Explainers

Infant formula is big business with Australia and a number of ASX stocks at the forefront. Here's a guide on the infant formula sector and ASX-listed companies that are involved in the trade. This updated guide recaps what you need to know about the sector generally and some of the market themes in the past 12 months. Key points The infant formula sector has grown rapidly in recent years and a number of ASX stocks have benefited. Catalysts have been population growth in China and the broader Asian-Pacific region as well as a consumer preference for imported brands. The sector has seen several challenges in 2020 with supply chain disruptions (particularly the daigou trade) and China ramping up investment in its domestic industry. A number of ASEAN countries represent alternative opportunities but are unlikely to ever be as lucrative as China. 7 ASX stocks are direct players in infant formula: A2 Milk (ASX:A2M), Bubs Australia (ASX:BUB), Nuchev (ASX:NUC), Jatcorp (ASX:JAT), Synlait (ASX:SM1), Clover Corp (ASX:CLV) and Fonterra (ASX:FSF) Happy Valley Nutrition (ASX:HVM) and Australian Dairy Nutritionals (ASX:AHF) are working to become full players in the years ahead HRL Holdings (ASX:HRL), Bioxyne (ASX:BXN) AuMake (ASX:AU8) are indirect players in the sector. Industry overview Over the past several years demand for infant formula has grown exponentially, and this is particularly true in Asia with China being the largest market. ASX infant formula stocks are particularly strong evidence of this growth. For instance, the market's biggest stock A2 Milk (ASX:A2M) rose from 56 cents in March 2015 to $13.76 in November 2020. Bellamy's (ASX:BAL) experienced similar growth before it was acquired last year. The broader ASX dairy sector is even larger, but not all dairy stocks play in the infant formula trade because it is a highly regulated niche. Where infant formula all came from Infant formula dates all the way back to 1865, a time during which women who were not able to breastfeed often employed a wet nurse -- another woman who could breastfeed -- to ensure her children were well fed German chemist Justus von Liebig developed, patented and marketed an infant food, first in liquid form but moving to a powdered form as it prolonged preservation. His formula consisted of cow's milk, wheat and malt flour and potassium bicarbonate. (Modern formula is also made with cow's milk but is supplemented with a stack of additives necessary for healthy growing babies including protein, fat, Vitamins A, C, D, E and K, carbohydrates and nucleotides, among others.) As preservation techniques, scientific knowledge and manufacturing practices grew steadily throughout the 20th century, so did the demand for and availability of the product. By the 1970s, generic brands were being sold in addition to commercially marketed brands in American retailers. Justus Von Liebig hard at work. Historic demand drivers The population boom in the ASEAN region, particularly in China, is often cited as a reason for today's booming market for infant formula generally. In 2008, the Chinese market was rocked by the an en masse infant formula contamination that resulted in 54,000 hospitalisations. Rabobank's Michael Harvey explains that this marked the opportunity for Australian and New Zealand brands to enter China. "It triggered a lot of Chinese consumers to want imported brands and to really question the safety and quality of local supply chains," he told Stockhead. "That was the trigger for a spike in Chinese demand for imported dairy and infant formula. "Imported brands in infant formula do trade at a premium to local products so there’s a desire for imported brands and a consumer willingness to pay a higher price." The Chinese government spent the next decade trying to restore its domestic market. They were unsuccessful for the most part in that they couldn't stop the success of companies like A2 Milk and Bellamys. The impact of 2020 The infant formula sector has been hit by COVID-19, but not in the way you might think. It is easy to point to trade tensions, but Harvey says other factors in the Chinese market have been more important. "Birth rates in China are slowing so the overall driver is slowing, you've got a Chinese government keen to have stronger local brands and that leads to them being able to compete better," he explained. "It all just feeds through into taking a little bit of the growth profile away." "Don’t get me wrong it’s still the biggest market it’s still growing but there are some structural slowdowns in the market." While COVID-19 hasn't changed the fact that babies need food, it did make cross-border trade more difficult. These were more global supply chain logistical issues and the daigou trade