Bega Cheese and Blackmores' infant formula venture rocked by slow sales

Bega stock crashed 16.8 per cent to $5.40 after executive chairman Barry Irvin told shareholders at the company's annual general meeting on Tuesday that regulatory changes in China had resulted in discounting and oversupply in the Chinese and Australian formula markets.

"While this time last year supermarket shelves were empty and customers in Australia and internationally were providing ever increasing orders, the combination of a regulation change in China, a supply response to the demand signals and the evolution of supply channels to market now sees significant discounting in the market place and signs of short-term oversupply," Mr Irvin told the meeting.

"This change in market circumstances has seen our expected sales not materialise at levels that were initially forecast and some strong headwinds for the partnership particularly in the Australian market."

According to industry sources the latest figures from Aztec Data show the Blackmores infant formula has secured less than 0.4 per cent of the Australian market since launching in late January. That means they are selling roughly 1600 units a week, compared to about 400,000 for the category.

Australia retail sales data is indicative of Chinese demand for infant formula, as it is estimated around half of all purchases made in Australia are sent via courier to China by personal shoppers known as Daigou.

Blackmores is discounting its infant formula on Chinese websites to attract customers.

Usually, a tin of its formula costs 229 yuan ($44) but it is now selling for less than half that at 99 yuan in the Blackmores store on Alibaba's T-mall site. In comparison, a tin of Bellamy's formula is selling for 200 yuan, a slight discount from the normal price of 238 yuan.

One Daigou entrepreneur, who trades under the name Kangaroo Street, said infant formula was different to other products in that it takes a long time to build a brand and develop a loyal following.

"People are giving this to their children," she said via instant message, adding they were looking for a recommendation or a long track record.

"It takes time for consumers to understand and get to know a brand."

Mr Irvin announced a $5 million to $7 million provision on the value of its stake in its Blackmores joint venture.

"The partnership is keeping the business under constant review and will continue to monitor the performance with our partner Blackmores as market evolution and circumstances becomes clearer," he said.

The market situation is similar to that described by Blackmores itself when it delivered a surprise profit warning in August.

Blackmores said that big retailers such as large pharmacy chains and the supermarkets bought large amounts of stock towards the end of the 2015-16 year in anticipation of the boom in vitamins continuing.

But Blackmores and the retailers were caught out by a change in approach from the Chinese businesses in Australia that have been raiding the shelves of these retailers for years to send product back to China. These businesses, known as daigous, are looking to buy directly from the manufacturer to avoid the retail mark-ups.

CLSA analyst Shaun Weick said he "continues to believe that Blackmores faces significant challenges in infant formula driven by a lack of differentiation in product offering with additional investment in building brand awareness in domestic markets necessary before material traction can be gained offshore".

"Weakness in domestic performance has been clearly demonstrated by material price discounting of late (up to 50 per cent in Woolworths), while recent feedback from our industry contacts continues to suggest limited traction in China to date."

Mr Irvin said Bega expects earnings before interest, tax, deprecation and amortisation to be broadly in line with the 2016 result of $66 million, excluding the provision on the Blackmores venture.

However, he was able to provide farmers with a more upbeat update on the outlook for dairy commodity prices, which are expected to improve throughout the next 12 months. Mr Irvin said farm-gate milk prices are likely to be "more reflective" of market returns.

"The ongoing growth in dairy foods and the improved outlook for dairy commodities are expected to improve our financial performance in FY2017, however this improvement will be offset by a very challenging business environment for our dairy nutritionals platform particularly in infant formula and growing up milk powders."

The Bega writedowns come after a horror year for the Australian dairy sector. Murray Goulburn's decision to inflate – and later slash – the price it paid farmers for milk against a backdrop of falling global dairy prices has sent shockwaves through the sector and pushed farm-gate prices down across the industry.

This story was first published on The Australian Financial Review.