Abbott Labs (NYSE:ABT) is cutting the prices of its baby formula products in China by 4%-12%. The move comes after the Chinese regulators started an anti-trust investigation against the company and a handful of its peers such as Mead Johnson, Nestle and Danone.  The investigation will look for signs that suggest these companies colluded to fix the prices of their products at a higher rate than would have been possible if they were genuinely competing against each other in the country.
While this may seem like a big event because China has been a major focus for the company in multiple business segments, we believe that investors should not worry because the Chinese baby formula market represents a very small portion of the company’s revenue. According to Euromonitor, Abbott accounted for just 3% of the $12.69 billion total infant formula sales in China last year. That means the company generated only about $380 million, or less than 2% of its total revenue from the Chinese baby powder market in 2012.  Even if this revenue declines significantly, the dent on Abbott’s top line is going to be very small.
Further, we believe that this event will have no negative impact on the company’s market share in China because all the major multinational players are equally impacted by the investigation. If there is an impact at all, it should be an increase in the sales volumes of these multinational players at the expense of local manufacturers because Chinese parents increasingly prefer globally renowned brands over domestic labels.
Limited Impact On Abbott’s Market Share
As mentioned above, Abbott is not facing the investigation alone. Other leading non-Chinese baby formula manufacturers like Mead Johnson, Nestle and Danone are also facing the same investigation and have responded similarly by cutting their prices. Mead Johnson is cutting its prices by 7%-15%, while Nestle and Danone are cutting their prices by 6%-20% and 5-20% respectively.    Since the prices of all the major multinational players in this market have fallen simultaneously and almost equally, we see no reason why any one of these players could gain market share at the expense of its rivals.
Sales Could Actually Grow At The Expense Of Local Manufacturers
In 2008, China faced a major milk scandal in which adulterated milk powder caused 53,000 infants to fall sick, out of which around 13,000 babies had to be hospitalized.  Since then, Chinese parents have shown a strong affinity towards trusted brands from multinationals like Abbott, Mead Johnson and Nestle. (Read more about the Chinese milk scandal here) This preference is likely to grow stronger once the prices of products from these companies decline and they become affordable to a larger section of the Chinese population. If this happens, more Chinese households can be expected to replace the local brands they currently use with renowned names like Similac (a product from Abbott), thereby boosting the sales and market share of multinational players at the expense of domestic manufacturers.
Should this trend materialize, Abbott is well positioned to benefit from it because the company has been boosting its production capacity in the country for several years. The company already has a nutritionals (category which includes baby formula products) manufacturing plant in Guangzhou while another one is being built in Jiaxing and is scheduled to start operations in late 2013.  Further, the company is rapidly expanding its footprint in China with plans to more than double its city presence by 2015 through expansion activities. This will ensure that the company’s products are more recognizable and easily available to a wider section of the Chinese market.
Our price estimate for the company remains unchanged at around $38 per share.Notes:
- Abbott Cuts Baby Formula Prices in China, Wall Street Journal, July 9, 2013 [↩] [↩]
- Mead Johnson to cut formula prices amid China probe, Channel NewsAsia, July 11, 2013 [↩]
- Danone, Nestle Will Cut China Prices Amid State Probe, Bloomberg, July 3, 2013 [↩]
- Danone says will cut China baby formula prices by 5-20%, Channel NewsAsia, July 8, 2013 [↩]
- China milk scandal: 53,000 children ill from tainted powder, The Telegraph, September 22, 2008 [↩]
- CHINA: Abbott to open Chinese infant nutrition plant, Just Food, November 14, 2012 [↩]