essentially shutting down in Australia - with international tourists and students locked out. This was also true in Hong Kong - another key location for the daigou trade - with travel restrictions on mainland residents. "Clearly with Victorian lockdowns for an extended period of time, with no international students and tourists that’s impacting the daigou trade and that’s still a very, very important market for a lot of brands looking to get into China," Harvey said. "The challenge there will be: you’re looking at another 12 months of impact because non-essential travel may not be allowed until mid next year, you may not have international students for a while - so there are some challenges in the channel." But what about trade tensions? Harvey admits trade tensions cannot be ignored but are far from the most important factor in the market right now. "Clearly trade tensions are high between Australia and China. We’re certainly of the view that they’ll remain at a heightened level for a period of time and that will remain a risk for Australian exporters," he said. "You could argue it hasn’t been affected up until now per se – the risk is there but time will tell where things go. "The counter-argument is mums and families have their favourite brands and Chinese consumers that buy Australia and New Zealand brands are very loyal to those brands so the Chinese government might not want to disrupt access to that product. "But there is a risk a broader risk for Australia, but at the moment we aren’t seeing an impact in terms of trade flow – it’s more COVID-related impacts on that daigou channel." Harvey also said any trade disruption was a two way street saying it was likely we wouldn't see another acquisition for some time. "The acquisition was part of a broader strategy where you see companies wanting to build our their brands and global presence," he said. "Australia & NZ have been targets due to strong brands that resonate in the market. It will mean Chinese companies are more cautious about that going forward." Are there any other markets for ASX infant formula stocks? Earlier this year, Rabobank named ASEAN-6 countries (Indonesia, Malaysia, the Philippines, Singapore Thailand and Vietnam) as ideal candidates for secondary markets. These countries already consume 12.9 billion litres of dairy products per year and by 2030 this will balloon to 19 billion. Some small caps such as Bubs Australia (ASX:BUB) and Nuchev (ASX:NUC) have been hedging their bets in this regard in looking beyond China. But Harvey warns no one will be as big as China in their own right. "You’re not going to find another China but clearly they see markets in the northern hemisphere but more importantly they’re looking within the Asia-Pacific markets," he said "So clearly South East Asia clearly a target and you’re seen companies actually launch in those markets - that’s an ongoing theme and something you’ve seen accelerate in the 12 months." ASX listed infant formula and dairy stocks There are 12 ASX-listed stocks with some involvement in the infant formula space. Below we profile the companies in the sector, except market giant A2 Milk which needs no introduction, beginning with the direct players. Swipe or scroll to reveal the full table. Click headings to sort. Direct players A2 Milk (ASX:A2M) The New Zealand headquartered company needs no introduction. It listed on the ASX in March 2015 and rose from 56 cents to nearly $14 per share today off the back of market penetration. In its last financial year, the company saw a 30 per cent spike in both revenues and profit. Sales had effectively doubled in the last year to $337.7 million. A2 Milk it has been declining in recent months after telling shareholders it was noticing a fall in the daigou trade. Nonetheless this was a single channel logistics issue and underlying demand in China remained strong. In August, its CEO expressed belief being New Zealand based would leave it immune from a deterioration in trade that may come due to diplomatic tensions between Australia and China. Bubs Australia (ASX:BUB) It should come as no surprise that a company going by the name of Bubs dabbles in infant formula. Bubs is one of only two stocks specialising in goat milk-based infant formula and also makes fresh milk and yogurts. Its produce is sold in supermarkets here and exported to the Asia-Pacific region. The company listed at 10 cents in early 2017 and sits at 70 cents today, although is off its all time high of $1.42. Bubs has been one of the more active in protecting itself from Australia's trade tensions with China. It has sought to move production to the country and has been looking to other markets, particularly Vietnam. Nuchev (ASX:NUC) Nuchev is the other player in goat milk