Bellamy’s Australia has fallen into a serious hole. The share price of the organic infant formula producer has declined 67% since early December.

Bellamy’s is a premier producer of infant formula and had achieved significant sales growth in the past 24 months following a boom in demand for quality infant formula from China’s middle class parents. The company listed on the ASX in August 2014 offering shares at $1. The shares followed Bellamy’s rapid growth in sales and reached an all-time high of $16.50 in December 2015 before materially declining to trade near $4 at present. This fall has seen over A$750m of shareholder wealth evaporate.

Trouble first started emerging at Bellamy’s in early December last year. The company provided a trading update to the market announcing a substantial downgrade to its Chinese growth aspirations citing “temporary volume dislocation in China due to regulatory changeover” and “the flow-on effects of restructuring the route-to-market in China”. In short, Chinese agencies imposed new restrictions on the importation of baby formula into China, causing competitors who were unlikely to comply with the new rules to liquidate inventory. This led to deep discounting by competitors, affecting Bellamy’s sale volumes and profit margins.

To make matters worse, shortly after the first downgrade Bellamy’s shares were placed into a month long trading suspension to allow the company to negotiate material volume reductions on its contracts with key suppliers. Due to its rapid growth before, Bellamy’s had entered relatively long-term ‘’take-or-pay’’ contracts with suppliers, including Fonterra, to secure supply.

The trading halt was lifted earlier this month with Bellamy’s announcing payments to suppliers for failing to take minimum volumes and reductions in contract volumes going forward. More importantly, it also indicated an inventory build-up of over six months’ stock (estimated to be worth A$105m), a further profit downgrade and removal of CEO Laura McBain.

The problems at Bellamy’s stem from two fundamental issues:

  1. A lack of understanding of its route to end market – In this case, to parents in China
  2. A lack of brand equity – The company had not built a strong enough brand to withstand discounting by competitors

Bellamy’s distribution chain is complex and heavily reliant on numerous Chinese resellers known as “Daigou” (Chinese for “buying on behalf of”). Daigou have been vital in enabling the rapid growth experienced by Bellamy’s and other infant formula producers. In general, Daigou buy a wide range of luxury goods and were estimated to account for up to 12% (US$7.5bn)[1] of Chinese luxury spending in 2015. With infant formula, Daigou typically purchase product from Australian pharmacies and supermarkets, ship it to China and resell the product to local parents. Bellamy’s failed to recognise a substantial slowdown in sales by the Daigou to Chinese parents when regulation changed and competitors began discounting. The company continued to manufacture product and allowed inventory to build.

The issues at Bellamy’s have no quick fix. Bellamy’s faces tough decisions around how best to repair its brand and clear excess stock. Failure to effectively execute this restructuring could see the company’s balance sheet come under significant pressure.

Companies experiencing rapid growth can often get caught out by a lack of market experience or understanding. It is important that these companies have a Board and management team with strong market experience and understanding. It is reasonably clear in retrospect that Bellamy’s did not have this.  It is not surprising to see the recent shareholder activism seeking to remove the existing Board.

Sam Trethewey

Portfolio Manager

Disclaimer: This is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser.

[1] Source: Financial Times (https://www.ft.com/content/0e0c6a36-330c-11e6-bda0-04585c31b153)