Bellamy’s (ASX BAL) is a Medium-Risk High-Reward Chinese Infant Formula Play

This article was originally published at MF & Co. Asset Management.

Bellamy’s (ASX BAL) is a Medium-Risk High-Reward Chinese Infant Formula Play

Today, we’ll look at why we think Bellamy’s is a medium-risk play with strong upside potential. The stock has been falling in and out of favour with investors as regulatory approvals continue to be delayed since 2016. A few years ago back in 2013, Bellamy’s share price and revenue experienced strong and continuous growth, mainly thanks to strong demand from China. Bellamy’s spectacular growth thanks to China suddenly stalled in 2016 following regulatory changes.

As a result, Bellamy’s baby formula was banned from the Chinese markets which resulted in a significant correction in the BAL share price. Bellamy’s has had to apply for the State Administration for Market Regulation (SAMR) approval to officially sell to the Chinese market again. We have been waiting for this since July 2018, when we first looked at this stock. However, we think the SAMR approval is close. This is why we think BAL has good upside potential.

About Bellamy’s Australia (ASX BAL)

Bellamy’s Australia (ASX BAL) is a leading company in Australian food and beverage and is the parent company of Bellamy’s Organic, Australia’s largest organic infant formula producer. Bellamy’s also exports its products to customers in China, Hong Kong, Singapore, Malaysia, Vietnam and New Zealand. As a result of the strong demand for Bellamy’s products in Asia, the company opened an office in Shanghai in 2012 and Singapore in 2014. Following a highly successful initial public offering in July 2014, Bellamy’s Australia Limited (BAL) listed on the ASX on 5 August 2014.

Bellamy's Share Price (ASX BAL)

The Chinese $20BN baby industry

The majority of Bellamy’s business activities are focused on selling baby food products in Australia. However, their second-largest activities, are located in China. Ever since the baby formula crisis in 2008 where tainted milk powder killed several babies and injured more than 6000 others, Chinese consumers have turned to foreign brands they can trust. For this reason, Bellamy’s Australia, like many other infant formula brands, have focused their attention on the potential of the massive $20 billion Chinese baby formula market.

Thanks to demand, competition is fierce. Bellamy’s Australia competes against brands such as Enfamil, Kabrita, and Yili – which is their biggest competitors in China. For Chinese consumers, Australian products are perceived to have a much higher quality. The demand for Australian products became extremely high. This resulted in a fast-growing market share for Bellamy’s Australia in China.

However, the China Food and Drug Administration (CFDA) was replaced by the State Administration for Market Regulation (SAMR) in 2018. SAMR banned more than one thousand (1,000) baby formula brands including Bellany’s to protect the Chinese market and the sales of domestic products.

The banning of more than one thousand baby product brands including Bellamy’s resulted in an enormous rise in baby formula prices in China for Australian products. Prices reached more than $45 for a box of baby formula while the retail price was about $30. This is the reason why nowadays, baby formula powder is being bought in large quantities by Chinese shoppers in Australian supermarkets and shipped back to China for a huge markup.

SAMR approval critical to Bellamy’s

Just before the State Administration for Market Regulation (SAMR) restrictions in 2016, Bellamy’s had a market share of 24% in Organic baby formula in China where they only had an 8% market share two years earlier. Bellamy’s China operations were growing fast in a Chinese market that was experienced an average annual growth of 13%.

China organic baby formulaChina organic baby food

Source: Euromonitor, ‘Baby Food’ includes ‘Dried Baby Food’, ‘Prepared Baby Food’ and ‘Other Baby Food’ Represents retail sales value (constant price, formal channels)

The market ban led the cessation of operating activities which resulted in a fall of 24.9% in revenue and a fall of 63.8% on net profit after tax (NPAT). This has had a major negative impact on Bellamy’s share price and the stock has struggled since then. On April 24, 2019, Bellamy’s secured a part of the key regulatory approval from SAMR. This lead to a strong rally in the share price, more than 50% off its lows. Bellamy’s is still awaiting final certifications and is very confident that they will get them. So much so, that Bellamy’s has committed to double their spending on marketing and sales in 2019. When the SAMR approves the sale of Bellamy’s products in China, this could lead to a strong rally in share price and subsequent revenue. The company announced that they will start selling new products as soon as the last approvals come through.

