Which Infant Formula Stock is a Best Buy Now?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I always consider a short-term stock price decline to be an opportunity for investors to accumulate a company’s shares at a low price. Recently, Mead Johnson Nutrition (NYSE: MJN) experienced a significant decline of 8.1% on the market to only $68.85 per share. The huge fall in its stock price was due to the news that China has launched an investigation into possible antitrust violations. Other infant formula manufacturers, including Danone (NASDAQOTH: DANOY.PK) and Abbott Laboratories (NYSE: ABT), also took a hit on the market after the news. While Abbott was down by 1%, Danone’s share price declined by around 2.5%.

Foreign players might have to reduce their product prices in China

According to Reuters, dated back 2008, because of industrial compound melamine in infant formula, at least six babies were killed and thousands of others have kidney stones, Chinese people turned to foreign milk products. Thus, it was a good chance for foreign companies to increase their product prices. Recently, People’s Daily reported that China had evidence that the milk-power companies have managed to increase their product prices about 30% since 2008. Right after that, Danone and Nestle announced that they would cut the price of their infant formula milk products in China. Personally, I would expect Mead Johnson and Abbott followed the same path.

Which one might be the most affected?

Mead Johnson seems to be the most affected, as it derived the majority of its sales from the China/Hong Kong region. In 2012 around $1.16 billion, or 29.7% of the total revenue, was generated from China/Hong Kong, while the U.S. ranked second, contributing $990 million in sales in 2012. Moreover, Infant formula is the largest revenue contributor for the company’s business, generating nearly $2.3 billion, or 59%, of the total 2012 revenue. Within the huge 77.9 billion Yuan ($12.70 billion) Chinese milk formula market, Mead Johnson has as much as a 13.5% market share.

Abbott Laboratories also had a significant position, but not as much as exposure like Mead Johnson, in the infant formula industry in China, with around 6.8% market share. However, Wells Fargo analyst Lawrence Biegelsen commented that because of the lower exposure and the company’s diversified business, the overall risk to the total company was minimized. Abbott’s largest revenue and income contributor was the Proprietary Pharmaceuticals segment, with more than $18 billion in revenue and nearly $7.95 billion in profits in 2012. The Nutritionals segment contributed only $6.47 billion in sales and more than $1 billion in operating income for Abbott.

China is also a big part of Danone’s operations, contributing as much as 6% of the total sales to the company, behind Russia, France and USA. In the baby nutrition market, Danone is also a big player, taking around 14.8% of the total market share in the total milk in modern trade. It planned to accelerate its double-digit growth in this country through the relaunch of Dumex, entry into the Hong Kong market, and e-tailing management.

Valuation

Even after the significant decline on the market, Mead Johnson seems to be quite expensive. It is trading at $69.30 per share, with a total market cap of around $14 billion. The market values the company at as high as 17.1 times its trailing EBITDA. Danone has a lower valuation than Mead Johnson. At $14.30 per share, Danone is worth $42.50 billion on the market. It is valued at 11.6 times its trailing EBITDA. Abbott is the cheapest among the three, with a much lower EBITDA multiple. It is trading at $34.90 per share, with a total market cap of $54.40 billion. The market values Abbott at only 4.58 times its trailing EBITDA.

My Foolish take

Mead Johnson might take action by cutting their infant formula prices in China, following the path of Nestle and Danone. Consequently, it would certainly affect the company’s bottom line negatively in the near future. Among the three, I like Abbott the most as it has the least exposure to the infant formula market, along with the diversified business. Moreover, it is trading at a much lower valuation compared to both Danone and Mead Johnson.

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Anh HOANG 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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