A2 Milk sets out changes imposed by Chinese regulators

Wednesday 6th April 2016

Speciality milk marketer A2 Milk has outlined a number of regulatory changes signalled by the Chinese government in relation to the lucrative infant formula market, in an investor presentation in Sydney.

The company, whose shares have risen 245 percent on the NZX and 213 percent on the ASX in the past year on the back of an infant formula boom in Australia and China, said the dairy product now accounts for 53 percent of group revenue. That compares with just 7 percent two years ago.

Most of A2's infant formula sales are through Australian supermarkets and popular brands are often resold from Australia to China’s grey market through online retailers or “suitcased” in by travellers because it costs significantly more in that country.

A2 said its direct sales into China are increasing through cross-border e-commerce sites such as T-mall and JD.com and Mother & Baby retail stores.

The Chinese government signalled last year further food safety laws designed to tighten infant formula supply chains and improve food safety.

Two years ago China’s Certification and Accreditation Administration cut the number of foreign infant formula brands that could be sold in the country significantly after the market became flooded in the wake of the 2008 melamine poisoning scandal. This time around, under new laws due to be implemented shortly, manufacturers will be limited to selling only three brands and nine formulas in China.

Chinese manufacturers commonly produce infant formula in large batches to reduce costs and shift any leftover to distributors to sell in different regions under sub-brands at lower prices to the original brand. Chinese media have reported the government calculates as many as 80 percent of the more than 2,000 Chinese infant formula makers could be eliminated by the law change but it could prove beneficial for foreign producers such as A2 which rarely export more than three brands anyway.

Chief executive Geoff Babidge has been typically cautious in his comments on the impact of the regulatory changes after the company was caught out two years ago when its manufacturing partner Synlait had to wait for registration.

He said while the infant formula regulatory environment in China continues to evolve, the company considers itself well placed to respond to the changes in conjunction with Synlait.

It’s assessed the risks and still forecast full-year group revenue to be in the range of $335 million to $350 million – more than double that in 2015 with group operating ebitda in the range of $45 million to $49 million – a tenfold increase on last year.

In its investor presentation, A2 outlined the timing of a raft of Chinese regulatory changes but stopped short of providing much detail on the likely impact on its business.

It said it complies with a new China advertising law applying to China label product that took effect in September last year.

A new 11.9 percent cross-border e-commerce tax on goods bought via foreign websites takes effect on Friday and A2 said only that it affects both free trade bonded and non-bonded imports.

A third draft of the Food Safety Law Implementation Plan is also expected in coming months under which both domestic and imported infant formula product needs to be registered under and comply with.

Regulations are also being drafted after consultation ended last month on China’s WTO submission which introduced the three brand, nine formulas, policy last year.

And a proposed change in scope to include toddler nutritional formula will mainly restrict packaging and advertising with consultation due this week, A2 said.

Later this month it’s due to release the published results of a human clinical trial conducted on 45 people in China, chosen due to its significant levels of reported lactose intolerance.

The results lend further support around the digestive benefits of milk free of the A1 protein, it said.

“Findings enhance the commercial opportunity for A2 within China and other markets with high levels of milk intolerance,” Babidge said.

A second clinical trial is now underway on 600 Chinese, including adults, pre-schoolers, and infants.

(BusinessDesk)

BusinessDesk.co.nz

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