Not Quite There Yet
Today, we take a look at another player in the infant milk business, Bellamy’s Australia (ASX:BAL). This company has made tremendous progress in a relatively short span of time having recognised opportunities in the infant food market, offering an organic option to parents looking for higher quality premium offerings. However, despite a successful track record and appeal, we believe the company’s investment potential isn’t quite there yet, as there continues to be issues in China, one of its largest markets. At this juncture, we Traffic Light the stock.
In the previous week, we have provided an overview of the broader Infant Formula (IF) market segment as well as taking a comprehensive look at a niche player. This week we are checking in on a more well-known face, Bellamy’s Australia (ASX:BAL) which is a much larger rival with a market capitalisation of $1.39 billion.
Source: Company Website
Before moving on to the company’s recent developments and why it has attracted our attention, a offer a recap on the Infant Formula market. We continue to view this segment positively
considering its long run growth potential with the global infant food and formula market set to be worth some US$50 billion with an expected value of some $69-70 billion in 5 years while the IF segment alone accounts for 67% of the total.
We also see significant opportunities in the space considering that the market grows along with the number of births and the increasing number of women in the workforce. A distinct difference here with Bellamy’s is that its focus in on organic infant formula which we believe to be the fastest growing segment – it is set to grow to A$2.4 billion in Australia alone (from $1.72bln currently). Note that this segment has been growing at a double-digit pace every year since 2009.
With that said, the increasing degree of health consciousness has also translated well into the baby food market with an increasing number of mothers looking to maximise nutrition for their babies and demand for high quality products has subsequently surged. Bellamy’s has been ahead of the curve having focussed on this segment since inception.
We were also attracted to Bellamy’s because of the rising demand for organic baby food internationally and specifically in China. Considering the massive surge in China’s middle to upper middle-class, this presents a significant opportunity. Note that, the upper middle-class market segment is attracted to premium organic products due to the perception of its superiority to non-organic alternatives and that it presents the best possible option to provide babies with the best upbringing.
This demand for premium organic products was supported and cemented by the 2008 melamine scandal in China which led to 6 deaths and over 50,000 hospitalisations. No doubt, with locally sourced milk’s reputation somewhat tarnished, this has strengthened further the opportunities for Australian dairy products which have earned a reputation for being clean and high-quality.
We see Bellamy’s a highly plausible addition to the portfolio which is set to benefit from these underlying trends. Despite such positives, however, a major stumbling block in our view is the likely regulatory delays. Note that, China Food and Drug Administration (CFDA) regulatory approval has been recently required to sell products there.
The reason for the delay is that CFDA along with AQSIQ (General Administration of Quality Supervision, Inspection and Quarantine of the People’s Republic of China) and SAIC (State Administration for Industry and Commerce) have been merged into a single body with the Chairman only recently appointed in June further causing delays on all applications.
Another issue is the ongoing trade tensions globally with Australia and China seeing some diplomatic tensions that can also cause further delays down the line. Note that issues in China are highly relevant as revenues here account for circa 30% of the total which have a sizable impact if the company can’t market its products.
Next up, we take a brief look at the company’s background and most recent financials to paint a broader picture before we conclude our view on the stock.
Brief Company Overview
Bellamy’s Australia (ASX:BAL) is a Launceston, Tasmanian-based organic food business, which specialises in premium baby food and infant formula. The company (previously known as Bellamy’s Organic) is relatively young having only been formed in 2003 by David Bellamy (pictured below) as a family-operated company.
Image Credit: Lifetime Health Products
The company was the first to offer organic baby food and was certified back in 2003 then later entered into the infant formula market in 2005 with its first organic baby formula. To date, the company is the only Australian-made organic infant formula on the Australian market.
Tasmanian Pure Foods then purchased Bellamy’s Organic in 2007. Tasmanian Pure Foods was a privately-owned business set up to invest in and focus on Tasmanian food and agribusinesses. A couple of months ahead of its August 2014 IPO, Tasmanian Pure Foods was renamed Bellamy’s Australia.
Moving on down, the company’s product line entails a broad range of organic food and formula for babies and toddlers. The company now offers over 40 products divided amongst 4 age (or life cycle) categories and starting from (i) 0-6 months, (ii) 6-12 months, (iii) 1-3 years, and (iv) +3 years. As can be seen in the graphic below, this includes infant formula, ready-to-serve baby food, chewable baby foods and rusks, snacks and mixable cereals.
