The share price of Australian infant formula makers tanked on Tuesday, following a report from the Australian Financial Review that the Chinese government intends to increase production of local baby formula and reduce foreign involvement.
The share price of market darling A2 Milk Company Ltd (ASX: A2M) was down 8.63%, Bellamy's Australia Ltd (ASX: BAL) was down 5.31% and Bubs Australia Ltd (ASX: BUB) was down 9.38%.
What new regulations is China proposing?
The new action plan, prepared by China's National Development and Reform Commission, outlines a target of Chinese-produced formula to reach 60% of the infant formula market, in comparison to its current market share of 47%,
The intentions of the proposed plan are to squeeze foreign players out of the supply chain and encourage Chinese consumers to purchase products made locally. To reduce foreign involvement, the plan recommends tougher regulations on e-commerce sales and enforcing a zero-tolerance policy on importing unregistered infant formula.
Do Australian infant formula producers have an advantage?
Chinese consumers lost trust with local milk powder producers following a contamination scandal in 2008, which resulted in the death of several children in China and the hospitalisation of thousands more. As a result, Australian infant formula producers like market darling a2 Milk have trusted brand recognition among Chinese consumers by using high-quality and organic raw materials.
This gives Australian producers a competitive advantage over Chinese milk powder companies. Chinese producers can't afford to upset local consumers by eradicating imports totally, and will be forced to meet higher standards. As such, Australian companies could benefit as Chinese producers may look to acquire foreign companies or set up overseas production facilities.
Should you invest?
Australian producers are accustomed to battling tighter Chinese regulations—a prime example being Bellamy's, which is still awaiting state approval for its organic baby formula. In addition, the strategic document released by the Chinese government has not been officially translated into English and lacks a clear time-frame for when Chinese production will increase.
European companies Danone and Nestle are the biggest foreign players in China and should be viewed as the prime targets if such a plan were executed. The plan may also work in favour for Australian players that could emerge as potential takeover targets for Chinese producers looking to expand operations.
Given the overlying trade war between China and the US, the strategic plan released by the Chinese government could be purely political. In my opinion, the document was released more than two weeks ago and can be interpreted as a red herring to explain the sell-off in Australian infant formula producers rather than having any long-term ramifications. I think that the sell-off could potentially be an opportunity to buy quality companies like a2 Milk with a longer-term outlook.
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