Just six months ago, organic baby-food company Bellamy’s was flying the flag for a new Australian economy. Australia’s reputation for healthy, clean food was going to pick up the resources slack as China’s growth transitioned from infrastructure to consumption,
No stock encompassed the opportunity better than Bellamy’s, where sales grew from less than $30m in 2013 to $245m in the most recent financial year.
The stock is in a trading halt this morning. Another downgrade is likely, just a few weeks after the company’s first profit downgrade caused the share price to halve.
Knives will be out. The company’s lack of infrastructure will be scrutinised. Its lack of marketing expenditure will be blamed. But the cause of its woes is much simpler.
Here today, gone tomorrow
In China, there is nothing extraordinary about a product experiencing a dramatic surge in sales. A company’s brand can quickly become the latest, hottest product. With a growing middle class of more than 150 million people, becoming hot can be transformational.
And then, all of a sudden, the latest and greatest will be usurped by the next hot thing. Sales evaporate and bewildered executives can’t do anything about it.
This comes as a shock for a lot of Western investors. They think they have found the next Coca-Cola or Gillette – a brand that can grow for many decades in a market that itself is growing rapidly – only to see its growth prove remarkably ephemeral.
Asia’s best brands don’t exist yet
It should not be that surprising though. As I was starting high school in 1990, China’s GDP was less than $US2,000 per person. Most of its population was still well below the poverty line. While Coca-Cola was telling me sugary water was going to give me a six-pack and make me happy, my Chinese equivalent was already in the work force trying to feed his family. There was no point advertising to someone who couldn’t afford to buy your product.
Almost by definition, a strong brand is one that has been around a long time and has a permanent place in its customers’ psyche. China’s economy is so new and changing so fast that very few brands have been able to establish themselves. So what’s hot one day can be very cold the next.
Local brands will reign in China
Second and third generation Asian consumers are already shying away from Western brands and flocking towards “cool” Korean and Japanese products. Korean cosmetics companies have been prime beneficiaries. I don’t doubt that Asia will have plenty of established local brands in a few decades’ time. Indeed, entrenched Australian food brands may well have a place.
Bellamy’s might just be one of them.
For every company that manages to reach the peak, though, there will be hundreds that get a foothold only to tumble back down. It is almost impossible to pick the winners today. Indeed, the victors might not even exist.
If Ben Graham’s cigar-butt approach to investing appeals, there are hundreds of deeply discounted assets plays in China and Hong Kong. They tend to be traps not bargains. If you are a fan of Charlie Munger’s high quality businesses, picking winners won’t be any easier. China’s economy is a primordial soup where the survivors will be few and far between.
What amazes me is how many broker analysts have their EPS forecasts massively wrong (for TPM and SRX as well). Do they talk to the company and get an indication that their forecasts are at least in the ballpark? As a retail investor, what can we do, just ignore broker forecasts?
The forecasts are wrong because the future is unknowable. So yes, I suggest ignoring them.
Thats why they are called forecasts and not for certains…
I appreciate the point. Some companies seem to manage the expectations better, they may point investors to broker reports on their websites, they won’t comment but the fact that they pointed to the report is usually a good sign. I note that SSM recently responsed to a price query by pointing to an analyst forecast and implying that they were in the ballpark. http://www.openbriefing.com/AsxDownload.aspx?pdfUrl=Report%2FComNews%2F20161102%2F01798179.pdf
Fantastic article. This applies to pretty much any developing country. The lessons of the last 20+ years of the big boys going to China to make a fortune, and losing one, have been long forgotten.
Far better dealing with countries and markets where you can have some semblance of knowing what’s going on, and avoiding any hyped up Next-Big-Thing.
I think you’re learning the wrong lesson. How about “not blindly going where every lemming is headed, and not paying for a perfect blue sky”.
There are a lot of cultural issues at play here.
I am told that many Chinese do not trust Chinese e-commerce sites to buy Western products because there are too many fakes and counterfeit goods. It has even been reported that in China some “entrepreneurs” were obtaining used baby formula tins, refilled them with local product, sealing the tins and passing them off as the genuine article.
That is why some well to do and middle class Chinese would rather pay more and have a trusted daigou source their product. Their daigou provides the baby formula plus an original Coles, Woolies or Chemist Warehouse receipt, and in some cases a photo of them purchasing the goods.
Bypassing the daigou may actually have been counterproductive.
This is another example of why businesses should seek to have diverse workforce with diverse leadership.
Take a look at how much Bellamy’s was shorted before the collapse. Shorters saw it coming a mile away
http://www.shortman.com.au/stock?q=bal
Perhaps the Chinese govt simply wants to protect its growing domestic dairy and diary product value added industries. The lesson is that the Chinese dairy herds and breeding stock have ironically been developed with our help.
Look at Australia, NZ The UK, The US and Canada: All five countries have enjoyed broadly similar levels of prosperity over the past century, speak the same language and are ethnically and culturally similar.
Yet, not counting situations where patent protection or technological advantage spawned a brand (e.g., Hoover, Xerox, IBM etc.), how much commonality is there between consumer brands in those countries?
There is some (e.g., Coke, McDonalds etc.) but not much.
I’ve given an enormous amount of thought to brand survivorship, and I’ve reached the conclusion that, in the very long term, there are no reliable a priori indicators that an investor can use. You simply need to be cognisant of the zeitgeist.
Bellamy’s has been an easy call for the past few years because the price was so utterly dependent on growth, it’s going to get a whole lot harder as the price goes down from here. My sense is that another contamination scandal will rescue the shareholders’ fortunes. Failing that, sales will probably stabilise at some lower level, that is nonetheless substantially higher than $30m.
