A little more than a decade ago a Tasmanian family started a company catering to the needs of babies, infants, and toddlers with organic infant formula and food products. The company, Bellamy’s Australia (BAL) went public on the ASX on 4 August of 2013 with an issue price of $1.00 per share. The stock opened and closed at $1.31 with an intraday high of $1.34. On 29 December of 2015 the stock price hit an all-time intraday high of $15.48 and now trades around $11.00, a roughly 700% increase since its first trading day.
New Zealand based a2 Milk Company (A2M) was born in 2000 as a result of a breakthrough discovery in the kinds of beta-casein proteins found in milk. While the A1 protein was a source of discomfort for some consumers, the A2 protein was not, and so the company went about searching for cows that produced only the A2 protein. In 2013 the company launched its a2 PLATINUM® infant formula. A2M dual-listed on the ASX beginning on 31 March with a first day closing price of $0.56 after reaching an intraday high of $0.60. The stock price is now trading at $1.72 for a 210% increase. On 23 August of this year the stock price hit an all-time intraday high of $2.22. The following chart displays the stellar performance of these two high-flying growth stocks. Bellamy’s is in blue and [email protected] in green.
The driving factor for both companies was Chinese demand for safe and healthy infant formula. In late October of 2015 venerable Australian manufacturer of healthy foods and supplements of all kinds for both humans and animals, Blackmores Limited (BKL) announced a joint venture with Bega Cheese (BGA) to launch a line of infant formula products. The share price quickly leaped over $200 and reached an all-time intraday high of $220.90 on 5 January of this year.
As is the case with many high growth market darlings, all of these companies saw share prices plunge on uncertainties over the state of the market for infant formula in China. The carnage began earlier in the year but the last three months have been particularly brutal. Here is a three month chart for Blackmores.
And now we see the bleak performance for Bellamy’s, again in blue, and A2M in green.
Navigating the high growth seas sometimes requires nerves of steel and the ability to separate the “wheat from the chaff” in whatever financial events are driving down the stock price. On 24 August Blackmores released Full Year 2016 results that should have pleased investors. Revenues rose 52% and net profit after tax (NPAT) went up an impressive 110%. However, Blackmores warned that earnings for the first quarter (Q1) of 2017 would come in lower than earnings reported a year ago. Investors were definitely not impressed with that or with management’s contention that sales would improve later in the year. When Q1 2017 results were announced on 27 October the stock price fell below $100 for the first time in a year. The story behind the numbers apparently overrode the pre-announcement to expect weaker results. The story is Blackmore’s entry into the infant formula market is not making the impact management had hoped for, describing sales as “sluggish.” Sluggish aptly describes the $9 million in infant formula revenue when compared to Full Year 2016 formula sales from Bellamy’s and a2 Milk Company, which generated a reported $500 million in revenue combined.
Add to that the statement of changes in buying patterns from Chinese exporters and the panic selling may be understandable. To some investors the surprise may not have been the drop but the quick recovery of the stock price in the days immediately following the announcement.
As you can see from the price movement charts, the share prices of both A2M and BAL fell dramatically in conjunction with the BKL announcement. The drop from a2 Milk Company came despite the company’s own Full Year 2016 results announcement, which was outstanding. Revenue was up 127% and NPAT swung from a 2015 loss of $2 million to $30 million in the black. Apparently some weakness in milk sales overshadowed the fact infant formula accounted for more than half of revenues; management expects continued growth in its baby products; and improved results in the company’s US market.
In yet another surprise Bellamy’s reported its Full Year 2016 financials a few days before the other two companies and they were solid, to say the least. Revenues of $244.6 million were up 95%, reaching a new record for the company. NPAT increased 320% – from $9.1 million to $38.3 million. The stock price rose but began to collapse on the Blackmores news.
Do investors have reason to be concerned that the high growth days for these companies are behind them? Based on earnings and dividend growth forecasts, it appears the analyst community doesn’t think so. The following table includes the three principal players in the infant formula market along with Bega Cheese, the joint venture partner of Blackmores and a supplier of Bellamy’s.
Investors looking for growth at a reasonable price (GARP) should note that three of these companies have expected P/EG’s over five years below 1.0, the benchmark that indicates the company’s valuation – Price/Earnings Ratio – is justified by its anticipated earnings growth.
All of these companies have double digit two year growth forecasts for both earnings and three of the four for dividends. While Blackmores and Bega may be trailing in the infant formula market, their solid average annual rate of total shareholder return over five years suggests the additional revenue streams of both companies have performed well. For example, Blackmores is moving into the Indian market and its China division saw a 220% increase in revenues of the company’s other products.
The dividend yields for BKL, A2M, and BAL may be relatively modest but all are fully franked and expected to increase substantially, with Bellamy’s dividend expected to more than double.What may be uppermost in the minds of nervous investors rings a familiar bell here in Australia – the situation in China. At the end of October an analyst at Citi downgraded both BAL and A2M to a SELL recommendation based on challenging conditions in China in FY 2017 for infant formula providers.
In 2008 Chinese consumers were shocked to learn some locally produced milk and infant formula was tainted with melamine. Thousands of babies were hospitalised and at least six died. Concerns over food safety spread, enriching the coffers of Australian companies known for providing safe and healthy food. Despite government efforts, the problem persists in the minds of Chinese consumers, 71% of whom still felt food safety was a big problem according to a 2015 survey from Pew Research Global Attitudes survey.
The new Chinese leadership has launched intensive anti-corruption efforts along with added good safety regulations which are impacting food product importers. New food safety regulations may pose new hurdles, but sound businesses have historically found ways to overcome obstacles place in their paths. The proposed regulations range from cracking down on online sales of imported products at inflated prices and a Fresh Product Registration required of all importers. Foreign importers have until the close of 2017 to comply.
While these new regulations may appear daunting, in the long term they may prove to be “chaff” blinding investors from the “wheat” in the fundamentals – demand. Returning to the Citi analyst’s SELL recommendations we find some existing inventory will not meet the new regulations, and the subsequent inventory clearing could hurt all three Australian producers of infant formula. However, the analyst sees these volatile conditions lasting until 2018, with “Bellamy’s and a2 Milk Company’s premium brands and established Chinese customers being well-positioned in the medium to long term.”
From the onset of the 2008 scandals through 2015 imports of milk powder and baby formula increased by more than five times, according to officials in the Chinese Food and Drug Administration (CFDA). On 29 October of 2015 the Chinese Government announced a “two-child” policy, allowing Chinese couples to have more than the previously allowed single child with the obvious potential of increasing demand for infant formula.
The Chinese government may be posing new regulatory hurdles, but the demand for infant formula in China is not slowing down. In 2016 the APEJ region (Asia Pacific Excluding Japan) is expected to account for 46% of global infant formula revenue, making it the largest single market. Within the APEJ China is expected to account for 90% of revenue.
The global infant formula market is forecasted to achieve a compound annual growth rate (CAG R) of 10.1% between 2016 and 2026. Investors should take note of the relative size of the APEJ infant formula revenue, as shown in the following chart, keeping in mind the role China plays in the APEJ.
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