China's booming economy has attracted many companies in their quest for growth. However, all that glitters is not gold. China can bring a lot of hassles, too, in the form of regulatory headwinds, making it tough for foreign companies. For instance, as Chinese authorities stepped up their efforts to consolidate the milk-formula industry and create strong "domestic brands" through 10 companies within two years , it also initiated price-fixing charges on many foreign companies. The likes of Mead Johnson Nutrition (NYSE:MJN), Danone (NASDAQOTH:DANOY) and Nestle (NASDAQOTH:NSRGY) were at the receiving end of such steps, but what has the impact been so far? Let's take a look.
Mead Johnson gets back on track
Mead Johnson is the largest baby formula company in China with 14% market share last year . The company decided to get its name cleared by cooperating with the regulatory requirements in order to regain the trust of Chinese consumers . Mead Johnson is a pediatric nutrition company and competes with more diversified food and beverages players like Danone and Nestle in the pediatric nutrition market.
Mead Johnson reported a strong third-quarter that beat consensus estimates. Asia/Latin America, the largest segment of the company, saw gains of 19% year over year as compared to 2% in North America/Europe. Voluntary product recalls by competitors in China also resulted in Mead Johnson's strong performance. On the back of robust sales across the board, its consolidated revenue surged 14% year over year to $1.05 billion .
With 70% of revenue from Asia/Latin America, Mead Johnson is focused on emerging markets for growth. The company remains on track to achieve $1 billion in sales in 2015 from Latin America. Despite regulatory headwinds, Mead Johnson is bullish about its long-term growth prospects in China because "China drives 60 percent of worldwide nutritionals market growth," according to Morgan Stanley's David Lewis .
On the back of strong sales across all segments, Mead Johnson's adjusted earnings climbed 28.2% year over year to $0.91 per share. Buoyed by an encouraging third quarter, Mead Johnson raised its fiscal 2013 earnings per share guidance to the range of $3.30−$3.37 from the earlier $3.22−$3.30.
Following the Chinese regulatory hiccup, investor confidence was shaky and share prices were under pressure. In order to regain investors' faith, Mead Johnson's board of directors authorized a new share repurchase program of up to $500 million. This, along with robust third-quarter results, has instilled a new lease of life into Mead Johnson's stock.
Danone takes a big hit
China is important for Danone's baby nutrition division as it derives more than 20% of its overall sales from China. Danone has had its own share of problems in China, and like Mead Johnson, it was slapped with a penalty and was forced to cut prices by as much as 20% after a milk-powder price-fixing probe.
A month later, in August, Danone had to voluntarily recall infant formula products in Asia due to an unfounded botulism contamination scare coming from New Zealand-based supplier Fonterra. As if this was not enough, two of its units--Dumex in baby food and Nutricia in medical nutrition--recently faced bribery allegations in China.
As a result of the Fonterra scare, Danone expects total damage of $564 million to its full year sales. Its baby nutrition division sales declined 8.6%, and sales volumes declined 7.3%. Mead Johnson seems to have gained from this, as indicated on the previous earnings call.
Nestle continues unperturbed
Nestle has also been under the microscope for price-fixing investigations in China . However, being the largest food-maker in the world , Nestle was confident that this won't have any visible impact on its margins in China in the long-term, as any decline in this segment will be more than offset by gains in other segments.
This is probably the reason why Nestle is looking to capture more of the Chinese market. It has been expanding in China and acquired a 60% stake in Yinlu Foods Group. Nestle has over 27 factories in the Greater China region. In July, it announced the opening of two more factories in China. The company reported 4% growth across the board for the nine month period across all three geographies and is confident about delivering 5% organic growth for the full year.
Hence, as a result of a diversified business, Nestle can continue its Chinese investments and benefit from the world's most populous nation in the long run.
Which one should you pick?
Mead Johnson seems to be gaining at Danone's expense in China. It got out of regulatory hiccups and has got its business back on track. Mead Johnson has also initiated a shareholder-friendly move such as share repurchases, indicating that it is confident about its long-term prospects. Also, a dividend of 1.60% is one more reason why Mead Johnson looks like a good stock to buy.
On the other hand, Danone has been struggling from a variety of issues in China, which is why it should be avoided for the time being. But Nestle seems to be handling its Chinese affairs quite well, and the fact that the company's business is spread across different regions is a good advantage to have.
So, in my opinion, investors should consider either Mead Johnson or Nestle for their portfolio if they are looking to profit from the nutritional food market.
Fool contributor Mukesh Baghel 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.
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