Here's exactly how Bellamy's got into its deep hole, and how it hopes to climb out

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The key problem for Bellamy’s is that it got caught out with a lot of infant formula on its hands when sales in China dipped.

Tanking sales in China caused by a change in regulations left Bellamy’s with warehouses full of its organic infant formula and its trade customers with so much stock that they didn’t need to re-order for a while.

Revenue hit a speed bump, the company’s share price more than halved and today the CEO who built the China market, Laura McBain, was shown the door.

The organic infant formula maker had ramped up production so it could meet what it believed was an unstoppable growth curve.

And for many years it was stellar, with growth rates of 70% a year for the company as a whole. In 2016, revenue from China/Hong Kong grew 331% to $62 million. This encouraged the company to put in place manufacturing deals with other players so it could meet demand.

However, at the end of December the company estimates that it had inventory levels valued at between $105 million to $110 million, representing almost six months worth of revenue.

A five year contract

On top of that they had a five-year manufacturing contract with Fonterra, the world’s biggest dairy exporter, to ensure supplies to feed the once-booming China market.

If Bellamy’s allowed that production to continue, the warehouses would just be getting fuller. With revenue stalled, profits would disappear.

To get out of a hole Bellamy’s renegotiated its contract with Fonterra.

Details are sketchy because of confidentiality clauses within the contract between Bellamy’s and Fonterra.

However, we do know that Fonterra will still be paid the same originally agreed amount by Bellamy’s; it’s just that the money will come over eight years instead of the five under the first agreement.

Overall, taking all supply contracts into consideration and not just the one with Fonterra, Bellamy’s will have to pay out shortfall payments between $11 million and $13 million each year for at least two years. The first payment is due in the 2018 financial year.

Much depends on whether sales will recover in China as the warehouses there empty and supply returns to more normal levels.

In any case, the company is working hard to cut production so it doesn’t keep filling warehouses.

No change this year

This will take time. Production can’t be wound down overnight. Orders have to be shaved, changes made to schedules and payment. The company expects no material change in inventory by the end of this financial year.

“A part of Bellamy’s strategy is to subcontract manufacturing of its products,” the company said in a business update today.

“Its key manufacturing contracts have minimum volume commitments to secure access to the necessary manufacturing facilities.”

That’s where the shortfall payments come in. “Under its contractual arrangements with Fonterra and other suppliers/manufacturers, where the company is not able to fulfil minimum volume commitments, it is required to make shortfall payments,” Bellamy’s says.

Currently Fonterra only manufactures one of Bellamy’s three infant milk formula products. Bega Cheese is also a supplier but Bellamy’s says there has been no change to that agreement yet.

Much depends on demand from China.

“The company continues to believe in the strength of its brand and products and global sales footprint,” says Bellamy’s.

“Bellamy’s is focused on building a sustainable business that can execute on the significant, long term opportunities in Australia, China and other markets, and deliver long term value to its shareholders.”

But a return to growth won’t be this year.

Bellamy’s expects full year revenue to be in the range of $220 million to $240 million, at best flat on 2015 and well below previous analyst expectations of about $330 million.

“The company is actively working to realign its supply chain and key customer channels to target more sustainable and visible growth across its home market and South East Asia and the important China market,” Bellamy’s says.

“Key aspects of this are pricing strategy, route-to-market, ongoing marketing programs and improving customer relationships.”

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