The Tasmanian group’s export strategy is in disarray because of problems with the milk formula marketing group’s newly acquired Victorian cannery.
But it’s not a sector-wide issue. At the same time, shares in its competitor a2 Milk kept charging onwards and upwards.
There is no doubt that a2 Milk is the better run company. But trading at eight times historic sales, is it really possible to make a buck out of it?
In contrast, could the uncertainty surrounding Bellamy’s be an investment opportunity. These are the questions I ask myself.
Before its suspension from the ASX, Bellamy’s shares last traded at $6.74 — less than half its 12-month high in August 2016 of just over $15, giving it a market cap of close to $780m.
Meanwhile, a2 Milk’s shares have gone the other way, more than doubling from a low of $1.71 in October 2016 to trading at about $3.77, giving it a market cap of $2.7 billion.
That is what multiple profit upgrades can do. The question is whether to jump on, despite the stock looking ridiculously expensive — even for so-called growth companies. The ASX-listed vegetable and fruit grower Costa trades on two times’ sales, while Bellamy’s traded on three times prior to its trading halt.
No cream left on table
Back to Bellamy’s, where there has already been a great deal written, basically around the theme that the rug can be pulled from under your business at any time when you’re dealing with China.
I admit that it doesn’t look good. On July 4 Bellamy’s completed a share capital raising of just over $60 million, then three days later the company says the main reason for the capital raising, the Chinese import licence owned by its newly acquired Camperdown Powder facility in Victoria, has been suspended! Some $45.5m was raised by Bellamy’s from retail investors. Does the company give that money back? It’s a shemozzle.
But at what point is it a buying opportunity?
Amid all this are interesting questions for investors: whether Australian companies can really tap into the giant and growing Chinese markets, and also whether there is still money to be made.
The first point to make is that the whole sector which exports “Australian made” food based/vitamin products (Blackmores) does not have a demand problem. If a company runs into a problem in China it is typically a supply issue, which can relate to regulatory concerns.
In buying the Camperdown cannery with the export licence Bellamy’s was trying to overcome the hurdle of not owning its own manufacturing. This is why a2 Milk purchased a stake in Synlait Milk (SM1), the New Zealand contract manufacturer. Plus, about a third of the company’s herd produces a2 milk only.
Put simply, a2 can say to the Chinese government that it has control over its supply chain. Bellamy’s can’t. So a2 has done a better job at managing the regulatory issues but, just as important, it’s done a better job managing brand perception. Bellamy’s famously slashed its prices and flooded the market last year.
A2 has always managed to keep the supply in check, hence managing to maintain its premium brand status among the all important Chinese consumer.
Now to the all important question of value. Bellamy’s — now run by Andrew Cohen who has taken over from Laura McBain — might turn out to be a buy, but this will only be the case if the group resolves the manufacturing issue, and then allows investors to work out what an appropriate profit margin should be.
Bellamy’s should have higher cost of goods sold than a2 Milk because of the expense in obtaining organic product. It might look good on a sales multiple, but the overriding factor now is its profitability.
As for a2 Milk’s value, I’ll pass on some advice from fund manager Chris Prunty at QVG Capital, who has previously owned the stock: “A2 is caught up in mid-cap growth bubble. Mid-cap growth stocks are the most dangerous part of the market because there is a scarcity premium built into these stocks.” So watch out!
Richard Hemming is an independent analyst who edits www.undertheradarreport.com.au
Source: The Australian