For the last two years, Bellamy’s organic infant formula out of Australia has been one of the two rising stars of the Chinese infant formula market. The other has been ‘a2 Platinum’ produced here in New Zealand by Synlait for The a2 Milk Company (ATM).
In recent weeks, the Bellamy’s business has run badly off the tracks. This has sent jitters more widely through the infant formula industry.
First, there was a cautious market guidance release by Bellamy’s on 2 December, and the Bellamy’s share price immediately crashed 40%. Then on 12 December, Bellamy’s asked that its shares be suspended from trade for 48 hours while they assessed their position. This suspension has subsequently been renewed twice and currently runs through to 13 January 2017 while further assessment occurs.
It is now apparent that Bellamy’s had been losing market share for some months, but things really went awry during the second half of November. Bellamy’s has blamed regulatory disruption and competitive price-cutting in China for their problems.
The market-fear contagion spread rapidly to ATM investors, and ATM shares suffered a reactive decline in early December approaching 20%. However, ATM has assured its shareholders that its ‘a2 Platinum’ sales continue to grow strongly and that all is well. Increasingly, it is looking as if many of the problems are indeed specific to Bellamy’s and perhaps some other companies to a lesser extent, but that there continue to be winners as well as losers. The challenge is to identify who fits into each category.
There are three key reasons why Bellamy’s misfortunes are relevant to the New Zealand dairy industry. The first is that it demonstrates yet again that value-add dairy is not an easy game. Strategies can quickly come apart at the seams without all of three key elements: a sustainable point of difference, strong marketing and coherent logistics. Even apparently successful fast-growing businesses can get the speed wobbles.
The second reason is that although Bellamy’s is Australia-based, it has important contractual arrangement with New Zealand-based Fonterra. Specifically, Fonterra has contracted with Bellamy’s to be a key long-term processing partner at Fonterra’s Darnum Park facility in Victoria. Those arrangements are now looking in jeopardy.
Third, Fonterra’s new-found enthusiasm for organic milk here in New Zealand has in all likelihood been built on assumptions that the Bellamy’s business will continue to thrive. Without Bellamy’s and its China market for organic infant formula, the international demand for New Zealand sourced organic milk powder looks shaky.
Obtaining information on market shares for infant formula in China is fraught with difficulties. This is because there are multiple channels. There are Chinese supermarket channels which are in major decline. There are ‘mother and baby’ stores, which have become increasingly important as ‘bricks and mortar’ outlets. And at the top-end of the market, online sales are the most important of all.
Online sales include both formal and informal imports. The formal channel is regulated by China Customs and shows up in Chinese statistics. The informal channel, also known as the ‘grey trade’, does not show up in these Chinese statistics.
This grey trade is managed by overseas Chinese who buy product either wholesale or retail in overseas countries, and then ship it to customers back in China in packs of up to 10 tins. These packages are able to pass through with minimal formal documentation. The expatriate Chinese buyers who manage the trade are known as daigou, literally ‘buyers on behalf of’.
Describing the daigou business as ‘grey trade’ can lead to false assumptions. For example, the Chinese authorities know precisely what is happening and they are happy to let it proceed, at least in the meantime. It provides competition in the market place and stops price gouging by the registered importers.
This daigou activity is a major reason why infant formula prices in China have been reducing rapidly over the last 18 months, which is precisely what the Chinese Government has been wanting to achieve. Prior to that, the mark-ups in China were outrageous.
For both Bellamy’s and ATM, the daigou trade has been fundamental to their growth. For a while, part of this trade was functioning from New Zealand, but that has largely ceased. This is because New Zealand now allows only registered exporters to send infant formula overseas. Accordingly, the trade from ‘down under’ now focuses on sourcing from Australia. In this regard, Australia also presents better opportunities because there is no GST on infant formula.
In the last three years, supermarket and pharmacy sales of infant formula in Australia have trebled. Now, we know that Australian women are not suddenly having a lot more babies, and we also know that there has been no sudden move away from breast-feeding. The explanation is that all of this extra infant formula is going to China.
