Unofficial ‘grey channel’ into China a big earner for firms.

Australasian infant formula stocks have proved a pretty good bet lately.

You've got A2 Milk, the top performer on the S&P NZX/50 for 2015, whose shares have almost doubled in value in the past year, to be trading at $1.82 at midday yesterday.

Then there's Bellamy's Australia, which has delivered a 14-fold gain to investors since it listed on the ASX in August 2014.

The so-called "grey channel" into China's booming infant formula market has emerged as a major driver of sales for these firms and others.


This involves budding entrepreneurs sourcing product from Australian supermarkets and shipping it to China, where it's resold online.

But while this unofficial trade has been a boon for manufacturers, it faces a risk - regulation.

You don't have to go far to find an example of where that's happened before.

In 2012 New Zealand's Ministry for Primary Industries cracked down on unregistered exporters shipping infant formula through grey channels for eventual sale on Chinese websites such as Alibaba's

At that time the ministry and Customs estimated such exports had swelled to become a $150 million industry.

Now the same thing is happening across the Tasman, with supermarket shelves being cleared of formula by online traders.

In November photographs of supermarket trolleys stacked high with boxes of A2's Platinum formula brand were widely circulated on social media.

Last month A2 managing director Geoff Babidge said the company had increased supply to Australian retailers, but some outlets were continuing to run out of stock.


A2 products could be found on Taobao this week selling for 189 yuan to 295 yuan a can.

That's great, but Stock Takes wonders how much grey channel sales contributed to A2's recent earnings upgrades - which sparked a major share price rally in the final weeks of 2015 - and how sustainable they are as a revenue source.

Will we see earnings downgrades from the likes of A2 and Bellamy's if the authorities, be they Australian or Chinese, turn off the tap on this trade?

In November, Australia's Department of Agriculture and Water Resources said it was investigating allegations some baby milk exporters had been shipping more than they were allowed to under Aussie law.

Unregistered exporters are not allowed to ship more than 10kg to China.

Meanwhile, supermarkets have reacted by introducing limits on the number of cans individual shoppers can purchase, but there are reports that bulk buying is still going on.

A2 also sells formula directly in the Chinese market through its distributor, China State Farm.

But its recent announcements don't provide clarity on whether it's the unofficial trade, or direct sales into China, that are contributing the most to the impressive baby milk revenue growth the company has been reporting.

In fact, the last two trading updates don't even discuss the grey channel dynamic.

One infant formula industry source said some kind of crackdown on the Aussie/China formula unofficial trade was likely this year.

Stock Takes approached A2 to see if the firm shares any of these concerns.

"Over the past two years the A2 Milk Company has been building its sales across Australian retailers, official cross-border e-commerce sales platforms and mother and baby stores in China," a spokesman said. "Ongoing development of brand and maintaining high-quality product delivery are key to infant formula growth in Australia and China."

Arria eyes NZX

British technology firm Arria NLG is tipped to be considering an NZX main board listing, which could take place this year.

The company, whose software is used by companies to generate reports usually produced by analysts, already has strong links with New Zealand.

It raised $20 million from high-profile Kiwi investors including economist Gareth Morgan and former Telecom boss Theresa Gattung before its 2013 listing on London's AIM market.

Arria, which has links to Diligent co-founder Brian Henry, got into a spot of bother early last year when an announcement about the loss of a major contract with oil giant Shell knocked 70 per cent off the value of its shares.

They closed as low as 4p in May.

The stock has recovered to close at around 25p yesterday, but remains well below the 2.82.5p closing record reached immediately after the 2013 float.

Stock Takes understands one reason for Arria listing in New Zealand would be that around half of its shareholders, by number, are based here. A market source said the float, should it go ahead, could raise up to $20 million.

The company had been floated as potential NZX contender before it carried out its London listing.

Reporting season a circuit breaker

This month's sharemarket sell-off took place amid a vacuum of New Zealand company-specific information.

Getting some focus back on the fundamentals of NZX-listed firms will be a good thing and reporting season - which kicks off next month - should help.

"It'll be nice to get a reminder that the sun still comes up in the morning," JBWere investment strategist Bernard Doyle said last week.

"Reporting season can be a nice circuit breaker in a period of quite poor market conditions."

Major firms reporting next month include Air New Zealand (a major beneficiary of the oil slump), Auckland Airport - which has been riding high on the back of a tourism boom - and Mighty River Power.