Equities

I have just returned from China, looking at how Australian goods such as infant formula are sold and marketed, given the strong Chinese demand for such products. Being able to speak with shop attendants in their native language let me get to the source of information. In this wire, I share the key takeaways.

A2M Chinese labelling creating demand

One retail assistant in a Shanghai mother-baby store told me she had a target to sell 100 tins of A2 Milk per month and was selling well above that. She mentioned one key reason Chinese mums are buying from the store instead of online, which is 50% cheaper, is due to the A2M’s Chinese labelling. The labels promote an active ingredient, Lactoferrin, that the stores advertise as more tailored for Chinese children, which is driving foot traffic.

A2M dominating shelf space in Shanghai mother and baby stores. 

Regulatory hurdles

The State Administration for Market Regulation (SAMR) is a market regulator created in March 2018. The new super-ministry for market regulation subsumed three ministries: 

  • China Food and Drug Administration
  • State Administration of Industry and Commerce
  • General Administration of Quality Supervision Inspection and Quarantine. 

SAMR is now significantly impacting foreign companies, especially those involved in food and pharmaceuticals. The rate of approvals by SAMR has been decreasing rapidly. From August to December 2017, 209 overseas formula recipes were approved averaging 42 approvals per month. Since January 2018 until now, only 95 foreign formula recipes were approved, averaging 6 approvals per month – an 86% decline in foreign brand approvals. Currently, there are 200 foreign applications filed and not approved.

There is a Government mandate to increase onsite inspections which is a significant disadvantage to foreign suppliers who must make their factories available to Chinese authorities. Since the onsite audit requirement was implemented only three imported brands have been approved at the time of my visit to China. Two of them have Chinese ownership and one is from Denmark where Crown Prince Frederik intervened and personally lobbied for the SAMR team to visit his country’s facilities.

Point of differentiation

Commoditised infant formula products are struggling to compete in China against incumbent brands unless they offer a point of differentiation. Some trends are products that include non-dairy nutritional items and the promotion of non-cow milk products such as goat’s milk with its associated health benefits.

Increasing breastfeeding rates

It is our belief that infant formula market growth will come from consumers buying more premium products - while being marginally offset by the headwinds of flat birth rates and increased levels of breastfeeding (the percentage of mothers who breastfeed have gone up from 30%-40% to 50% due to government and hospital awareness programs).

Fight for the cities

The key battlegrounds for infant formula providers are in tier 3 and 4 cities as opposed to tier 1 cities like Beijing and Shanghai. Tier 3 cities like Weifang and Baoding have a population of over 9 million and 10 million respectively so they are still lucrative markets to target. Increased investment is going into lower-tier cities and new challenger brands are trying to secure a foothold in these areas, where established brands such as A2M dominate larger wealthier cities.

Advantage A2

The business’ biggest competitor is Wyeth’s Illuma A2 product which sources its milk from Ireland and is yet to receive a SAMR inspection.

Brands that received registrations early such as A2M have a head start and the regulation delay is a significant advantage for A2M. This competitive advantage is material and the longer the delay for other products, the better it is for A2M.

Having already received registration, A2M should aggressively expand into mother-baby stores to take more premium shelf space and provide mothers with the peace of mind that its products are here to stay.

We believe that A2M can take further ground in the mother-baby store segment through tactical on-the-ground sales and marketing initiatives to promote the brand such as using incentivised sales metrics for retail assistants. 

We own A2M as a research-driven investment in WAM Capital and WAM Research. Shares in A2M closed up 14.3% for the month to date.  

Interested in undervalued growth companies?

Get the latest insights from Wilson Asset Management delivered straight to you by clicking the follow button below and you'll be notified every time I post a wire.




Comments

Please sign in to comment on this wire.

David Broad

Great to hear from an expert with particular language expertise in an expanding market place with difficult regulatory issues.