By early 2016, Bellamy’s had achieved a 21.6% market share in Australia (Aztec supermarket and pharmacy commercial data), up from about 10% market share when the company went public in July 2014. Based on an Australian market that had trebled in size – on account of daigou purchases – together with additional sales to China through the formal system, the overall Bellamy’s growth had been about six-fold. The shares that were offered for AUD $1 back in August 2014 rose to over $15 at the end of 2015. The market capitalisation of the company exceeded AUD $1.5 billion.
From March to November 2016, the shares bounced around between $15 and $10, but the market remained largely unaware that Bellamy’s was losing market share in Australia – dropping to 14.9% by November from 21.6% in March, according to the Aztec data. Bellamy’s gave no indication at its AGM in late October of anything that was astray and the shares rallied above $12.
However, it is now acknowledged by Bellamy’s that their own China online store was discounting products in early November. This included ‘Singles Day’ (11/11; i.e. 11 November), which has come to be a massive day for China purchases for all retail products. It would therefore seem that, at least by early November, Bellamy’s knew it had excess inventory.
This suddenly left the daigou who were purchasing at non-discounted prices in Australia at a competitive disadvantage. In mid-November, they shifted their allegiance to other brands. Accordingly, it would seem that Bellamy’s, by not properly factoring in the importance of the daigou, shot themselves in the foot.
When the share market began to recognise what was happening, the response was fierce. CEO Laura McBain gave a telephone conference to analysts, but that simply raised more questions. The answers McBain provided were fluffy answers such as that she was ’happy’ with the overall situation. Subsequently, there were also many negative online investor comments about the Chair and CEO of Bellamy’s having made substantial sales of their own shareholdings as recently as August. Did the Chair and Manager know something that the market did not know?
The subsequent and ongoing suspension of the shares is extraordinary. Until there is clarification from the company as to the extent of the pickle they are in, then any judgement as to ‘where to from here’ can only be speculative.
On perusing the original prospectus issued by Bellamy’s in 2014, I note that Bellamy’s put great weight on the fact that their products were 100% Australian-made and 100% organic-certified. This was their point of differentiation. What was never stated was that all the organic milk powder ingredients were imported, much of it from Europe and most likely since then also from New Zealand. So yes, the product was Australian made but the key ingredient was not! And there lies an Achilles heel of a non-transparent supply chain to go alongside the bullet-wounded foot.
It seems that the greatest short term beneficiary of Bellamy’s has been ATM with its ‘a2 Platinum’. Between March and November, while the Bellamy’s ‘Australia plus daigou’ market share was sliding, the ‘a2 Platinum’ market share in the same market rose from 15.7% to 24.8%. A somewhat enigmatic announcement from ATM CEO Geoff Babidge just prior to Xmas, that ATM continued to experience strong ongoing growth since its November AGM and was not experiencing regulatory barriers, would suggest that the ATM market share may well be heading even further north.
Although I did not foresee the magnitude of Bellamy’s problems, I am not at all surprised that they have struck difficulties. Some months back, I wrote that New Zealand organic dairy farmers should be watching Bellamy’s closely, because their New Zealand organic farming future was in all likelihood dependent on ongoing success at Bellamy’s.
In private communications with prospective organic dairy farmers, I went further with advice that they should be cautious of becoming reliant on major ongoing price premiums. And lying behind that was my own knowledge that Bellamy’s was reliant on non-transparent supply chains for imported organic powders of which the broader consumer market seemed unaware.
I have also written regularly that there will continue to be big winners and big losers in infant formula. In China, the important products are not only the Stage 1 and Stage 2 products that dominate in domestic New Zealand and Australian markets, but also Stage 3 products for one to three-year olds. Indeed Stage 3 is a considerably bigger market than the combined Stage 1 and 2.
Linked to this, the New Zealand industry has not recognised that imported infant and toddler formula is now much more important in China than imported whole milk powder (WMP). The Europeans dominate the former which is experiencing rapid growth. In contrast, New Zealand dominates WMP imports for which the numbers bounce around but with minimal overall growth in the last four years.
The broader challenge now in New Zealand is that many of the stable doors have been left open and swinging for a long time. It is very hard to regroup once the horses have bolted and galloped over the horizon.