and is one of the newer entrants to the infant formula trade having listed in December last year. Goat’s milk contains more vitamins than cow’s milk including 46 per cent more vitamin C. Medical experts claim that it is easier for babies’ to digest. Shares have been on a rollercoaster ride since its IPO listing at $2.60 then rising as high as $3.77. The company plunged in March, rose in April but has been on the way down again in recent weeks. The catalyst has been falling revenue - which more than halved in the September quarter. While sales were weak, the company also blamed a transition to a new distributor. Clover Corp (ASX:CLV) This company makes supplements for infant formula - among other products - and exports to Asia as well as Europe. Europe has been particularly strong because of new laws governing the content of infant formulas specifically requiring a minimum quantity of DHA (a type of Omega-3). Clover's core product is encapsulated tuna oil which uses docosahexaenoic acid (DHA), an omega-3 fatty acid particularly healthly for the brain. Clover has been consistently profitable in recent years even amidst COVID-19. It went from $3.6 million to $7.6 million in FY18, then to $10.1 million in FY19 and $12.5 million in FY20. Although it admitted its most recent profit may have been influence by "pantry stacking". Synlait (ASX:SM1) The acquisition of Bellamys has left A2 and Synlait as the only two companies over a billion dollars. Synlait is a dairy processor that serves A2 Milk among other companies and A2 owns just under 20 per cent of the company. While Synlait remained profitable amidst COVID-19 it warned it was seeing demand stagnate. It opted to raise $200 million earlier in November to give it more financial headroom. The company was hindered by a long running legal dispute over its plans to build a second processing facility but recently settled the conflict and anticipates production beginning in mid-2022. Fonterra (ASX:FSF) Fonterra is another New Zealand based stock although it is a co-operative owned by around 10,500 New Zealand farmers. While it is only a small cap on the ASX, it is the largest dairy company and exporter in the world. It was one of the earliest stocks to set up shop in China having begun building farms in 2007 but a few weeks ago opted to sell them as operating costs rose. Jatcorp (ASX:JAT) This company has had various endeavours in its listed life, from energy projects to plant based food. But infant formula has been one of its more successful endeavours, owning a facility in Melbourne which it bought from an owner that was an approved exporter. It is also in the daigou trade with its Sydney-based channel Green Forest. Work in progress players Happy Valley Nutrition (ASX:HVM) Happy Valley is at an earlier stage than most of its peers having not yet completed its facility and found the $328 million it estimates it will be needed. It intends to build in New Zealand's Waikato region operating with a business to business model. The company pinpointed 2023 as the first year of production. Australian Dairy Nutritionals (ASX:AHF) This company owns several dairy farms and a processing facility in South Western Victoria. Its assets include the Camperdown Dairy which was once owned by Bellamys and is the same one responsible for Camperdown dairy products. The company long intended to get into infant formula and worked on developing a proprietary formulation, Tummy Health. In early November it told shareholders it had secured a manufacturing partner. Production will begin in March next year and it will hit supermarket shelves the following quarter. Indirect players HRL Holdings (ASX:HRL) This company provides laboratory services which tests substances, including infant formula for contamination. It was hit earlier this year by New Zealand's strict lockdown but was able to return to business as usual relatively fast. Bioxyne (ASX:BXN) Bioxyne describes itself as a health and wellness company, focusing on "clinically effective health and wellness products particularly in the gut and immune health areas". It makes this list because one of its products is supplements for infant formula (proTract) which keeps babies’ gastrointestinal system healthy. AuMake (ASX:AU8) AuMake is a China-focused retailer which sells infant formula and several other products including cosmetics, skin care and food supplements. Until COVID-19 hit its was heavily focused on the daigou and Chinese tourist markets. Ever since borders have been closed to China, the company has had to reach consumers online and has had success. It claims to be ahead of other Australian companies selling into China in seeing the way Chinese consumers shop online and changing its business model accordingly.