SAMR approvals a major risk and roadblock for Bellamy’s

The speed of the SAMR approval is critical to Bellamy’s Australia. If Bellamy’s Australia is unable to obtain the approval at all, this can have major consequences for the company. The approval is crucial because they have already doubled their marketing and sales expenses for 2019 in expectation of the approval. On the upside, approval from the State Administration for Market Regulation (SAMR) will be a massive positive and a huge comeback for Bellamy’s. Since Bellamy’s is already a well-established brand in China, the approval will allow Bellamy’s to supply strong demand for its products quickly.

Financial performance

Bellamy’s Australia announced its revenue growth, excluding Camperdown was 33.2% for FY2018. On a like-for-like basis, the Australian label portfolio including Food grew 24% versus FY17, and Chinese label revenue declined by 51% which was impacted by the delayed SAMR registration. The gross profit margin for FY18 was 39.6% (FY17: 38.1%). This increased to 42.5% in 2H18. The margin increase was driven mostly by lower cost of goods sold from improved ingredient purchasing and manufacturing arrangements. Stronger revenue management disciplines also contributed, including reduced promotional discounts and minor price increases.

Bellamy (ASX BAL)revenue

Bellamy’s revenue growth since FY14

In the BAL 1H19 Results Presentation on February 27, 2019 CEO Andrew Cohan discussed the financial results of FY19’s first half. In this presentation he explained the decrease in revenue and net profit, blaming it on several factors including a delay in the SAMR registration, the decision to run down the trading inventory prior the Australian label rebrand and an overall slowdown of pedigree performance.

In response, the company started rebrand to counter the growing global competition in the organic baby segment. However, Bellamy’s has a pristine balance sheet with group cash increasing to $95m, zero debt levels and continued access to a $40m working capital debt facility. This gives them the ability to pursue an aggressive growth strategy for the coming three years.

This, and with a large marketing campaign in China with celebrities with millions of followers on social channels makes Bellamy’s Australia, an interesting growth stock, especially at this relative low share price.

Bellamy (ASX BAL)-comparison 1H19 and 1H18

Peer Comparison

P/E 33.570 44.540

A2M shares continue to have the highest PE of the two, where WHA and BUB both made losses last period.  At 33x & 44x PE, both stocks seem to be overvalued compared to an average sector P/E of 17.40.

P/B 4.57 20.50 1.82 7.07

A2M has the highest price to book ratio. On a Price to Book ratio, A2M looks overly expensive compared to the other brands.

EPS Growth 3.3% 110% (140%) (193.75%)

A2M has the highest EPS growth of 110%. BAL has an EPS growth of just 3.3%.

NPAT 16.5M 153M (4.417M) (4.933M)

If we look at the half-year results of 2019 we can conclude that A2M has by far the highest NPAT with 153M. This is mainly due to huge increases in sales in the US and China, both markets in which BAL is not currently active. On a like for like basis, A2M is by far the superior baby formula company. However, A2M already has approvals from China and is globalised. If Bellamy’s was able to get the final SAMR approvals, we can expect similar performance as A2M. This means very strong upside potential in exchange for the SAMR approval risk that is currently present.

Bellamy’s is a medium-risk high-reward play

Bellamy’s Australia Limited (ASX BAL) is a leading food and beverage company based in Australia. Bellamy’s Australia aims to retake a strong market position in the Chinese baby market after the State Administration for Market Regulation (SAMR) banned them from selling their products in 2016.

The company is still awaiting final certifications from the State Administration for Market Regulation (SAMR) and is very confident that they will get it. In response, they have doubled their spending’s on marketing and sales in 2019. Bellamy’s is considered to be a medium-risk, high-reward play because of a number of factors.

Firstly, Bellamy’s has already proven to be profitable both in and out of China. Recuring and proven revenue exist, there is no speculation about that. Secondly, Bellamy’s has already gotten partial approval for some of their products – the probability of getting final approval for all products is relatively high. Finally, the final SAMR approval will all but guarantee revenue will multiply once they get it, meaning upside for Bellamy’s is being held back artificially. The potential upside is particularly strong as well if we take A2M as a model for Chinese market penetration.

However, the flipside risk on this is that there are politics at play when it comes to the approvals. Chinese regulation is hard to predict and a number of factors such as the ongoing trade war, protectionism and other things can present itself as significant risks to Bellamy’s achieving final SAMR approval.

Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia.

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