Why the foundation of milk stock superstars like Bellamy’s Australia Ltd is at risk

Investors have been rallying behind baby formula and milk product superstar stocks such as Bellamy’s Australia Ltd (ASX: BAL) and A2 Milk Company Ltd (ASX: A2M) in the last year or so, while other dairy stocks such as Fonterra Shareholders’ Fund (ASX: FSF), Bega Cheese Ltd (ASX: BGA) and Bubs Australia Ltd (ASX: BUB) have been on close watch.

But what is one thing all of these stocks have in common that could make or break their operations?

Dairy farmers.

The farming community across Australia has long struggled with drought issues and financial uncertainty, but if there’s a group that gets the raw end of the deal, it’s dairy farmers.

High feed costs, water issues and low milk prices combine to make turning a profit near impossible for many dairy farmers, and according to the ABC, a recent national confidence survey of dairy farmers showed less than half see any future for the industry.

While the share price of players like Bellamy’s rocketed up 169% from just $8.20 in August 2017 to its all-time high of $22.08 in March this year, dairy farmers have been fighting suppliers for a fair price for the raw product each of these companies relies on.

The big reason for Bellamy’s and A2’s success in recent times has been their foray into the Asian market, with both striking lucrative long-term supply agreements with Chinese-based buyers.

Australian baby formula products, in particular, are seen as “safe” throughout Asia due to the rigorous checks and balances the raw products go through to make sure they are uncontaminated.

And who is at the coal face of those procedures?

You’ve got it, dairy farmers.

If they don’t succeed, how can anyone else?

With the baby formula sector likely to continue to boom, you can assume the demand will continue to be there for the base milk product from our dairy farmers, but if the farmers themselves continue to be hamstrung by paltry prices for their product, how are they supposed to weather the actual storms, or lack thereof, that threaten their cows?

Fonterra today announced its farmgate milk price for 2017/2018 alongside its earnings guidance.

Fonterra’s share price has struggled in the last 12 months, down from $5.80 at this time last year to open today at $4.62.

The announcement today revealed Fonterra is reducing last season’s forecast farmgate milk price from $6.75 to $6.70 per kgMS.

Fonterra’s chair John Monaghan said reducing the price was “the right thing to do” for the long-term interest of shareholders and said the company “wanted to be upfront with farmers” but needed to “keep our balance sheet strong”.

Shares in cheese maker Bega have been on the incline recently – hitting a 52-week high to close off July 18 at $8.01 when Bega announced it would acquire the Koroit Facility in Victoria for $250 million.

Bellamy’s and A2 have seen share price slides of late, with Citi downgrading A2 last week to a sell and reducing its price target from $10.90 to $9.50.

Citi still has a buy on Bellamy’s.

While investors can rest assured companies in the dairy space will make decisions on the basis of protecting profit, the plight of dairy farmers cannot be ignored, and the long-term health of the sector will be related to their success.

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Motley Fool contributor Carin Pickworth 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 Scott Phillips.

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