Battling It Out for the Infant Formula Market
Nestle, Mead Johnson, Abbott Laboratories, and Danone are each targeting the developing world.
During periods of economic uncertainty, investors often seek refuge with names that operate in resilient sectors such as health care and consumer staples. However, even consumer staples companies can suffer erosion in market share amid downturns, as price-conscious consumers opt for cheaper private-label alternatives over branded fare.
The one area where consumers are least likely to stint on their purchases is anything that pertains to their children, especially when they're at their most vulnerable as infants. That makes infant formula one of the few truly enduring branded consumer staples.
When it comes to infant formula, parents at all income levels in the developed world - and increasingly, the emerging markets - are deeply brand-conscious. Indeed, while packaged food sales have grown 6.1% annually over the past five years, sales of baby food have climbed 9.6% annually over the same period. Rising populations in emerging markets are driving growth in the $36.7 billion global baby food market.
Exemplified by Nestle's (NSRGY) recent deal to acquire Pfizer's (PFE) infant-nutrition business, the industry is rapidly consolidating and manufacturers are expanding their share of developing world markets. While the top five brands account for 20.8% of the global market, the top five manufacturers have a commanding 57.6% market share.
The US market is dominated by three brands with a combined 90% share of sales: Mead Johnson Nutrition Co's (MJN) Enfamil (40% of the market), Abbott Laboratories' (ABT) Similac (40%), and Nestle's Good Start (10%).
The Infant Formula Oligopoly
This oligopoly is derived partly from the US Food and Drug Administration's stringent criteria for infant formula, making it difficult for both new and private-label competitors to enter the market.
These infant formula manufacturers have also shrewdly developed longstanding relationships with US health-care providers. It's rare for new parents to leave the hospital without being loaded down by free samples of infant formula. The perceived imprimatur of health-care providers is key in developing brand awareness and establishing a relationship with these products during the first week of an infant's life.
According to data from the Centers for Disease Control and Prevention, nearly a quarter of babies who ultimately go on to be breastfed have already received formula before they're 2 days old.
On the other hand, doctors and hospitals are also placing a greater emphasis on breastfeeding. The percentage of babies exclusively breastfed at three months rose to 35% in 2008 from 30.5% in 2004. However, those rates drop precipitously over the ensuing months of a baby's life as mothers return to the workplace following maternity leave, with just 14.8% of babies exclusively breastfed at six months.
While the high cost of formula is a consideration for some parents who favor breastfeeding, the US market is actually heavily subsidized. UBIC Consulting estimates that at least one-third of the US infant formula market receives support from government programs. Those programs include both food stamps as well as the Special Supplemental Nutritional Program for Women, Infants, and Children (WIC).
The number of food-stamp recipients is at an all-time high of 44.7 million, up 70% from 2007, with the Congressional Budget Office projecting a further rise to 47.2 million by 2014.
Meanwhile, WIC covers nearly 9 million women and children, many of whom may also have access to food stamps. However, these programs are in the budget-cutting crosshairs of congressional leaders, so there's a risk that funding or eligibility could soon be curtailed.
Baby Boom Nations
In emerging markets, particularly in Asia and South America, birth rates surpass the US by an average of 37.7% among the dozen larg-est nations in these regions. That factor along with increasing urbanization and a burgeoning middle class support further growth in sales of infant formula.
Although China's one-child policy means that its birth rate slightly lags the US, analysts estimate that its middle class - already roughly the size of the entire US population - could reach 700 million people by 2020.
As with their developed world counterparts, women in the developing world are increasingly returning to work after childbirth, fostering their greater reliance on infant formula ver-sus breastfeeding.
When it comes to their wee ones, mothers demand the top first-world brands. That holds especially true in China after the mainland's 2008 scan-dal involving milk powder tainted with the toxic chemical melamine. Because Chinese companies had adulterated the milk, skeptical consumers now place a premium on foreign brands and imports.
India's birth rate exceeds China's by nearly 71%. With roughly 25 million babies born each year, the subcontinent has the fastest growing infant nutrition market in the world. At an estimated $400 million, India's baby food market is just a fraction of the Chinese market, but it's expected to grow to $700 million by 2015.
While Nestle holds an estimated 85% share of the Indian infant nutrition market, its share of the Chi-nese market stood at just 2.3% in 2010.
At 19.8 times 2012 earnings before interest, taxation, depreciation, and amortization (EBITDA), Nestle's acquisition of the Pfizer unit did not come cheaply. However, it should boost Nestle's share of the Chinese market to 9.7%, for a third-place ranking behind Danone (9.8%) and Mead Johnson (11.7%).
Nestle's leading market share could decline modestly in other markets if regulators require it to divest certain assets in exchange for approving the deal. But overall, the deal should help Nes-tle garner the top market share in Asia, although it remains to be seen how asset divestitures will affect its leading market share in other devel-oping regions.
The Pfizer unit earns 85% of its revenue from the developing world, with 25% of sales in Chi-na and another 60% of sales in other emerging markets. Emerging nations accounted for 40% of Nestle's 2011 revenue, with a 13% rise in organic growth versus the modest 4.3% uptick in revenue from the developed world.
Although Nestle's origins are in baby food, its revenue in that category, which includes well-known brands such as Gerber and Nan, constitutes just 7.8% of the food conglomerate's sales. Nestle remains a buy in the growth portfolio up to $60.Editor's Note: This article was written by Ari Charney of Personal Finance.
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