Formula for disaster

The tainted infant formula scandal is spreading from one product and one company to infect the entire domestic dairy industry. Foreign brands could be the big winners, writes Tony Jin.

China’s “melamine incident” has spread from infant formula to taint all dairy products and from Sanlu Group to sour the entire Chinese dairy market, mainland newspapers are reporting. According to industry experts spoken to by the Chinese press, the scandal will compound the tough times dairy makers are facing as a result of stiff competition and falling profit margins. The industry is unlikely to return to normal anytime soon, and certainly not before a reshuffle of industry dominance.

"No matter who the culprit is, our family will not drink milk in the months to come,” a typical dairy consumer told the China Securities Journal. An industry expert told the newspaper that “Sanlu and the products of some other brands found contaminated have entangled the dairy industry as a whole in the crisis. The panic is going to linger for a while, resulting in a sluggish market.”

Milk fridges have become the least popular places in supermarkets across the country, China Business News reported, and sales of dairy products have plummeted over the past week despite slashed prices across the board. The panic has even impacted on the food processing sector. Shares of giant meat processors Henan Shuanghui Investment & Development (000895.SZ) and Zhengzhou Sanquan Foods Co (002216.SZ) both took the maximum daily 10% dive last Wednesday and Thursday.

Liu Jinhu, an analyst with Guohai Securities, told the China Securities Journal said the scandal could mean an opportunity for foreign firms to capture a larger share of the Chinese infant milk powder market, particularly in the economically developed Yangtze River Delta and Pearl River Delta regions. Foreign brands already had an upper hand in China’s high-end infant formula market because domestic firms struggled to source enough premium raw milk. “Melamine in powder has made the bell curve further skewed to foreign brands with Mead Johnson, Dumex, Wyeth and Abbott underscoring their dominance in the Chinese market,” Liu said.

BOABC, an agriculture and food consultancy, warned that China’s dairy export sector will take a big blow from the scandal. It predicts foreign brands will have absolute control over the high-end infant powder market in one or two years.

Kang Jingdong, an analyst at Xinda Securities, told Caijing magazine it was unfair that the clean domestic brands, which have gone to great lengths to capture a share from foreign giants in the high-end infant formula market, have been tainted by the scandal. “Their efforts now look as though in vain as the Chinese brands are considered not to be trusted,” he said.

The foreign dominance claim was disputed by some industry watchers. Sanlu is just a crappy brand whose products are sold only in less developed regions, one analyst told the China Securities Journal. Therefore, the multi-billion yuan infant powder markets in those regions, mostly in western and northern China, are likely to be filled by domestic brands that are costlier than Sanlu but cheaper than foreign competitors.

Sanlu, however, is a giant in terms of aggregate amount. The Hebei province-based firm chalked up US$1.46 billion (RMB10 billion) in revenue in 2007, behind only the Inner Mongolia duopolies Mengniu and Yili (some of whose products were also found tainted). It churns out 5,730 equivalent tons of milk a day, behind Yili, Mengniu and Shanghai-based Bright Dairy & Food. Sanlu’s milk powder sales volume was ranked China’s number one for over ten straight years.

The creditability crisis is likely to prompt a reshuffle that might subvert the Inner Mongolia duopolies. Ma Guowu, marketing boss of Sanyuan, a brand found clean, told the China Securities Journal the company's sales tripled in recent days. Sanyuan collects 70% of its revenues from northern and central China.

“If demand in the south [in China] surges, we will extend our network nationwide,” Ma said. “We have been approached by some dealers in recent days but we will scrutinize their qualifications before cooperation.”