CHART: Around half of Blackmores sales are being driven by the China grey market

Traditional Chinese herbs at a medicine shop in Beijing. Guang Niu/Getty Images

Blackmores briefly became a $200 stock, the most expensive on the ASX, on the back of reports that its vitamins are much loved in China, the world’s biggest emerging market.

Part of the appeal in China is that Australia is seen as a clean and green country. Its vitamin supplements, the logic goes, must be of the highest quality and so China’s emerging middle class want the best.

However, the trade driving Blackmores at the moment is through a grey market. Like infant formula, especially the A2 Platinum brand by the ASX-listed A2 Milk company, the vitamins arrive in China by an indirect route.

The vitamins are bought from Australian retailers and then are sent to consumers in China, according to Chris Kallos, health care equity analyst at Morningstar.

This grey market was a key driver of the 36% growth to $125 million in Blackmores’ sales revenue in the 2015 financial year.

“We estimate the domestic grey market accounted for $70 million of the uplift in fiscal 2015 revenue and expect this growth will continue,” Kallos says.

Morningstar has increased its fair value estimate of Blackmores to $150 per share, up from $85. Today Blackmores is trading at $171.92. Twelve months ago the price was $32.

Kallos sees the following drivers of demand from China for Blackmores products:

  • More cash to spend. The rise of the middle class in China and increasing disposable income. This is fueling increased consumption of mainly health and beauty products. The fall in the Australia dollar is also helping.
  • E-commerce shopping channels in China. China has more than 640 million internet users in a population of 1.4 billion people. “Although Blackmores offers direct sales on its own website, current tariffs create a price disadvantage to stock provided by entrepreneurial intermediaries buying locally in Australia,” Kallos says. Chemist Warehouse recently flagged its intention to establish an online presence in China.
  • China-Australia Free Trade Agreement (ChAFTA). “The recent signing of ChAFTA marks an important step in tariff reduction designed to enhance Australian and Chinese business engagement,” Kallos says. ChAFTA allows about 85% of Australian goods to enter China tariff-free.
  • Food safety. “Pollution stemming from rapid industrialisation is a major problem in China,” Kallos says. “Farmland affected by pesticides, soil pollution and harvests contaminated with heavy metals are issues driving a general demand for imported foods. Furthermore, food-related health scares have raised Chinese consumer awareness of quality and increased the demand for Australasian-made products.” And that puts Blackmores, with 100% manufacturing in Australia, in a good position.

Kallos forecasts Blackmores domestic sales of $277 million in 2016, growing 9% in 2017 and the same in the following year.

And China’s grey market channel sales of Blackmores’ products to total $224 million in 2016, growing at 30% in 2017 and 20% in 2018.

Here’s how the grey market stacks up against domestic Australian sales:

The forecasts don’t take into the account the potential upside of a new partnership with Bega, the dairy company, to develop an infant formula product.

“We highlight and acknowledge the potential opportunity is significant and hence difficult to quantify,” Kallos says. “We believe the risk to our earnings forecast is skewed to the upside.”

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