There is no doubt that Bellamy's Australia Ltd (ASX: BAL) was a superstar stock in 2015 and became an instant market darling for many investors.
The shares started 2015 at around $1.69 a share and ended up closer towards $16.50 by the end of the year – a monster gain of 876%.
It has been a contrasting story in 2016, however, with the shares losing around 35% of their value since hitting that high of $16.50 in late 2015.
While it would be normal to expect the shares to take a breather after such a strong performance, there is, nevertheless, a number of factors that have seen the shares become surprisingly volatile over the past few months. This despite the company confirming several times that it would generate full year sales of between $240 million and $260 million.
Five factors that I think have had the biggest negative impact on the infant food company's share price include:
Changes to Chinese regulations – This has perhaps been the single biggest issue facing Bellamy's and a number of other companies in the sector that sell a significant proportion of goods into China. Bellamy's is confident, however, that these new taxes are unlikely to impact the demand for Bellamy's products and that Chinese consumers will be able to easily absorb any price increases as they have done so in the past. Nevertheless, there has been anecdotal evidence that suggests shipments of goods are being delayed at Chinese customs and that some local courier companies have delayed making deliveries into China.
Increasing levels of competition – The global baby formula market is growing at around 7% a year and is expected to increase even further following the official ending of China's one-child policy. As a result, new players are entering the market in a bid to grab a slice of the action and established players like a2 Milk Company Ltd (Australia) (ASX: A2M) are ramping up their production levels to take advantage of the growth.
Flat second half margins – In its first half results, Bellamy's recorded sales of $105.1 million and forecast second half sales of between $134.9 million – $ $154.9 million. While this level of sales growth in the second half would be impressive, investors have been concerned that management expects second half EBIT margins to remain the same as the first half.
Stretched valuation – According to CommSec, Bellamy's is expected to deliver FY16 earnings per share (EPS) of 23.5 cents. I think this is a little on the low side considering the company recorded first half EPS of 13.9 cents. Nevertheless, even if the company generates full year EPS of 30 cents, the company is still trading on more than 35x estimated earnings. At $16.50, it was trading on 55x estimated earnings. When companies trade on such high valuations, even the slightest change in sentiment will have a huge impact on the share price.
Increased short selling – It might be hard for some investors to believe, but Bellamy's is now the 11th most shorted stock on the ASX with around 8.6% of all shares currently short sold. As the graph below highlights, there has been a huge spike in short positions starting at the same time the share price started to fall.
The increased level of short selling has coincided with weakness in the share price, but the bigger concern for investors is that short positions have continued to climb over the last month. Short sellers are usually very well informed and some investors might now be asking whether or not there could be more downside risk from here.
Foolish takeaway
There is no doubt Bellamy's is a quality company, but at the end of the day it comes back to what somebody is prepared to pay to own it. I'm not totally convinced that the shares are offering a good enough risk-reward proposition to be a standout buy, but I would definitely consider buying if the valuation became more attractive than it currently is.
