Bellamy's Australia: Favourable risk/reward emerges

About the author:

Author name:

By Belinda Moore

Job title:

Senior Analyst

Date posted:

16 August 2018, 9:10 AM

Sectors Covered:

Agriculture, Food & Beverage, Travel and Chemicals

Key points

• We believe recent regulatory activity suggests assessment rates for China infant formula registrations are returning to pre-merger levels. In our view, this increases the likelihood of Bellamy's (BAL) receiving CFDA approval in 1H19 and provides a potential positive near-term catalyst not captured in the stock’s current price.
• With a favourable risk/reward return profile, we upgrade to an Add rating and set a new share price target (Morgans clients only). Only suitable for investors with a high risk tolerance.

Sell off creates opportunity; SAMR appears back to business

BAL’s share price has fallen ~60% from its March high. We attribute the severe weakness primarily to its delay in receiving SAMR registration for its China labelled infant formula products (previously referred to as 'CFDA registration’). We believe the delay in SAMR approval is due to the merger of China’s CFDA, AQSIQ and SAIC functions into a single regulatory body (SAMR) during 1HCY18.

The merger created delays in processing applications and no approvals were announced for over three months. However, we believe there is sufficient evidence to indicate the SAMR is returning to its pre-merger assessment rates (1-2 rounds of approvals per week).

It announced a new round of approvals on 14 August and released its "3 stipulations scheme" outlining the new body’s organisational structure and functions. We believe these developments increase the likelihood of BAL receiving SAMR approval in 1H19.

Highlighting the risks

Our positive investment view on BAL is only suitable for investors with a high risk tolerance. We detail potential negative catalysts in greater detail in this note. Clearly, the greatest risk to our view is that BAL does not receive SAMR approval at all or it is received in CY19 and the proposed CBEC regulatory changes (requiring SAMR) are enforced.

Given the brand's strong appeal to Chinese consumers, we continue to expect BAL will receive SAMR approval. With indications the SAMR assessment rates will increase, we believe the potential upside rewards of approval outweigh downside risks.

We revise our forecasts

We have revised our FY18/19/20 NPAT forecasts by 7.2%/18.0%/20.0%. Our FY18 revision reflects a more conservative 2H18 GP margin. In FY19, we have removed our entire full year estimate of BAL’s China labelled MBS sales and the revisions to FY20 are largely due to a re-basing of our forecasts.

We believe FY19 earnings growth will be underpinned from a full-year benefit of lower ingredient costs (expansion in GP margins) and market share gains. FY20 should benefit from an expansion into China MBS and Camperdown achieving profitability. Over time, we see scope for BAL to implement price rises, expand its product range and enter new geographies.

Investment view

There is still much to like about BAL. Its delay in receiving SAMR approval has afforded investors the opportunity to acquire a company with a premium brand (point of differentiation), operating in a growing, high-margin category which enjoys an established domestic presence and strong brand awareness among Chinese consumers.

These are qualities its emerging FMCG peers have found difficult to replicate. With the stock oversold and evidence China’s SAMR is back to business, we believe the potential rewards from near-term catalysts outweigh the outlined downside risks. We upgrade to an Add rating with a new price target (Morgans clients only).

More information

Morgans clients can login to view our detailed report and share price target for Bellamy's Australia (BAL). Alternatively, please contact your nearest Morgans office for access.

Disclaimer(s): Analyst owns shares.

The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.