Treasure Chest: Bellamy’s Overpriced

This story features A2 MILK COMPANY LIMITED, and other companies. For more info SHARE ANALYSIS: A2M

The share price of Bellamy's Australia surged 31% recently after a competitor sparked an optimistic outlook. Bell Potter does not believe the outlook can be extrapolated.

-Reaction to recent inventory shortfall at a2 Milk cited for share price surge
-Few reasons to warrant a premium rating of the stock
-Bell Potter believes there is better value elsewhere in the sector
 

By Eva Brocklehurst

The share price of Bellamy's Australia ((BAL)) has surged 31% rise since ASX-listed competitor a2 Milk Company ((A2M)) provided an optimistic outlook based on infant formula sales expectations.

Bell Potter calculates Bellamy's share price is now trading at a headline FY18 enterprise value/operating earnings (EBITDA) multiple of 25.7x, a 35% premium to its global infant formula peers.

Moreover, it is trading at a 27% premium to a2 Milk. The premium is unwarranted, in Bell Potter's view, given Chinese supply challenges that are to be faced over the next 12-18 months. The broker suspects the main reason for the share rally is a reaction to inventory shortfalls that occurred at a2 Milk, which would have prompted renewed optimism regarding rising demand.

This may be the case, although the broker would expect any uplift in demand to be short-lived, as a a2 Milk has already secured additional inventory from supplier Synlait Milk ((SM1)). Bell Potter recently initiated coverage on Synlait Milk, New Zealand's fourth-largest milk processor, with a Buy rating and $4.38 target.

Further to Bellamy's share price premium, there appears to be no risk incorporated to reflect the securing of a CFDA registration. China Food & Drug Administration is the regulatory body responsible for healthcare services in China. The broker highlights the fact that Bega Cheese ((BGA)) has recently disclosed it could no longer register its product.

A failure to secure CFDA registration, which would potentially require a separating of production among three suppliers, would not only be a material headwind to Chinese sales, in the broker's opinion, but also result in a damage to the company's reputation among Chinese consumers, which in turn would affect the ability to route product through the grey market channels.

Other risks include continued certification of the products as organic, the emergence of new competition in a highly competitive global marketplace, as well as supply chain disruptions.

As a result Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, downgrades the stock to Sell from Hold, retaining a $4.21 target price.

In contrast, back in February Citi came to the conclusion that after a -67% drop in the share price since October 2016, the risk/reward for owning the shares had become more balanced and upgraded to Neutral, High Risk. The broker believes Bellamy's needs to build a direct-to-consumer business in China, although at this stage the company cannot afford to do so.

The turnaround strategy is risky, the broker acknowledges, and will take a long time. Morgans also observes conditions were uncertain at the time of the first half results, although management appears to be making some progress in turning around the business.

Bellamy's is a Tasmanian company which distributes and markets certified organic infant formula and food products throughout Australia, China and Southeast Asia. There are two Hold ratings and one Sell on the database. The consensus target is $4.26, signalling -27.1% downside to the last share price. Targets range from $3.72 (Ord Minnett) to $4.75 (Morgans).

See also, Treasure Chest: More Pain For Bellamy's? on January 19, 2017.
 

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