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A2 Milk shares fall as Bellamy's slide continues

Thursday 12th January 2017

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A2 Milk Co shares fell today, with rival ASX-listed Bellamy's Australia sliding another 17 percent after yesterday's slump when it cut its profit forecast for the second time, announced chief executive Laura McBain's exit, and tweaked the terms of its supply contract with Fonterra Cooperative Group. 

As at 2 pm in Wellington, Bellamy's ASX-listed shares had dropped to A$4.46, the lowest since August 2015. On the local index, A2 Milk fell 1.3 percent to $2.25, while Fonterra Shareholders' Fund rose 1.8 percent to $2.72. 

Bellamy's ASX-listed shares, which have been on a trading halt since Dec. 12, traded up to 40 percent lower yesterday after the beleaguered dairy company said lower than expected demand for its baby formula has impacted its revenue and profitability, leading to increased inventory levels, excess ingredients and a shortfall in payments to suppliers. A2 shares were dragged lower when Bellamy's was put in a trading halt before it gave an indication as to why, with concerns that what was affecting Bellamy's was a sector-wide issue.

The Australian infant formula maker ran into trouble after China moved to tighten regulations in a bid to crack down on the grey market - or 'daigou' - and allay concerns about food safety. Under the changes, each legal entity will only be allowed to have three brands with three recipes for infant formula, something that’s expected to decimate the number of brands and labels on supermarket shelves in China from more than 2,000 currently to around 200.

"Clearly the whole sector came under pressure from the Bellamy's issues," said Matt Goodson, managing director at Salt Funds Management. "There are still significant regulation changes happening in China, in particular there will be labelling changes, and the way in which A2 needs to sell its product will change in the future - it sells less through the 'daigou' channel and more through established distribution channels in China."

"The key for them will be in successfully navigating that change. For Bellamy's there's been a complication, they had some very large take-or-pay contracts which meant that when their sales slipped behind they were still on the hook to pay for volumes, which meant they needed to start discounting, and that failed to move sufficient product and appears to have hurt their brand at least in the short term," Goodson said.

Bellamy's renegotiation of its take-or-pay contract with Fonterra was a significant part of yesterday's update, and while management refused to comment further on the details of the changes during an investor conference call, they said they were confident about their work with Fonterra in China. 

The two companies announced a five-year agreement in late 2015 which included a take-or-pay organic powder contract. That contract has now been extended by three years though required volume commitments have not been reduced. Termination rights for the contract have also been altered, giving Fonterra the right to end the contract if a person or group acquires more than 50 percent of the voting shares in Bellamy's, or if someone acquires more than 40 percent and Fonterra thinks they have effective control of the Australian company.

 

BusinessDesk.co.nz

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