Every boom brings with it a bust. But when it comes to companies relying on China for a large portion of their sales, the wild card of government regulation looms large over any decision made by management.
For Murray Goulburn, the swings in the dairy market were first felt in early 2016, when a profit warning triggered a collapse in the share price as it slashed the price paid to dairy farmers for the milk it bought as it grappled with oversupply in the China market.
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Bellamy's CEO Laura McBain has been widely credited for transforming the family-run local company to a global brand.
Even so, it went ahead with an estimated $300 million outlay on a new infant milk formula plant that was based partly on a contract to supply the US major Mead Johnson, a deal that was axed last month as the downturn in the China market began to bite.
It was Bega Cheese's turn in October as it warned of sluggish infant milk formula demand in China where it has teamed up with Blackmores to launch a new brand. Investors took fright, dumping its shares.
So it seemed it was only a matter of time before one-time market darling Bellamy's Australia was hit. The surprise wasn't that it has been whipsawed by changes in the all-important China market, but that it took so long to admit it wasn't immune to the convulsion being felt by other large suppliers into China.
Healthy niche
It has carved out a presence at the premium end of the market, supplying organic infant milk formula, sold largely via e-commerce platforms into China as well as via the "daigou" channel of individual traders buying product off the supermarket shelves in Australia. The Chinese government, incidentally, is seeking to dismantle that latter channel.
The travails of Bellamy's have triggered the ousting of its long-term chief executive, Laura McBain, and a public brawl between some of its original backers such as Kathmandu co-founder Jan Cameron and the board over where responsibility lies, with a push for all the independent directors to be sacked. Cameron claims a group of shareholders who hold as much as 35 per cent of Bellamy's stock want to shake up the board, with a shareholder meeting to settle the matter slated for next month.
Since trading in Bellamy's shares resumed on Wednesday after a four-week suspension, they have slumped 38 per cent, with a series of brokers such as CLSA, Ord Minnett and Citi slapping "sell' recommendations on the company's shares due to uncertainty about how long it will take to turn the operations around.
![Bellamy's former CEO Laura McBain, who was ousted this week.](/web/20170115030758im_/http://www.theage.com.au/content/dam/images/g/t/r/b/n/o/image.related.articleLeadwide.620x349.gtocqa.png/1484359007849.jpg)
In the global market for milk products Australia is only a bit player, exporting modest volumes mostly of milk powders and cheese. Even so, a "clean, green" image has enabled some local processors to carve out a handy niche, even flying in fresh milk from northern NSW and, from next month, Tasmania.
But it is the higher margins available from processed dairy products in China, in particular infant milk formula, that has enticed local dairy groups. Booming demand for imported infant milk formula, particularly in the wake of quality scandals, eventually prompted the Chinese government to step in to try to regain control of the market. Faced with more than 2000 brands of infant milk formula from more than 100 manufacturers, all making a range of claims about their benefits, in mid-2016 it introduced new rules giving the government greater control over the market.
![Bellamy's can](/web/20170115030758im_/http://www.theage.com.au/content/dam/images/g/t/r/8/n/u/image.related.articleLeadwide.620x349.gtocqa.png/1484359007849.jpg)
New rules
All dairy factories supplying China must be registered and each manufacturer is limited to three brands, and three unique formulations per brand.
The new rules take effect from January, 2018, and all suppliers must be registered with China's Food and Drugs Administration. Unsurprisingly, there are concerns that delays in processing the paperwork will see foreign suppliers suffer as domestic Chinese suppliers are favoured. Reducing the number of suppliers will see smaller players exit, with the prospect that the premium end of the market will take share from the middle and lower end.
![Bellamy's used the informal daigou shopper channel as one of its major routes to market in China.](/web/20170115030758im_/http://www.theage.com.au/content/dam/images/g/p/f/j/l/g/image.related.articleLeadwide.620x349.gtocqa.png/1484359007849.jpg)
But in the short term, the changes have created a glut as suppliers get rid of product before the rule changes. As a result, the China market is likely to remain tough for at least the next year. Global players in the infant milk formula market such as Abbott Laboratories and Danone have complained of tough trading conditions in China as suppliers dump stock onto the market, although others such as Mead Johnson reckons they have strengthened their position at the top end of the market and are easily riding out the storm.
"China is very opaque," said Steven Spencer of FreshAgenda, a specialty advisory outfit to the dairy industry. "It is structurally short of milk – it is around 80-85 per cent self-sufficient."
![Original Bellamy's backer Jan Cameron has been involved a public brawl with its board over where responsibility lies.](/web/20170115030758im_/http://www.theage.com.au/content/dam/images/g/t/r/b/n/f/image.related.articleLeadwide.620x349.gtocqa.png/1484359007849.jpg)
The government there is pushing to restructure dairy supply as its consumers become more sophisticated, Mr Spencer said, as it shifts away from mostly small, village-based suppliers.
"The move now is to decrease the number of players to a smaller number of more reliable suppliers; less proliferation of suppliers mean fewer problems."
'Arm wrestle'
But the more-affluent consumers have the money to afford imported product, which they continue to buy.
"That's the arm wrestle," he said. "Will that import market ever go away? The consumer with money in their pocket are demanding imported product. The government is shutting down daigou and developing online – but there is still strong demand for imported product."
The issue for Australia is whether it has sufficient product to be more than a niche player in China.
"The Australian industry is well known ... [but] we don't get a free kick," FreshAgenda's Spencer said. "Europe is especially active with processed product, UHT [longlife] and so on. No one seems to be able to crack China and access the margins in the supply chain – a lot of people are clipping the ticket on the way from port to the consumer."
Globally, the dairy market has been buffeted by the removal of caps on European production, Russian trade sanctions that choked off a large source of demand, coupled with slowing demand from China. The consequent plunge in prices paid to local dairy farmers has forced some out of the market in Victoria in particular, cutting milk volumes – reductions that have been mirrored in all major markets globally.
Those reductions – with Australian production down an estimated 10 per cent – have set the scene for prices to rise, which is expected to become more pronounced during the next six months, according to forecasters such as FreshAgenda's Spencer and Rabobank.
Rabobank reckons Australia's milk supply will fall 7 per cent this financial year, hitting a 20-year low. For its part, Fonterra, the New Zealand co-operative, confirmed late in the week its collections in Australia fell 7.6 per cent in the December half alone.
"Most dairy processors are battling lower milk volumes, exacerbating the need for maximising milk returns and limiting the impact of lower plant throughput. The latest production data highlights a focus on a cheese-and-whey products stream [due to contractual arrangements], in preference over skim milk powder and whole milk powder," Rabobank said this week.