Two Aussie Dairy Exporters Collaborating to Tackle Baby Formula Market in China

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This afternoon, Bega [ASX:BGA] and Bellamy’s [ASX:BAL] announced they’d made an important deal. One which could see them dominate an important category of dairy exports.

Bega’s wholly owned subsidiary, Tatura Milk Industries, will help Bellamy’s make their organic infant formula. The deal will last for six years. It’s a contract that comes after the two companies have already worked together successfully for a decade. But formalising the deal could help give investors a bit more confidence.

In announcing the deal, Bega wrote that ‘Tatura Milk Industries’ management and long-term experience in the manufacture of organic infant formula provides Bellamy’s with the product integrity and quality standards required to meet the growing demand for high quality organic infant formula.’ Bellamy’s elaborated on that, saying that ‘The six-year agreement provides for a cooperative approach to ingredient supply and long range planning.’

In other words, Tatura will help make sure Bellamy’s is processing organic milk in the best possible way. This makes sense, since they’re the country’s biggest processor of infant formula.

Successful cooperation will help the two companies dominate market for imported formula in China. Since 2008, demand has shot through the roof. Towards the end of last year, reports emerged that Australian infant formula was selling in China for up to $100 a tin.

Currently, a 900g tin of Bellamy’s formula sells for about $84 from one of China’s biggest grocery e-tailers.

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The same tin is $23 online from Coles in Australia.

Revisiting the melamine scandal

In 2008, the melamine milk contamination scandal rocked China. Milk powder produced by the Sanlu group was found to contain melamine. Government inspectors audited other processors and found that 21 of them had melamine in their products.

Melamine is rich in nitrogen. So are amino acids, the base units of protein. Food testing methods that measure protein often look for nitrogen levels as a sign of protein content. Two of the main testing methods can’t tell the difference between melamine nitrogen and protein nitrogen. So food manufacturers sometimes illegally add melamine to up the protein test results. This way, they can water down products.

Melamine causes kidney and urinary problems. At high doses, it can be fatal. In China, tens of thousands of children fell ill as a result of consuming melamine-tainted dairy products. Some of them died.

The Chinese government came down hard on offenders. Two were executed. Five received serious jail terms. Even the government’s own Director of the Administration of Quality Supervision, Inspection and Quarantine was fired.

Unfortunately, the action taken wasn’t enough to allay the fears of many Chinese consumers. Hong Kong-based newspapers reported that the popularity of old-fashioned wet nurses (breastfeeding stand-ins) increased. The poorest families still rely on locally made formula, because it’s cheap. But imports have gone through the roof.

The rise of organic produce in China

With its clean, green, organic branding, Bellamy’s has an edge in China.

Global market intelligence agency Mintel recently ran a survey of Chinese consumers’ attitude and perceptions of organic food. They found that 80% of urban consumers believe organic products are worth the extra money. Just over half (56%) of respondents said they’ve recently started spending more on organic food.

Mintel’s Chief China Strategist, Paul French, said that ‘The significant rise in consumption of organic foods illustrates the extent to which [higher income] consumers will embrace any opportunity to buy and consume foods they perceive to have stronger provenance or origins in the way that it was grown and sourced. The success of foods grown and produced for export, and those foods from trusted foreign sources, are providing a level of confidence that is seeing consumers engage more effectively with the brands.’

BIOFACH, a German-based organic food trade fair, says that organic food consumption in China has nearly tripled since 2007. They believe it will double again this year, to reach nearly 2% of all food consumption in China.

At the start of this year, James Cook University released a study on organic food in China, and how Aussie exporters can meet demand. The study said that ‘In China, certain categories of organic products have good prospects, includinginfant formula and baby food.’ The authors researched how, when, where and why Chinese people buy organic. They found that:

For regional producers of organic food, the growth of the ‘green food’ market in China and the signing of a free trade agreement between Australia and China is critically important

The purchase of organic food is motivated by altruistic concerns (i.e., environment and animal welfare concerns) and self-interest (i.e., personal and familial health concerns, food safety concerns). Individuals who consume ‘green food’ and organic food are likely to distrust the Chinese food system. Age is an influential factor affecting purchase of certified organic food. Consumers aged 36 and over are more likely to buy certified organic food. The presence of children in the household is also an influential factor.’

They also noted that Aussie exporters face significant compliance costs. The Chinese government doesn’t allow products to be sold as organic unless they’re certified in China. Aussie exporters who’ve gone through the certification process report that it costs around $50,000.

Some exporters that don’t wish to go through the process elect to label their products with a widely-recognised ‘Green Food’ label instead. According to the study, not many Chinese consumers discern between ‘organic’ and ‘Green Food’ anyway.

green food
Source: ePubs
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Bellamy’s paid their $50,000 and got certified in 2008. CEO Laura McBain said it was worth it. ‘There are 200,000 babies born in Australia compared to 20 million born in China. It’s obviously a lucrative marketExport is now 50 per cent of my business, and has grown by 70 per cent year on year. China has the lion’s share.’

Investors reacted well to the news. Bellamy’s shares gained an extra few percent right after the deal was announced. Bega shares are also up marginally.

Source: Google Finance
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With a market cap $436 million, Bellamy’s is still technically a small-cap. If you’re interested in small-cap stocks, and want to learn how to pick a winner, don’t miss Sam Volkering’s report ‘The At-Home Investors Guide to Profiting from Australian Small-Caps’. Read this report and you’ll discover a smart but simple four-step guide to finding quality small-cap stocks with impressive growth potential. Click here to find out how to download your free copy.

Eva Mellors
Contributor, Money Morning

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