Why Bellamy’s Australia Ltd shares are a buy today

Credit: Bellamy's

If Bellamy’s Australia Ltd’s (ASX: BAL) run in 2015 was characterised by appreciation and excitement, 2016 (so far, at least) will go down as a year in which investors experienced doubt and uncertainty. The shares have fallen more than 31% since they peaked at $16.50 late in December, and did trade as low as $8.63 as recently as April.

There are a number of reasons why the shares have come under such intense pressure this year. Here are the four most likely reasons for the sharp decline, followed by why the shares could actually be a good buy today…

1. Valuation

Sales and earnings were growing rapidly for the infant formula producer to the point where investors were willing to pay as much $1.68 for every cent of earnings when the shares peaked. That is to say, the shares were trading on a price-earnings ratio of 168x earnings, based on the belief that earnings would continue to grow at an incredible rate (they increased 421% between the 2014 financial year (FY14) and FY15).

Such a valuation is justifiable for some companies, and perhaps even Bellamy’s. However, when a share is trading for that much and doubt starts to creep into the market, you can always expect the shares to retreat, sometimes heavily. And that brings me to my next point…

2. Regulatory Concerns

Much of Bellamy’s growth has come from China in the past, and is expected to come from there in the future as well. However, China has introduced a number of tougher regulations which investors believe may prove to be a roadblock for that growth, including higher taxes and potential restrictions on which infant formula companies can sell their products in the region.

Of course, this does have the potential to impact sales and earnings so it is arguably justifiable that investors have sold the shares down from their lofty heights.

3. Competition

Given Bellamy’s incredible earnings growth, competition was always going to be an issue. Fellow infant formula producer a2 Milk Company Ltd (Australia) (ASX: A2M) is also growing sales at an incredible rate, while vitamin producer Blackmores Limited (ASX: BKL) also made a push into the industry (although reports suggest that it is struggling to gain traction at this point).

Regardless, competition is something investors need to keep an eye on in the future as it could impact Bellamy’s margins and market share if consumers become more inclined to purchase cheaper products.

4. Heavy shorting

Recognising Bellamy’s sky-high valuation together with competition and regulatory concerns, investors have taken up heavy short positions against the company’s stock.

According to ASIC, 9.8% of the company’s shares were held in a short position as at 5 July 2016. That makes it one of the most shorted shares on the ASX, up there with Metcash Limited (ASX: MTS), Cover More Group Ltd (ASX: CVO) and Myer Holdings Ltd (ASX: MYR).

Here’s why Bellamy’s could be a buy

Despite the 31% decline in its share price over the last seven months or so, Bellamy’s shares still aren’t cheap. However, the company itself is one of the fastest growing companies on the ASX as it continues to ramp up sales of its organic infant formula product.

What’s more, China’s regulatory environment is something investors do need to keep tabs on, but Bellamy’s, together with a2 Milk Company, is arguably well positioned to cope with any changes and could perhaps even benefit in the long-run if smaller competitors are kept out of the market.

The short sellers have helped to drag Bellamy’s share price lower in recent months, but if the company can continue to impress with its rampaging growth, it is likely that many of those short sellers will be forced to close their positions which could help spark a boost in share price in the long-run.

Again, Bellamy’s is no risk-free investment, and more details will likely be shared by the company when it releases its full-year results in August. However, at $11.29 a share, now could be a good time to start doing some research on the business, and consider whether it’s worth a position in your portfolio.

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Motley Fool contributor Ryan Newman owns shares of Bellamy's Australia. 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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