China infant formula:133 domestic licenses down to 82

About 1/3rd of infant formula companies not granted domestic licenses。

    The China Food & Drug Administration (CFDA) announced on 30 May 2014that of the existing 133 domestic infant formula production companies, 82were granted new licenses, largely in line with our expectation (the numberof unique companies dropped from around 100 to 65 based on our analysis,i.e. about one-third were eliminated). As indicated in our sector report, Chinainfant formula - Two propellers for growth (26 May 2014), we estimate theeliminated players have around 5% market share of the infant formulamarket. Separately, the General Administration of Quality Supervision,Inspection and Quarantine (AQSIQ) is reported to have announced that only94 brands are allowed to be imported into China from 1 May 2014 (source:Xinhua News). This compares with 800-1,000 import brands previously,according to Xinhua News citing industry expert Wang Dingmian. While thereduction in import brands is not exactly new as the Chinese governmenthad reduced the number of authorised overseas infant formula productioncompanies to 49 in early May 2014, the number of import brands left doessurprise us on the downside.

    Overall, we reiterate our view that these new regulations by the governmentwill speed up the consolidation of the infant formula industry and wouldbenefit the remaining players including Biostime (1112 HK, Buy) and Yashili(1230 HK, Neutral). We prefer Biostime given its premium brand, broadproduct range and strong and growing distribution network. We see Yashili’srevenue and earnings under pressure in FY14F due to its sales networkreform and new membership programme as well as intensifying competition.

    Biostime - production license granted; 400g packs may be available。

    As expected, Biostime was granted a domestic production license which thecompany plans to use the domestic plant to produce a sub-CNY200/900gseries under the Adimil brand. Based on the information registered with theCFDA, this new sub-CNY200 will be called Adimil Golden Care and thecompany may launch 400g packs in addition to the 900g packs. We believethe 400g packs are likely to cater to the more price-sensitive Chineseparents who purchase infant formula that is below CNY200.

    Some companies may be granted licenses at a later stage but theirmarkets and customers would likely be lost by then。

    Of the 51 domestic companies that did not receive new licenses, 14changed to just producing infant formula base powder (a semi-finishedingredient used in infant formula for some companies), 23 were granted anextension to obtain their licenses, 5 were rejected and 9 applied to have theirlicenses cancelled. The 23 companies which were granted an extension toobtain their licenses would likely have 2 years to satisfy the newrequirements. Some of these companies may be granted licenses at a latertime but, in the meantime, they would not be able to produce infant formula.

    Thus, depending on when they could obtain their licenses, their markets andcustomers may have been absorbed by other remaining players by then, sowe believe it would be difficult for them to re-gain their sales.