Australia | Aug 29 2019
After an underwhelming twelve months brokers assess Bellamy's Australia still has large challenges to overcome for its infant milk formula expansion in China.
-Little progress on the Chinese regulatory front for Chinese-labelled sales
-Shift in Australian buying channel away from daigou towards cross-border e-commerce
-Significant untapped potential in Southeast Asia
By Eva Brocklehurst
Bellamy's Australia ((BAL)) remains confident it can execute a significant re-branding of its infant formula in a difficult market, yet its fortunes remain heavily dependent on the Chinese registration process as well as success with additional products.
Morgans suggests there is plenty the company needs to prove following a poor twelve months. Little progress has been made on the Chinese regulatory front and there is significant downside risk if new products fail to gain traction in what is already an overcrowded market category.
The company is guiding for FY20 revenue growth of 10-15% while the medium-term revenue target of $500m, originally set for FY21, has been deferred. Citi assesses, on current forecasts, this target will only be achieved by FY26.
FY20 guidance assumes no contribution from Chinese labelled product for the core organic infant formula although it does assume a contribution from the ViPlus product. The company is also launching a goat milk formula.
There is much uncertainty around the FY20 sales outlook given Chinese e-commerce law enforcement, increase support for Chinese domestic brands and declining Chinese birth rates. Preliminary estimates of 2019 birth rates suggest a decline towards around 14m infants, which would result in a -8% decrease in the addressable infant population.
Competition in the Australian organic infant milk formula category has also increased while, in the Chinese market, Danone and Johnson & Johnson have indicated interest in launching products.
Citi also points out, relative to other Chinese infant formula operators, Bellamy's and rival a2 Milk ((A2M)) are still under-investing in marketing initiatives, likely to be a function of their historical reliance on the daigou channel (local purchases of goods for China) which funded a lot of the sales, marketing and distribution costs.
Bell Potter notes the -24% decline in Australian revenue in FY19, which has tended to be daigou-centric, is symptomatic of the shift in the channel towards cross-border e-commerce. The broker's analysis of export data from Australia reveals a change in the route to market, with exports to China contracting (a proxy for daigou activity) at the expense of direct shipments to Hong Kong (a proxy for cross-border e-commerce).
The end result is likely to require increased brand investment by Bellamy's, along with the required on-ground investment in China. This would also provide some explanation for the soft margin guidance in FY20 in light of the anticipated revenue growth, in the broker's view.
Citi prefers to wait for evidence of improved sales and earnings before upgrading its recommendation. However, given the improved exit run rates in the fourth quarter and new product launches there is too much upside risk to have a Sell rating.
FY19 results missed broker forecasts, largely as de-stocking in the third quarter of FY19 took longer than management expected. This stemmed from higher inventory levels as the distribution network was consolidated.
The company has acknowledged the difficulty in assessing inventory levels beyond the first line of distributors, which makes forecasting sales challenging. However gross profit margins increased to 43.5%, a highlight of the result, Morgans points out. The broker emphasises that until there are signs operating conditions improve and Chinese regulatory approvals are received, forecasting accuracy remains low.
The second half sales decline of -11% disappointed Citi, given marketing expenditure doubled and manufacturing performed better. The broker prefers to wait for evidence of improved sales and earnings before upgrading its recommendation. However, given the improved exit run rate in the fourth quarter and new product launches there is too much upside risk to have a Sell rating.
On the positive side, Ord Minnett points out the company has expertise in sourcing organic product and enjoys a known and trusted brand but the economics of Bellamy's organic formula are less attractive than peers.
The company is awaiting approval from the Chinese regulator (SAMR) for its Chinese label products. Citi's forecasts assume registration for the core organic and ultra-premium formula items will be received in the second half of FY20 for a resumption in Chinese label sales by the first half of FY21.
Yet, given the continued delays around registration, in conjunction with China's new 60% self-sufficiency target, the broker acknowledges successful registration appears anything but certain. Moreover, SAMR registration picked up in the first half of 2019 but around 78% of approvals were for domestic Chinese brands and two of the three foreign brands receiving approvals had direct links with Chinese entities.
Hence, all up, there is significant potential but also significant uncertainty, in Morgan Stanley's view. The broker notes the shares are fallen -14% over the past two weeks, highlighting these issues with the Chinese channel and the cost of growth in China.
South-east Asia currently represents less than 5% of sales. Citi calculates, assuming Bellamy's could capture around 2% of the market by FY21, Vietnam would be a $20m revenue opportunity that could result in a 6% uplift to operating earnings in FY21. Expansion in Indonesia and the Philippines is also contemplated.
Bell Potter, not one of the seven stockbrokers monitored daily on the FNArena database has a Hold rating and $8.00 target. There are also four Hold ratings on the database. The consensus target is $8.09, signalling 7.4% upside to the last share price. This compares with $9.25 ahead of the results.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
FNArena is proud about its track record and past achievements: Ten Years On