Is Bellamy’s Australia a screaming buy..?

Investors who put their faith in Bellamy’s Australia’s (ASX: BAL) ability to meet new standards required to go on selling its (Guobiao) compliant formula into China will reap the benefits of the company’s first move advantage, while new entrants to this market are likely to find it increasingly difficult.

Given that the risks of Bellamy’s not meeting these new standards to continue selling into China – a market it’s been successfully operating in for over six years – seem low, the recent 14% hit to the share price, fuelled by market uncertainty does make the stock look considerably oversold.

What’s clearly fuelled the recent sell-down is the profit-taking by shareholders who decided to lock-in gains while the stock remains so highly valued.

Assuming Bellamy’s reaches mid-point of guidance at full year, with net profit after tax (NPAT) of around $32.5 million, or roughly 257% above NPAT from full year 2015, the shares would justifiably trade on a forward price-earnings (P/E) ratio of roughly 30.4x forecast earnings – and not the 104x last year’s earnings it’s been trading on.

Much of the market uncertainty is around whether Bellamy’s and its rivals in the infant formula space can obtain a registration certificate by the China Food and Drug Administration (CFDA) by 1 January 2018 to meet tougher food safety standards.

While new requirement specifics remain unknown, Bellamy’s infant formula and manufacturing facilities are already registered in China, which makes it ideally placed to transition successfully to the new standards.

Bellamy’s CEO Laura McBain has also allayed fears that the company will be significantly disadvantaged by a new 11.9% tax being imposed on goods bought from foreign websites – which  replaces a 10% parcels tax – due the sheer volume sold via the lucrative ‘grey market’ (customers selling products to one another) which is exempt from this tax.

Whether or not China decides to clamp down on ‘grey market’ sales – where individuals in Australia purchase items locally and sell it online to Chinese residents – remains unknown.

However, in an attempt to boost its margins, Bellamy’s is also actively ramping up its direct sales to Chinese consumers.

Not owning a single cow and the associate costs of being a milk producer has certainly enabled Bellamy’s to operate one of the best investment grade balance sheets of any stock on the ASX.

The stock has a long-term funding surplus, and exceptional earnings per share (EPS) growth over the last five years is forecast to remain so; with EPS of $0.38 in 2016 growing to $0.84 by 2018.

Similarly, return on equity (ROE) which has averaged 39.05% since 2010 is expected to grow from 51.83% in 2016 to 56.23% and 49.54% in 2017 and 2018 respectively.

One of the market’s top-performing shares last year, on the back of soaring demand for its products in Australia and Asia, Bellamy’s is now trading at a the 33% discount to its share price peak of $15.49 late last year.

 

This makes for an attractive entry point for investors who believe the stock’s fundamentals have not been compromised by tighter China food standards, but rather improved – by making it tougher for competitors to enter the world’s largest market – which only enhances Bellamy’s ability to grow its market share.

What also bodes well for Bellamy’s further expansion into China or beyond is the new production agreement with Fonterra (NZE: FCG) which reduces its reliance on manufacturer Tatura.

As a growth stock, Bellamy’s does deserve to trade at premium, and after the recent sell-down, the company is trading on a very modest 10% premium to its intrinsic value.

While the stock looks attractively priced against a medium price target of $17.07, market uncertainty suggests further share price weakness is in store.