China's shake-up heightens regulatory risk for Kiwi businesses

Former a2 CEO Geoff Babidge with infant formula on the production line. Photo / Supplied

China's dramatic regulatory crackdown is being closely followed by local fund managers amid speculation of possible flow-on effects to some Australasian businesses.

Questions have been raised, for example, about whether China could potentially look at introducing price caps on the sale of premium infant formula manufactured by international companies.

The speculation first surfaced after the State Council of China released new birth policy in July with a strong focus on reducing the costs of raising a child.

China moved to a three-child policy in May but the country's declining birthrate is thought to be more to do with the cost of education and other middle-class necessities than the controversial one-child policy.

While China is encouraging the population to have more babies, the Government has now moved to ease the financial burden on parents.

That resulted in the forceful intervention in the education sector last month, alongside a range of other regulatory moves in the online technology sector and against billionaires.

Investors in China have been shaken in recent weeks by a slew of regulations targeting sectors ranging from gaming to education. Photo / 123rf

"Fortunately, there are no major Australasian companies that are largely impacted at this stage. But there is uncertainty for some industries, such as infant formula where there are some concerns that China may go as far as introducing price caps to reduce the costs of raising children," said Will Curtayne, fund manager at Milford Asset Management.

"It's just speculation at this stage but the situation continues to develop and quite rapidly.
"[Raising a child] is pretty expensive if you are not a wealthy Chinese parent. Some of them will be paying nearly $60 a tin for premium infant formula."

He noted a recent shift toward domestic manufacturers in China, which has come at a cost to some international brands like a2.

"Price caps could be another way if they wanted to hurry up a transition back to domestic brands even more, by potentially just putting price caps on international products, rather than your domestic stuff," Curtayne said.

However, local firms see no reason to panic – at least not at this stage.

Fonterra, which doesn't export a huge amount of infant formula to China, appears reasonably unfazed by what's happening over there.

"We're seeing no changes in Infant Formula prices in China," a spokesperson said.

The a2 Milk Company, which has already experienced multiple earnings downgrades over problems with its sales network in China, declined to comment specifically on China policy.

However, as expected it has been monitoring developments closely.

A spokesperson said the company couldn't identify any reliable statement at the time that the government intended to take measures on infant formula pricing.

In its results commentary last month, a2 said the "dynamic and challenging market conditions" over the past year highlighted the need to review and adapt elements of the company's long-term strategy and execution.

"The company recognises that the China infant nutrition market structure is changing rapidly. While consumers still have a strong preference for premium infant nutrition, market growth is being impacted by a more pronounced reduction in the birth rate. In addition, the shift towards China label infant nutrition continues, the rate of new product innovation has ramped up, channels to market are changing and competitive intensity is increasing, with domestic players continuing to gain market share."

It has initiated a comprehensive review, including the company's approach to infant nutrition growth in both China label and English label channels.

Meanwhile, investors in China have been shaken in recent weeks by a slew of regulations targeting sectors ranging from gaming to education.

Chinese President Xi Jinping. Photo / Greg Bowker

China's two tech giants Tencent and Alibaba have both slumped more than 35 per cent from their highs for the year. Online tutoring companies such as New Oriental Education and TAL Education Group are down more than 85 per cent. Milford's Curtayne said China's intervention in the education and online tech sectors is a big reminder that regulation risk has heightened.

"China is not just doing this to spite international firms. They are doing this probably reluctantly to deal with growing social unrest driven by wealth inequality and the lack of affordability in education and health etc.

"The big shock and awe factor has probably largely played out but there will be incremental fine tuning and adjusting and certain sectors they continue to look at.

"So, for New Zealand businesses doing business up there it's a good reminder that the cost of capital and required return on investing in China has got to be higher because it is a high-risk destination."