The Formula Of A Trade War

Much fire and fury surround the Australian baby formula industry today, with Chinese shoppers clearing the supermarket shelves in hopes of turning around a huge profit reselling into the Asian market; a venture perhaps mirroring their own ‘art of the deal’. Demand is far outstripping supply, and with Australian companies looking to directly export their products, the sector seems to be a source of unending profits.

Bellamy's Australia Formula
Source: Bellamy’s Australia 

Conventional trade disputes are usually quickly resolved to minimize impact, but Trump has proven anything but conventional, with a stand-off ensuing from the global economic epicentres of China and the US. As the fallout from the trade war gradually washes up on Australian shores, the very same milk companies that went from strength to strength a year ago are feeling the tides of politics turning against them.
Investors in Bellamy’s; a prominent baby formula producer; were no doubt drowning in despair yesterday, after its share price dropped 4.92% off the back of a broker note from Goldman Sachs, slashing its price target by 18%. Overall, Goldman Sachs has reduced its earnings forecast for Bellamy’s by 1% for this year, and 22% in FY 2019, and a glance at current trade tensions reveal why – the CDFA potentially delaying its product approval by several months, giving an advantage to competitor A2 Milk Company Ltd.

Global tensions are heating up over a potential trade war between China and the US, with Australia being caught up as collateral. With our unique position of being politically tied with the US, and economically linked with China, Australian companies must be rigorous in maintaining their international relations in the face of diplomatic hostility.

Shaky investor confidence goes far beyond a simple brokerage note and reflects underlying weaknesses behind the astronomical growth of the infant formula niche. Especially in a market like China where the bulk of Bellamy’s growth has been occurring, brand loyalty is a huge factor that reigns over conventional marketing efforts, and any product delays could be devastating as rival brands establish a foothold in the lucrative sector. Wattle Health Australia Ltd and The a2 Milk Company Ltd (mentioned previously) are no doubt ecstatic over this development, both vying for the position of industry leader amongst Chinese consumers. It’s not all doom and gloom, however, as a P/E ratio of 27x based on forecasted earnings is still within an acceptable range for a growth company, and Goldman Sachs itself maintains a buy rating believing that long-term growth outweighs a small pain in the short-term. Bellamy’s new health-focused products are also targeted towards an increasingly health-conscious average consumer.

As such, existing investors would most likely be better off holding their shares as the price is projected to recover, absorbing the temporary weakness for high potential upside. For any entrants to the milk formula scene, on the other hand, further downgrades could occur resulting in a comparatively volatile investment considering the returns to be gained.

Overall, investors are encouraged to HOLD Bellamy’s shares as the current price drops reflect a knee-jerk reaction in a sensitive market. However, risks such as trade tensions and regulatory approval should be monitored regularly lest their share price is wiped off faster than their formula flies off the shelves.

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