Shares in former market darling Bellamy's Australia Ltd (ASX: BAL) rebounded modestly on Monday to close 3.74% higher at $4.16 per share. Although Monday's price gains placed Bellamy's amongst the top gainers on the S&P/ASX 200 Index (ASX: XJO) for the day, the rally is little solace for investors in the context of the company's whopping 66% fall over the last three months.
Accordingly, with no certainty that the company's share price has bottomed yet, I believe investors should avoid buying Bellamy's shares. Here's why.
Regulatory issues
Bellamy's experienced a torrid end to 2016, slumping almost 45% in December alone after management announced a shock profit downgrade as new rules by Chinese authorities disrupted supply in Bellamy's key growth market.
In sumamry, Chinese agencies imposed new restrictions on the importation of baby formula into China, causing competitors who were unlikely to comply with the new rules to liquidate inventory. Inadvertently, the fire sales led to deep discounting by competitors, affecting Bellamy's profit margins and revenue.
Operational issues
To make matters worse, shortly after the shock downgrade, Bellamy's entered into a month long trading halt to renegotiate key contracts with New Zealand-based supplier Fonterra Unit NZX (ASX: FSF).
From its review, management forecasts 2017 full-year revenues will be between $220 million and $240 million. Profit margins are expected to slow to between 6% and 9% of revenue in the first half, further reducing to 4% to 6% in the second half.
These estimates indicate no short-term respite is in sight, with the company anticipating a 44% to 66% drop in net profit.
Management issues
Bellamy's completed its trifecta of tumult after announcing a major reshuffle to its executive team.
Managing Director and CEO Laura McBain will depart the company effective 31 March 2017, with Chief Operations and Strategy Officer Andrew Cohen taking the helm as acting CEO thereafter.
Now what?
Though the change in leadership demonstrates the Board's intent to put Bellamy's business back on track, the pivotal regulatory issues in China remain.
Whilst Bellamy's currently remains solvent and compliant with it lending covenants, as investors in Slater & Gordon Limited (ASX: SGH) and Surfstich Group Ltd (ASX: SRF) can attest, things can continue to get worse before they get better.
Accordingly, with plenty of downside still left for the shares, I'd be weary of committing fresh funds to Bellamy's today.
Foolish takeaway
Although I don't expect Bellamy's to go the way of failed Forge Group and Dick Smith Holdings given the company continues to churn out profits, I don't expect a quick recovery to its share price.
Whilst it is entirely possible that Bellamy's China headaches will subside and only affect its 2017 results, I'd wait to see signs of a turnaround before committing to buying the stock.
