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Bega Cheese Ltd and Blackmores Limited baby formula venture in trouble

Bega Cheese Ltd (ASX: BGA) has announced today that it is writing down the value of the inventory in its joint venture with Blackmores Limited (ASX: BKL) by between $5 and $7 million.

Is this a sign that the baby formula joint venture was a bad move? Is this a repeat of Woolworths Limited’s (ASX: WOW) ill-fated move into home hardware?

As a result, Bega has seen its share price sink by more than 12% to $5.66 in early trading today.

This is what the company said.

“While this time last year supermarket shelves were empty and customers in Australia and internationally were providing ever increasing orders, the combination of a regulation change in China, a supply response to the demand signals and the evolution of supply channels to market now sees significant discounting in the market place and signs of short term oversupply.

This change in market circumstances has seen our expected sales not materialise at levels that were initially forecast and some strong head winds for the partnership particularly in the Australian market. The business has taken the view that it is appropriate to take a provision of in the range of $5-7 million on inventory representing the Bega Cheese’s share or the Bemore partnership.”

In other words, supply expanded at a fast pace as the incumbents like Nestle, Danone Nutricia, Bellamy’s Australia Limited (ASX: BAL) and a2 Milk Company Ltd (Australia) (ASX: A2M) increased production. At the same time, demand appears to have slipped – perhaps due to restrictions on imports into China.

Blackmores will likely have to take a similar writedown, and it seems unusual that the company’s share price hasn’t fallen at all today.

It also means that the joint venture is writing down between $10 and $14 million – which is a significant amount. With Blackmores’ baby formula priced at $29.99 a tin, that’s the equivalent of throwing between 333,000 and 467,000 tins of baby formula into the bin.

Foolish takeaway

Bega’s bad luck could be bad news for incumbents like Bellamy’s and A2 Milk. It could see all the baby formula companies forced to discount their product. Over the long-term though it should be good news – Bega and Blackmores could even be forced to shutter their joint venture – taking one competitor out of the market.

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Motley Fool contributor Mike King owns shares of Bellamy's Australia. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia owns shares of A2 Milk and Bellamy's Australia. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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