, its infant formula joint venture with Blackmores, had not done as well as hoped in China in its first year, and Bega would have to write down the value of its stake in the business. The shares promptly plunged 17%, taking the gloss off a doubling in net profit in FY16. Bega is considered a strong business, and analysts see a fair degree of scope for price recovery from here. But that would only take it back to whence it fell: blue sky potential from China won’t be part of the stock price for quite some time.
Freedom Foods (FNP, $4.46)
Market capitalisation: $811 million
FY17 forecast yield: 1.2%
Analysts’ consensus target price: $5.20
Wellbeing food specialist Freedom Foods is the latest entrant to the Chinese dairy market, signing a deal with Shenzhen JiaLiLe (JLL) Food Company in 2014 to launch Australia’s Own Kid’s Milk in China. The company says the product, launched last year, is now the largest imported children’s milk brand in China. Building off this success in the three to seven-year age bracket, the partners now plan to launch other dairy products in China, including infant formula and Ambient drinking yoghurt.
Dairy is not the main game for Freedom: its brands include Freedom Foods (allergen-free cereals and snacks), Paramount and Brunswick (canned sardines and salmon) and Pactum Australia and Pactum Dairy Group (UHT food and beverages for branded and private label customers). But as a participant in the Chinese export market, Freedom has seen its share price sink 12% in sympathy with Bellamy’s this month. Analysts are reasonably positive on the stock from here: it looks better value compared to its consensus price target than it did at $4.87, at the end of last month.
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