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March, 2018 1:38 PM


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Top Stocks in the Infant Formula Sector

Top Stocks in the Infant Formula Sector

By Bob Kohut 18.12.2017

Some newcomers to investing heed the advice from experts to invest in mega-trends, forgetting to read the “fine print.”  Their assumption may be that all stocks in a sector with strong tail winds generated by a mega-trend will benefit equally.  A corollary to that assumption is the belief that latching on to the current “market darling” in the sector is their best bet.

Recent history from exploding demand for infant formula – a subset of the agricultural sector that some believe will lead to a “dining” boom in Australia – provide an object lesson of some of the pitfalls of blindly putting investment dollars into a red-hot sector.

First, not all stocks are “created equal.”  Fundamental tenets of sound investing, such as diversification, still apply.  No matter how hot, a company whose business model is a relative “pure play” with single or limited product lines is subject to greater risk than a company with more diversified offerings.

Second, companies that prosper generally have a competitive edge over other players in the market.  The edge may stem from location, prior experience in the market; or a differentiating factor with the company’s products.

Third, quality companies in growing markets frequently recover from extreme share price drops following events that often prove to be temporary.  For the intrepid, this represents a buying opportunity.  For the cautious, fears of the classic bromide about avoiding the falling knife can lead to missing a chance to grab a bargain.

Fourth, markets with exploding demand breed ferocious competition.  Investors can forget the major ASX exporters of infant food products are not alone.  The Chinese market is where the action is currently, fueled by a 2008 scandal with domestic infant formula production that led to fatalities.  The following two charts illustrate what ASX players face.  The first shows import growth as well as country of origin; the second market share by company. 

ASX investors eagerly gobbled up shares of the first ASX player with big plans to expand into the Chinese infant formula boom.  The company – Bellamy’s Australia (BAL) – quickly achieved “market darling” status as its 2014 listing price of $1.00 per share ballooned to $4.95 within a year.  The stock price was so hot, Bellamy’s became the standard against which other ASX players were measured, with the moniker “the next Bellamy’s.”

Less favored in the early days was New Zealand’s a2 Milk Company (A2M).  Some investors seem to have ignored A2M’s diversified dairy product line enhancing its infant formula offerings as well as its competitive edge in the nature of the milk products it offered.  When the bottom fell out for Bellamy following a planned regulatory change initiated by the Chinese Government, A2M barely missed a beat.  The following five-year share price movement chart tells the tale.

Bellamy’s product line also has a competitive advantage due to the use of organic sources.  The stock price recovered but the company continues to be plagued by events beyond their control.  Investors buying in following the crash at around $4.80 have reaped a reward of a 117% increase.  The company offers a variety of infant foods for ages ranging from birth to three years, from formulas to cereals to solid foods and snacks.  All Bellamy products are certified by the Australian National Association for Sustainable Agriculture (NASAA).

The a2 Milk Company was recently added to the ASX 100 and the NZX 10.  In addition to its infant formula line, the company produces a variety of liquid milk offerings as well as cream and yoghurt.  The milk from a2 Milk Company is different, coming from cows certified as producers of milk containing only the a2 beta-casein protein.  The a1 beta-casein protein is actually a genetic mutation originating from breeding of European cows and is more difficult to digest.

While Bellamy’s share price has gained some traction, the company’s short-term future does not appear as solid as A2M’s.  The following table includes share price information as well as forecasted earnings and current revenue performance, on a trailing twelve month (TTM) or quarterly basis.

There are three newcomers to the ASX battling for market share in the infant food sector, with all earning the new analyst accolade of “is this the next a2 Milk Company” from some.  Synlait Milk (SM1) debuted in late 2016 while and Bubs Australia (BUB) came on in early January.  The most recent, Wattle Health Australia (WHA), began trading in March.  

Of the three Synlait is the only company to report solid revenue and profit for FY 2017, but Bubs seems to be winning the battle to be anointed the next market darling.  Bubs listed at the beginning of the year, with a 2 January opening price of just $0.07 and immediately reached for the skies.  First day investors have seen the share price rise a little more than 1,000%.  

