The Australian Financial Review is reporting that China's government has drawn up new roles for the regulation of the baby formula sector in the country of 1.3 billion people.
According to the AFR the main outcome of the plan is that Chinese baby formula producers could be advanced to gain market share potentially from popular overseas brands.
As you can guess, local baby formula makers are plunging in response to the news. Take a look at the scoreboard below.
The A2 Milk Company Ltd (ASX: A2m) share price is down 7% to $13.27.
The Bellamy's Australia Ltd (ASX: BAL) share price is down 4.3% to $7.93.
The Bubs Australia Ltd (ASX: BUB) share price is down 6% to $1.06.
The Wattle Health Australia Ltd (ASX: WHA) is down 7% to 56 cents.
All of these companies have significant Chinese sales and as such all are vulnerable to a Chinese market that is becoming increasingly unpredictable as a consequence of its escalating trade dispute with the US.
Moreover, as China is a one-party state where it's not possible to rely on the law with certainty to enforce a contract for example, the risk is even higher that changing rules favour Chinese companies over overseas companies.
Companies like Bellamy's and vitamins maker Blackmores Limited (ASX: BKL) have already reported wildly swinging Chinese sales that they attributed to changing demand or sales channels, rather than anything else.
While another exporter to China in Treasury Wine Estates Ltd (ASX: TWE) has been accused of 'channel stuffing' by short sellers, which is a practice where excess product is sold to wholesale distributors in the U.S. or China for example and the revenue is booked, even though the product has not been sold onto consumers by the distributors.
This is a normal accounting practice, but it's just that it can make sales or demand seem artificially high and swing wildly.
Bellamy's has history on this front and its share price has swung wildly ever since its initial public offering.
Bellamy's currently has a whopping 14% of its shares shorted and is reportedly still waiting on an important license from the Chinese regulator to allow it to continue its sales push into the country.
In my opinion the only investment grade business out of all of the above is the a2 Milk Company, although of course it's quite possible any of the others go on to deliver better returns.
The key takeaway from today's news though is to remember that all of these China-facing stocks are higher up the risk curve due to the unpredictable nature of sales.
