The Chinese dairy market was rocked by scandal in 2008 when it was discovered that producers were adding melamine, an industrial compound used to make plastic, to infant formula to boost apparent protein levels, but ended up causing six deaths and left thousands hospitalized with kidney problems. Producers like Synutra International (NASDAQ:SYUT) have never recovered, their stocks trading at a fraction of their former heights.
This coming as it did a few years after producers were charged in a fake milk scandal leading to malnutrition and leaving 13 infants dead, Chinese mothers largely abandoned domestic formula suppliers in favor of foreign ones, like Nestle (NASDAQOTH:NSRGY) and Danone (NASDAQOTH:DANOY).
Demand was so great that prices soared by as much as 30%, with foreign-made formula costing twice as much on the mainland as the same brands in Western countries. That led relatives as far away as the U.K. to buy up cases of formula locally and ship it back to China, causing supermarket chains like Tesco to impose a rationing system to limit the practice.
With runaway demand, analysts estimate the market there could hit $25 billion by 2017, but China has launched an investigation into whether foreign producers conspired to exploit the crisis to inflate prices.
In addition to Nestle and Danone, Abbott Labs (NYSE:ABT), Mead Johnson Nutrition (NYSE:MJN), New Zealand-based cooperative Fonterra, and Chinese producer Biostime have also confirmed they've been targeted for possible price-fixing and anti-competitive practices.
While it would seem to be simply supply and demand driving up the cost of infant formula prices, Nestle and Danone have already agreed to cut its prices, with Nestle saying it will lower them by 11% through 2014, with some products' prices getting slashed by as much as 20%. While that could be a gesture of goodwill, it could also suggest these companies previously colluded to raise prices.
Yet even if the foreign producers are found guilty of anticompetitive practices, don't expect domestic suppliers like Synutra to benefit. Chinese parents remain leery of locally produced product, and last year another formula maker, Yili, had to initiate a recall because of high levels of mercury.
Tainted food products out of China are nothing new, with antifreeze, lead paint, and other toxic substances having found their way into the food chain. And parents, it seems, would rather pay inflated prices than trust locally sourced products. Particularly when it comes to infant formula, "Made in China" is not a label that instills confidence.
Fool contributor Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. 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.