Troubles in China’s Milky Way for health companies

The sharemarket sell-off is sobering the rush to China-linked consumer companies.

Troubles in China’s Milky Way for health companies

If a sharp sharemarket correction has an upside, it’s that investors sober up pretty quickly on the sectors that have been “running hot” — and for sheer irrational exuberance nothing could beat the rush into “clean and green” China-linked companies over the past year.

The promise that China’s ­internet-enabled health conscious consumers offer to Australia is undoubtedly immense. Vitamin company Blackmores for example has a mere 1 per cent of China’s $15 billion vitamins market. But in common with every other substantial investment trend that grips the ­market’s wider imagination, shareholders in China-linked consumer companies — which promise more than they may ever deliver — are going to lose out.

In the past week as our local sharemarket flirted with bear ­territory, a string of China consumer stocks got severely tested.

Perhaps the most interesting drop came from vitamins group Vitaco, an extremely popular IPO last year that appeared to tick all the boxes: Vitaco offers the prospect of selling health supplements to China’s middle classes, it already had a strong international sales program and boosted its pre-float attractions with a major acquisition, the Musashi supplements company.

Vitaco was priced at $2.10 at IPO, it shot to a peak of $3.20 in November ... midweek in the ­middle of the stockmarket sell-off, it fell below its IPO price, a milestone no Vitaco shareholder might ever have expected last year when euphoria was sweeping across this sector.

Meanwhile, the most powerful Australian brands in the China consumer market did relatively well in what was a selling maelstrom last week: fresh from an interim profit upgrade just a week ago, Blackmores’ share price held steady over the week finishing more or less where it started.

Indeed, the same could be said for infant formula exporter Bellamy’s. This is a very strong ­performance for stocks that shot out the lights last year: Bellamy’s was up 500 per cent last year, while Blackmores was up 300 per cent in 12 months.

But there are now clear dangers present:

• After the Blackmores profit upgrade was announced, both Bellamy’s and milk exporter A2 Dairy bounced higher. This ­sector-wide momentum can work both ways: the outstanding issue with this sub-sector (milk-related products to China) is that if there is ever a quality incident that rattles confidence at one ­producer then all related stocks will be sold off together.

• What’s more, even with excellent operational performance figures, the existing problem for these stocks is their elevated share prices. As my colleague Simon Dumaresq of Eureka Report has noted in relation to Blackmores, it is a first-class company with strong management, a strong brand and great prospects.

On the other hand, the reality of China’s “health boom” is that the Chinese vitamin market is growing at about 10 per cent a year — but for Blackmores to ­justify its current share price, it would have to grow by 25 per cent a year for the next ten years — with no interruption of any kind. This is an improbable scenario, it is simply unrealistic to extrapolate the earnings for any company out this far, not to mention one that is exposed to the vagaries of the Chinese government.

For investors this is the ­challenge: the best companies walk a risk tightrope that simply does not exist for common or garden industrial stocks trading on multiples that would be less than half those reserved for the stars of the China consumer market.

Other companies get to ride the magic carpet along with the majors, but there is a big difference between promising to get a slice of the action and actually having the numbers on the board.

The art of separating the champions of the future from the opportunists of the day is exceedingly difficult. Indeed, to be as fair as possible, companies can only control what they do, they can’t control their public image or the disposition of traders towards their stocks. Looking at just the players we have mentioned in this piece: A2 Milk Company, Blackmores, Bellamy’s Vitaco — we get an average P/E ratio of 40 times 2016 earnings … it’s a feast, but for whom?

Meanwhile, new players rush to join the party: China Dairy Corporation, which is seeking to list on the local market made a well-timed announcement on February 10: after ten years of selling milk into China, the group is going to — you guessed it — move into the production of ­infant formula.