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Outlook Weakens Significantly For Bellamy’s

Small Caps | Dec 05 2016

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Infant formula distributor Bellamy's Australia issued a substantial downgrade to forecasts and brokers shave large chunks off growth expectations, while defending a2 Milk.

-Management attributes downgrade to market being flooded with discounted stock
-Share price reflects some assumption of a return to growth in FY18
-Yet, is volume dislocation the whole story?


By Eva Brocklehurst

Infant formula and food product distributor Bellamy's Australia ((BAL)) disappointed the market with a substantial downgrade to FY17 revenue forecasts at its trading update. Brokers have shaved large chunks off their growth expectations and several have downgraded the stock.

China's Singles Day and associated sales did not pan out to the company's expectations. There was also a belief that Singles Day would absorb excess competitor inventory, which was being heavily discounted in the market, and this did not occur. Regulatory changes are also having an impact, having been successfully managed in the second half FY16.

Morgans downgrades FY17 profit estimates by 45% and now expects FY17 net profit to fall 12%. The company has a strong brand, leveraged to favourable industry dynamics, but while short-term uncertainty prevails the broker downgrades to Hold from Add and reduces its target substantially, to $7.55 from $16.65.

Regulatory changes in China are causing brands which will not meet the December 31, 2017 CFDA (China Food and Drug Administration) approval deadline to heavily discount excess stock. Morgans accepts the company's guidance may prove conservative, recognising Bellamy's is expanding its distribution points in China while its formula shelf space at Coles ((WES)) has more than doubled.

The broker anticipates earnings growth will resume in FY18 but stresses that accuracy in forecasting is low at this point. The main upside risk to forecasts is corporate activity or sales in the second half coming in stronger than expected.

China remains a large opportunity. From January 1, 2018, following a reduction in the number of brands a manufacturer can produce, industry experts expect that around 2,000 infant formula brands will be reduced to around 300. This will create barriers to entry, and suggests that the company's products will receive more shop space. Management continues to expect temporary volume dislocation until regulatory registrations are completed in China.

As momentum has slowed materially and the market dislocation from regulatory changes continues, Ord Minnett also lowers its recommendation to Hold from Buy. Brands unlikely to gain registration are liquidating inventory and flooding the market with discounted stock, while the company is progressing well with its preparation for registration. Ultimately, Bellamy's Australia expects the changes and reduction in brands will have a positive effect on its premium product offer.

With the company guiding for profit to decline in FY17, the broker expects the stock will stand still for a period. Ord Minnett downgrades forecasts for earnings per share by 50-60%. Its target declines to $7.26 from $20.00.

Bell Potter was disappointed with the update. The broker downgrades net profit forecasts for FY17 by 42% and FY18 by 45% and reduces its target to $7.64 from $16.06. Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, downgrades to Hold from Buy.

Bell POtter envisages that with sales growth slowing, a step-change in marketing is likely to be ongoing rather than be a one-off. The company had previously highlighted investment of $15-20m in FY17. The broker believes the share price is reflecting, to some degree, an assumption of success in turning the business back to growth in FY18-19.

Citi has a Sell rating, lowering its target to $6.00 from $12.10. The broker believes investors should wait for cheaper entry points to the stock, having initiated coverage in late October with the same rating. The broker would want to witness an improvement in brand momentum and Chinese industry conditions before turning more positive.

Relatively, a2 Milk ((A2M)), which also provides infant formula to China, is doing better. Credit Suisse, which does not cover Bellamy's, noted a2 Milk has lifted its revenue run rate in the first half and also demonstrated stronger margin guidance for FY17. While the stock has felt the impact of the downgrade from Bellamy's, this now represents a buying opportunity for a2 Milk, in the broker's opinion.

CLSA also maintains a preference for a2 Milk and is wary of blaming the whole picture on channel disruptions, suspecting the downgrade to Bellamy's outlook is reflecting market share losses while a2 Milk was unhindered by the regulation-led market dislocation. Moreover, a2 Milk has a more differentiated product line and a unique proposition to the market. CLSA, not one of the eight brokers monitored daily on the database, retains an Outperform rating for Bellamy's.

Goldman Sachs is another broker that believes the majority of the downgrade is because the company lost share to other brands in China, particularly to a2 Milk, as signalled by Tmall/Taobao data and feedback from industry participants. Given the company's cost disadvantage versus regular infant formula brands, because of higher costs for organic labelling, the broker believes its ability to compete effectively in a falling price environment is challenged.

Goldman envisages limited catalysts for a significamt recovery in volumes or margins. The broker, not one of the eight monitored daily on the database, has Neutral rating and $6.20 target (reduced by 53%).

Bellamy’s Australia is a Tasmanian company which distributes and markets certified organic infant formula and food products through Australia, China and South East Asia. It sells three infant formula products and 47 food products and is principally a brand manager, with processing and, in some instances ingredient procurement, outsourced to processors.

The FNArena database shows two Hold ratings and one Sell. The consensus target is $6.94, suggesting 3.4% upside to the last share price. This compares with $16.25 ahead of the update.

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