It really amazes me not many “experts” point to BAL’s poor FCF generation capability and yet, many sell-side analysts forecast astronomical J-curve like growth assumptions to underpin their ambitious share price targets. This is the fundamental professional failure of analysts extrapolating current trends into perpetuity without questioning the real world sanity of having such assumptions.
My investment experience always leads me to look at Cash Flow generation first before accounting profits. In here, I look at two key ratios below – Trade working capital (definition: Current receivables + inventory – payables) as % of reported sales and net operating cash flow/accounting profits or some call it the cash conversion ratio. Both ratios have been showing alarming deterioration trends despite strong sales growth and accounting profits. Yet, not many experts put much rigour or debate as to what underpins such those alarming trends.
Note: Mead Johnson FY16 ratio relates to nine months of FY data, whilst Nestle and Danone FY16 relates to six months of FY data – as all three companies have December year-end FY period.
Using a comparable small group of peer group analysis, BAL’s Working Capital (WC) position stands out as high – and hence, deserves some scrutiny in regards to BAL’s competitive analysis. Without privy to direct BAL management contact, there were two questions that I had for some time and hence, prevented me from investing and paying up for BAL –
1) The key supplier terms in which BAL agreed upon. BAL is essentially a milk nutrition marketing company, as it does not own any upstream or downstream value chain assets. In a sense, this has enabled BAL to report very attractive ROE (46% in FY16) due to the capital light perception (other than working capital). However, BAL has only really started to diversify in the past 12-18 months of its upstream supplier base (eg: signing up Fonterra as an additional manufacturing partner to supplement its long standing supplier, Bega) in order to meet the strong demand backdrop. Under such backdrop, my concern is BAL has agreed on unfavourable terms in order to secure reliable supply – such as fixed volume take-or-pay like terms. Such terms are only good should there is a linear strong growth trajectory in actual sales growth. Otherwise, it could create an inventory overhang issue in slower sales growth environment – which in turn could create a virtuous cycle (ie – inventory overhang leads to channel stuffing and price discounting and then brand premium perception mis-management).
2) Distribution Channel: The BAL bullish narrative has been on its ability to sell to mainland Chinese customers who puts a premium on Australian’s food safety and quality vs local brands. Before the recent Chinese Government crackdown in April 2016, much of this has been sold via either the grey market or the T-malls equivalent like online channels rather than the traditional bricks & mortar channels. Earlier this year, BAL management appeared to have made a comment that circa 50% of its sales benefited from such channels. To me, that is staggeringly dangerous and led me to question two things – 1) how close is BAL to the end customer, given there could be as many as four layers of intermediaries (Australian supermarket, daigou, T-Mall agent in China, independent retailer in China) between BAL and the end-user of BAL products – and as such, how confident can BAL is when making future sales forecast?; and 2) how much of the strong sales growth in the past 12 months was apparent vs real demand? In a hotly sought after products backdrop, I have seen sales growth being “inflated” temporary due to wholesale agents clamoring for products and build another layer of upfront inventory. I point to the sudden collapse in sales trajectory narrative of Nufarm and Incitec Pivot in 2009 as well as Iluka Resources in 2012.
Before the 2nd December profit warning, the market was ascribing a FY17 PE of 21-23x (based on $12.13 share price). Not only these multiples were trading at a premium to some of the larger and more established offshore peers, the multiple was premised on an accounting profit figure, which has been a poor proxy to cash flow. If I was to use NetOpCF instead of a statutory figure, BAL would be trading on a current FY16 P/NetOpCF of 132x multiple.
The sales slowdown should not have come as a left-field surprise if one listens to offshore peers recent trading experience. I refer to comments made by Nestle, Mead Johnson and Danone comments about their China’s sales experience since June this year. Below is an example of such comment from Danone:
Source: Danone 3QFY2016 result press release 18 October 2016
BAL shares are currently in suspension. A typical trading revision should not have taken more than a day to sort out. This suggests an abnormal issue to the causes of the trading update. If I were to guess, the trading downgrade (assumingly) would be centred on either – 1) accounting irregularity issues – such as discovery of channel stuffing (ie – sales agents pushing products to middle person to meet sales targets); and/or 2) inventory write-downs triggered by distributors pushing unsold products back to BAL.
The positive thing about BAL though is its strong capital position as it has no debt. Despite the trading setback, the brand has goodwill value (especially to an opportunistic Chinese trade buyer) and BAL management’s recent investment initiatives are much required and part of the natural evolution of an emerging growth company.
Note – it seems like i cannot post rich text or tables on this comment box. This note has two tables to accompany with the comments.
Excellent commentary.
sj, stay consist to your mantra – ‘those who predict are very clever at pretending, in being all knowing of the un-knowbale…’
Perhaps someone else could look at the accuracy of ‘forecasts’.
I discovered that using a very simple algorithmic approach on past data yields accuracies as poor as the Analysts forecasts. Unfortunately for statistical purposes the sample sizes are under 500 (companies).
Repeating the analysis does required an ‘elapsed’ year as I have yet to discover sufficient historical forecast data
An aid to the integrity of corporate executive management will be the facility to track the probity record of its make up of its corporate board directors.
A classic case is the sudden downturn of Bellamy’s, a one time darling of the ASX, reports of directors selling major shareholdings prior to a huge profit downgrade has been reported to the ASX.
Another indicator is to examine the director individuals of the various corporate agriculture concerns that had made submissions to participate in the Federal government water buyback scheme, eg Websters Ltd, that saw them well positioned to reap a huge return for an entitlement to offer a non-identifiable nor visible materializing return of water to the Murray Darling River Basin.
Excuse me, this has the essence of a “provocative ministerial intervention?”