By Andrew Main

If Bellamy’s shares were worth more than $12 each last Thursday, what’s happened that makes them worth around $6.40, a bit over half that, yesterday?

The shares dropped by $5.28 on Friday alone and closed at $6.41 yesterday. This is a stock that was just under $15 four months ago.

Clearly, there’s been a loud pop caused by Friday’s profit warning over the Tasmanian company’s sales in China, which, up to now, seemed to conform to the old Billion Armpit Theory of the 1990s: whatever you sell in China is bound to find a billion buyers.

Specifically, CEO Laura McBain warned that changes to China’s import regulations had created “temporary volume dislocation” in the company’s distribution network in China.

That’s a euphemism for oversupply, borne out by reports from elsewhere that tins of Bellamy’s infant formula are now on sale in China at half the price of six weeks ago.

The crazy market in infant formula in China started back in 2008, after the notorious melamine scandal, when it emerged that local formula had been adulterated with melamine, a toxic product, causing some deaths, and illness to an estimated 300,000 babies in China.

In a country where the one child policy was still in force, the scramble for reliable formula was a godsend for scandal-free overseas suppliers such as Bellamy’s, which started in 2004 in Launceston, although it listed much later in August 2014, at $1 a share.

I got a glimpse of what it meant on a visit to Hong Kong three years ago.

Out of curiosity, I took the train up to Lo Wu on the Chinese border, opposite Shenzhen.

While Hong Kongers now seem to dress like golf professionals, the passengers on the train were mostly mainland Chinese men in cheap anoraks, each clutching a big box of formula that was clearly destined to be carried far inland to the baby at home.

Moving back to 2016, just to give you an idea of how stratospheric investor expectations have become, it emerged that single-day revenue in China from last month’s Singles Day shopping festival, which includes online sales, was more than twice the previous year’s, but “below the Company’s expectations,’’ according to the CEO.’

Switzer commentator Paul Rickard made the point on Monday that until last week, Bellamy’s shares had been priced “at a phenomenal level” and that after the company had revealed on Friday that it couldn’t grow as fast as planned, “the market is not going to forgive quickly.’’

So he advised caution even at these levels.

The brokers (and Paul’s an escaped broker himself) are a bit the same way.

Ord Minnett and Morgans have both downgraded the stock from a Buy to a Hold, while Citi has kept it as a Sell, having initiated coverage back in October with that recommendation.

So there’s a heavy element of ‘we told you so’ in Citi’s comments that coverage was initiated “with the view that risks were too high for infant formula exporters into China and investors should wait for cheaper entry points.”

They think investors can wait longer.

“Post Friday's shock market update, estimates have been slashed, the price target has halved to $6.00 from $12.10 and the rating remains Sell.

“The analysts state they need to see an improvement in brand momentum and Chinese industry conditions before they can turn more positive.”

“Interestingly, the loss of momentum also reduces the chances for a take-over approach, in Citi's view, while price discounting could severely hurt the Bellamy's brand, which would be a long term negative.”

Cutting to the chase, consensus estimates for the three brokers for this 2016-7 financial year are that the stock’s going to earn 32.4 cents a share, a cut in annual growth of 18.6% with a dividend yield of 1.6%, and a Price Earnings Ratio of 20.6 times, which is tall for a company surrounded by uncertainty.

Estimates for next financial year look better, however.

The consensus between the three brokers (two Tepids and one Sell) for 2017-8 is a lift in EPS to 37.6 cents, implying annual growth of 16%, paying a dividend of 13 cents and with a prospective P/E ratio of a slightly more manageable 17.8 times. 

My stab at the Big Picture is a bit more rosy.

Clearly, Bellamy’s did a sensational job of riding the reputational wave, and even if demand seems to have dropped short of investor expectations, Bellamy’s products haven’t wavered in reliability and it’s worth noting that the regulatory changes in China are aimed at clamping down on dodgy imports.

That’s hardly a problem for Bellamy’s in the long run, and it looks as though the short-term oversupply of baby formula in China is partly due to cheap stock trying to get in ahead of the crackdown.

That problem will inevitably go away.

And the Chinese people are going to keep having babies, and with so many mothers working, the demand for formula is likely to stay strong.

A negative for Bellamy’s is that the domestic production of formula in China has risen significantly since the scandal faded, so there’s not such a big cake for the imported formula products to share.

But even if you downgrade the armpit theory from a billion to a few million, it’s still a massive and relatively untapped market. It’s just not growing quite as fast as the optimists were thinking.

So is Bellamy’s a buy? Long term yes, short term no.

There could well be more price weakness as the stale bulls get carted out, but it’s one to watch closely.

No one’s going to ring a bell to herald the eventual share price recovery.