Synlait opened on 25 November of 2016 at $2.95 and is up 109%.  Yet Bubs is the least diversified of the three, restricting its product line to products earning the label of Australian Certified Organic including infant formulas made from goat’s milk, solid foods and fruits, vegetable purees, cereals, and toddler snacks.  Bubs has been in business since 2005, accumulating numerous awards along the way before coming to the ASX via a reverse merger.  

The share price performance from the outset has been stunning, perhaps due to the company’s reputation or its early agreement to distribute products in China via, with the wife of the founder serving on the board at Bubs.

Another explanation could be the doubling of revenue between FY 2015 and FY 2016.  The stock price was rising non-stop until the company’s Full Year 2017 Financials showed a more modest revenue increase of 7.8% along with a $5.1 million-dollar operating loss.  Here is a one-year price movement chart for BUB.

The company has put together a string of positive announcements regarding supply agreements in China, but the stock price took another tumble when market participants learned a major stockholder, Next Step Global Limited, had sold 6.8 million shares of BUB.  However, Next Step still has a 12.4% stake in the company, down slightly from 14.6%.

The company’s most recent positive news was the acquisition of a 49.9% interest in dairy producer Nulac Foods Limited, piquing investor enthusiasm for the acquisition and the subsequent capital raise to fund the acquisition and provide additional working capital.   While Bubs is exciting investors, it remains the weakest of the three in terms of revenue and gross profit on a trailing twelve-month basis.  The following table compares the performance of the three companies.

New Zealand based Synlait Milk provides products to support the “health and nutritional wellbeing” of both adults and infants, according to the company’s website.  Synlait has four major product groups:

• infant and adult nutritional powders;
• whole and skim milk powders;
• anhydrous milk fat; and
• lactoferrin

The infant formula powders are available for ages from birth to three years.  Anhydrous milk fat is used in the production of chocolate, confectionary candy, ice cream, processed cheese, and for baking.  Lactoferrin is used in nutritional products and infant formula. 

Earlier in the year Synlait acquired New Zealand Dairy Company to add another state-of-the-art blending and consumer packaging facility.  In its first Full Year Financial Reporting since coming on the ASX, the 2017 results saw revenues of $759 million, a 38.8% increase, and net profit after tax (NPAT) of $38.2 million, an 11% rise. 

Investors looking for “the next a2 Milk Company” should know Synlait has a partnership agreement with A2M allowing Synlait to export infant formula to China. A2M has a small equity interest in Synlait. 

Given that one of the recognised agricultural mega-trend is increasing demand for safer and higher quality foods, Wattle Health Australia’s outsourcing of supply and manufacturing seems risky at best.  Although the company has released positive news since listing, it remains a company yet to generate meaningful operating revenue, much less profit. 
The company is focused on product formulation, with three age range formulas available in both a Gold Care+ line for infants and toddlers with sensitive digestive systems and three aged range conventional infant and toddler formulas.

Despite its start-up status, investors have been driving up the price with each new announcement. The first was the acquisition of a 5% equity interest in Blend and Pack as a producer of Wattle infant formula products.  Blend and Pack has a licence from the Chinese government to produce infant formula.  

Supply agreements with Abbey Healthcare in Malaysia and Chinese retailer Aiyindago Zhuhia Business Chain Limited to supply 100 stores prior to a national rollout buoyed investor interest.  Agreements with Metcash Limited (MTS) to supply their network of stores in Australia and a joint venture with the Organic Dairy Farmers of Australia for the production of organic powdered milk fueled the fire.  Another agreement with a Chinese retailer – Tesco Lotus – kept the fires burning bright.  In August the company’s capital raise was oversubscribed, another sign of burning investor interest.

The key news driving the share price is the Blend and Pack agreement.  Currently a2Milk it the only ASX listed player with the CFDA (Chinese Food and Drug Administration) approval required by Chinese regulators for importing commencing with new regulations taking effect in January.  Blend and Pack already has a licence to produce infant formula and is awaiting final approval of its CFDA licencing application to comply with the new laws in China.  

The share price is up about 630% since the company listed, but has cooled off as of late November.  The company had expected final approval of the CFDA licence for Blend and Pack in November, but investors are still waiting and perhaps have taken some profits in the interim.

While Wattle and Bub are garnering the most investor interest, Bellamy’s a2M, and Synlait already have a track record of meaningful selling of what they make in China. 


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