BofA Securities sees growing pains ahead for Danone and a2 Milk share prices

Investment bank BofA Securities has dented both the Danone [BN.PA] share price and Reckitt Benckiser [RKT.L] share prices after unveiling a new ‘deep dive’ research report on China’s infant milk formula (IMF) market.

BofA said that accelerated demographic pressure in China, peaking premiumisation, intensified competition, promotional activity and regulatory risk meant that the outlook for the market had “significantly deteriorated both structurally and short-term”.

BofA downgraded French food and drinks firm Danone to underperform from neutral. This reflected the impact of “deteriorating IMF China on top line and margins”.

Indeed, in its first-half results, Danone said infant nutrition sales had seen only low single-digit sales growth hit by COVID-19 disruption and a slowing birth rate in China.

The Danone share price, which has climbed from €52.62 at the close on 4 January to as high as €65 at the close on 16 August, fell from €61.76 at the close on 6 September to €59.60 at the close on 8 September – the day after the research report was released.

 

Why a2 Milk is likely to underperform

BofA also picked IMF maker a2 Milk [ACOPF] as an underperformer, stating that it expects it to remain under pressure. In its recent annual results, a2 Milk said the Chinese IMF market size had decreased, and it had seen stronger competition from domestic brands. This had led to discounting and the erosion of if its premium brand position. Its shares have fallen from $6.50 at the close on 15 April to $4.09 at the close on 10 September.

The BofA report was more positive about Nestlé [NESN.SW], giving it a buy rating as it “expects a milder headwind given relatively limited exposure with only 1-2% of sales”. It also has a buy rating for Reckitt Benckiser, which agreed to sell its IMF business in China to Primavera Capital Group in June for $2.2bn.

Reckitt’s shares have fallen from 6,591.26p at the close on 4 January to 5,447.86p at the close on 28 July. It has been hit by rising raw materials inflation and a slowdown in demand for disinfectants as COVID-19 fears ease. It dropped from 5,844p at the close on 7 September to 5,684p at the close on 10 September.

BofA gave an underperform rating to ingredients manufacturer Chr Hansen [CHR.CO] but expects a “somewhat less negative impact given the ability to upsell ingredients to customers even in the absence of price increases”.

BofA also likes Chinese domestic brands: it has a buy rating on China Feihe [61.86.HK] and H&H [1112.HK] “given undemanding valuations and share gains”.

 

Milk market turning sour

In the report titled ‘Perfect Storm’, BofA said it expects a “flattish category” in the next five years for China IMF.

It said the market would further deteriorate over the next 12 to 18 months off the back of the steep decline in the number of births in 2020 (down 18%), accelerating decline in the number of women aged between 20 and 34, potential de-stocking with distributors and the government’s focus on increasing breastfeeding.

It added that premiumisation in the IMF China market is plateauing because of the extremely high bar in absolute prices, upcoming more stringent standards on ingredients/formulations potentially limiting product differentiation and “increased promotional activity on the back of a fast-shrinking baby pool”.

It added that local players have “significantly narrowed the gap in terms of quality perception and brand loyalty [with] international players”, as well as more aggressive marketing and stronger distribution/supply chain. 

 

Macro trends

According to BofA, the China IMF market is worth $26bn, but its growth has been slowing over the past decade. According to Euromonitor, industry value growth has moderated from strong double digits a decade ago to mid-to-high single digits over the past five years, before turning slightly negative in 2020. The sharp deceleration in volume was the major driver, driven by a declining birth rate.

The Chinese National Health Commission has stated that it expects the birth rate to keep falling in 2021.

There are also concerns that recent government regulation on key markets, such as the technology sector, may extend to IMF and the marketing of milk powder to mothers rather than breastfeeding.

“The largest exporters of IMF to China are the EU, New Zealand and Australia. While volumes continue to demonstrate double-digit year-on-year declines, sequentially volumes look to have formed a bottom in recent months” - Bell Potter

 

Not all analysts are so doom-mongering, however. Bell Potter believes Chinese IMF import volumes have bottomed out.

“The largest exporters of IMF to China are the EU, New Zealand and Australia. While volumes continue to demonstrate double-digit year-on-year declines, sequentially volumes look to have formed a bottom in recent months,” the investment firm wrote.

The Chinese government’s decision in May to allow couples to have up to three children and tackle the declining birth rate may be another positive driver for IMF.

 

China’s infant milk formula market set to grow

Despite the gloomy BofA prediction, other surveys show a brighter picture. Research and Markets believe China IMF will increase over the next four years, driven by factors such as high female workforce share, rising middle-class and dual-income families, and increased spending on premium nutrition.

There is certainly interest in IMF brands, with a2 Milk reportedly attracting takeover interest from Nestlé.

Of the other key stocks mentioned in the report, Danone has an outperform rating, according to Market Screener, and a target price of €62.68 thanks to confidence in its new CEO, share buybacks and high dividends as investors look to value stocks. Reckitt is also rated outperform with a 7,076p price.

An ETF to watch that holds some of the key stocks is the iShares Stoxx Europe 600 Food & Beverage ETF [EXH3.DE], in which Nestlé and Danone have 30.51% and 6.90% respective weightings.