Source: Company Website
Based on FY17 results, the company’s flagship product is the Infant Formula line which accounts for the lion’s share (>80%) of revenues, though explicit breakdowns aren’t provided. It is safe to infer that the remainder comes from food products.
On a regional basis, the company has a strong presence in the Australasian market noting that that circa 66.7% of revenues come from Australia and New Zealand. The company also has an online store for a different distribution channel and is part of this regional segment.
Considering the strong demand for its baby products in Asia, the company subsequently opened an office in Shanghai, China in 2012. Bellamy’s now also distributes its products in Hong Kong which accounts for about 30% of all revenues.
The company has also been developing its exposure in Southeast Asia since January 2014 and now sells to Malaysia, Singapore and Vietnam which together comprise circa 3% of revenues.
The graphic below shows the company’s current structure:
Source: Bellamy’s Australia (ASX:BAL)
Ultimately, we believe Bellamy’s is well positioned to take advantage of an expanding market, of which both infant formula and baby food segments are growth categories. The company also produces products that are well differentiated with “Australian-made” and “100% certified organic” branding, attracting parents who are willing to pay for their children to have the best nutrition.
This differentiation is so far paying off, with the company, according to Euromonitor, having a sizable share of over 16% in the global organic baby formula market. The brand is well established in Australia and has a growing presence in China, Singapore, Hong Kong, Vietnam, Malaysia and New Zealand.
We also like that the company has a capital light business model and doesn’t own or operate any manufacturing facilities or organic farms. The company operates by managing its entire supply chain and is heavily involved with its suppliers from raw materials to manufacturing to packaging and packing. Management notes that they have continued to build on relationships with suppliers for organic ingredients in both Australia and globally to support growth requirements while also being involved in the development of organic farming in Australia.
Recent Financials Review (1H18)
Moving on down to the company’s most recent results released last February 2018 and covering the June – December 2017 trading period. Revenues were solid, up 47.9% year-on-year to $174.91 million on the back of strong volume growth and further market share wins. Normalised revenues which adjust for the Camperdown acquisition show a similar result, up 43.7% year-on-year.
The graphic below shows normalised results:
Source: 02 February 2018 Company Presentation
Gross Profit Margins (GPM) were under pressure, on the other hand, down 300 basis points to 36.6% and mainly reflecting some one-off charges and higher ingredients costs as well as some ageing inventory. According to management, 2H18 margins will improve when new procurement initiatives take effect as well as some new product launches. Normalised GPM was down 295 basis points.
On the cost side, despite the acquisition of Camperdown and the hiring of new talent, Total Costs for the interim period decreased 20.3% year-on-year to $29.12 million. Most of the decline was as a result of materially lower logistics or distribution costs per unit. These fell 46% year-on-year or circa $6.73 million. The company also reported sizably lower marketing costs of $6.35 million (-19.8% yoy) due to a change in management’s marketing strategy.
These improvements were partially offset by higher employee costs which increased some $798.5 million due to the hiring of new talent. The graphic below, show the costs as a percentage of revenue fell due to the aforementioned improvements:
Source: 02 February 2018 Company Presentation
Underlying EBIT thus, was up 75.1% year-on-year to $32.7 million and ending with higher EBIT margin of 18.7% up 290 basis points. All in all, the company ended the interim period strongly, with underlying NPAT up 68.4% year-on-year to $22.41 million while Diluted EPS almost tripled to A20.4 cents versus last year’s A7.2 cents.
Given the robust results, management has provided strong guidance expectations as shown in the graphic below:
Source: 02 February 2018 Company Presentation
Summary and Investment Conclusion
Bellamy’s Australia (ASX:BAL) has made tremendous progress over its relatively short lifespan having recognised, from the outset, the growing demand for premium organic infant food products. The company is also well placed to ride the longer-term trend given the growing middle class in Asia, the demand for Australia infant formula, low breastfeeding rates and the loosening of the Chinese Family Planning Policies.
Despite that however, the recent regulatory issues in China with the merger and recent appointment of new leadership for its Drug and Food Administration department, has led to significant delays, while current global trade concerns add further complexity to the equation.
Considering the company’s sizable exposure to China (~30% of revenues) we believe that the most prudent move is to adopt a wait-and-see approach. We are issuing a Traffic Light alert on Bellamy’s Australia (ASX:BAL), and prefer to monitor the situation before we initiate a buy recommendation.
