Why 2018 is a critical inflection point for baby formula stocks A2 Milk Company Ltd and Bellamy’s Australia Ltd

The stakes have never been higher for market darlings A2 Milk Company Ltd (ASX: A2M), Bellamy’s Australia Ltd (ASX: BAL) and Bubs Australia Ltd (ASX: BUB) as tightening regulatory restrictions in China could wipe out the vast majority of brands being sold in that country.

The chief executive of Bubs Australia is warning that up to 85% of the 2,500 baby formula brands being sold in China could disappear from the shelves as new Chinese regulations kicked in on January 1 this year, according to the Australian Financial Review.

We won’t see the impact of the shakeup right away as existing China-labelled products and those carried back by go-between agents called “daigou” can still be sold in that country.

But many industry insiders believe we will see the day of reckoning in 2018, and that is likely to have big consequences for our favourite infant formula stocks, which has been on a tear over the past year.

The share price of A2 Milk has surged by more than three-fold, while Bubs Australia is up by around 130% and even bad-news prone Bellamy’s has managed to jump around 60% in the past 12-months.

In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) has chalked up a gain of around 6% over the same period.

The new rules mean that Chinese authorities have to approve offshore manufacturing facilities before any company can import and sell infant formula into the country and each approved facility is only allowed to manufacture for three brands.

There is still a lot of ambiguity around how or when the news rules will be properly enforced and it is conceivable that some local producers could be impacted.

On the other hand, the massive consolidation in the Chinese market will be a big win for those players who have already secured approval or those who believe they can easily score one.

It is believed that A2 Milk has been given approval late last year while Bellamy’s and Bubs Australia will secure approvals in the coming months.

But the ground is always shifting when it comes to government regulations. It’s bad enough in Australia, let alone in less transparent economies, so investors should be on their toes as 2018 could make or break many in the sector and affect those related to the industry, like ASX-listed daigou business Augend Ltd  (ASX: AU8).

There is another big trend investors should be watching in the new year. The experts at the Motley Fool believe this will be a hot sector in 2018 and beyond. Click on the free link below to find out more.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of A2 Milk. 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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