Dairy company Synlait Milk is on the road to recovery after Covid took its toll. Photo / NZME
Covid-19 has cast a long shadow over milk nutrition company Synlait Milk, but chief executive Grant Watson says the recovery is now well under way.
After one year in the hot seat, Watson has high hopes for an as-yet-unnamed multinational which he says may one day supplant a2 Milk as Synlait’s biggest customer.
But for the moment Synlait — 20 per cent owned by a2 Milk and also a2′s sole supplier of infant formula — is still a work in progress.
The company has had a turbulent share price history since listing on the sharemarket in 2013.
Synlait rode the coat-tails of a2 Milk’s explosive share price performance, hitting a record high of $13.40 in September 2018.
During the pandemic, the stock traded as low as $2.80, but started to kick back into life late last year and early this year, and is now trading around $3.50.
Synlait’s troubles began when the all-important “daigou” trade, which involves individuals and businesses buying infant formula in Australia and sending it to China, came to a halt when Covid closed borders.
The upshot was that both Synlait and its biggest customer, a2 Milk, ended up with tonnes of unsold infant formula, which weighed heavily on both stocks and their respective earnings.
Signs of trouble first emerged in February 2020, when Synlait forecast a July financial year net profit of between $70 million and $85m, and warned that the previously-advised growth rate would not now be achieved.
Several earnings downgrades were to follow as the pandemic’s impact unfolded.
However, green shoots later emerged when Synlait signed a manufacturing supply agreement with what it has described as “an established, global category leader”. More than two years after that deal was announced, the client’s identity remains under wraps.
Under the agreement, Synlait will make, blend and package nutrition products — including plant-based products — for the new client.
The company conducted a $200m equity raising that year and later reset its banking arrangements.
Then, in April of 2021, came the resignation of chief executive Leon Clement, who had come to Synlait from Fonterra late in 2018.
At the time, the board said it recognised Covid-19′s huge impact on Synlait, “and the difficult challenge this would present to any management team”.
Market uncertainty and volatility continued into 2021, mostly around high inventory and the ongoing fallout from daigou’s demise.
Then the low point came in the 2021 financial year with a $28.5m loss.
At that point Synlait announced the appointment of new chief executive Watson, who was then the CEO of Taupo-based dairy company Miraka.
Watson had spent 10 years at Fonterra, where he held several senior roles including director of global foodservice and managing director of Tip Top.
Before that, Watson was chief operating officer at McDonald’s New Zealand.
As an aside, Watson speaks highly of the fast-food chain, which was his first job at the age of 16.
By 20 he was running McDonald’s Queen St, Auckland, restaurant. “What other business would let you do that?”
As things stand, infant formula is vital to Synlait.
So too is its trade with China, the world’s biggest infant formula market.
In its latest earnings update, issued in December, Synlait said its half-year profit would be down — partly reflecting the bedding in of a new, sophisticated SAP technology platform — but that its full-year guidance remained unchanged.
By the end of this year, Synlait says it will have completed its two-year recovery plan.
The company says it intends to exit 2023 and enter 2024 with a similar level of profitability to that experienced before 2021.
In the short term, Synlait’s biggest challenge lies in successfully registering formula destined for the People’s Republic.
In an update last year, Synlait said it had received notification from China’s State Administration for Market Regulation (SAMR) that the company’s current registration had been renewed. The renewal allowed Synlait to manufacture Chinese-label infant formula until February 21 this year under the previous “GB” standard.
In parallel, Synlait says it is working towards achieving its re-registration under the new food safety legislation.
The new GB registration timeline and process has been hit by China’s Covid-19 lockdowns, and Watson says gaining re-registration for the new GB recipe is a top priority.
Watson wants to emphasise that the company, which has substantial assets in Pōkeno and Māngere as well as its traditional base at Dunsandel, in Canterbury, is more of a New Zealand enterprise.
Synlait’s approach would mean a greater focus on milk suppliers in the North Island and on its assets in that part of the country.
While Synlait and a2 Milk have each undertaken their own initiatives, they remain closely linked.
A2 Milk has a 20 per cent stake in Synlait, second to China’s Bright Dairy, with a 39 per cent stake.
While the two remain on the best of terms, a2 Milk has embarked on a plan to be a manufacturer in its own right, through its majority-owned Mataura Valley Milk, while Synlait has signed up the new customer which it says may take the place of a2 as its biggest client in the years to come.
The identity of that new customer remains to be revealed, but the product will be plant-based.
Watson says it has been a “tough few years” for many companies and Synlait has been one of them.
After one year in the job, he says the company has made great strides but there is still work to do.
Synlait has substantial manufacturing facilities at Dunsandel, so it is typically thought of as being a South Island company,
Watson is keen to change that, and wants Synlait to be seen as a New Zealand entity, not just a South Island one.
“We need to be a New Zealand company operating in both islands.
“We will have a more of a leadership presence in the North Island, especially among farmers at Pōkeno, and the site at Richard Pearse Drive [Māngere],” he says.
As things stand, about two-thirds of Synlait’s kit is in Dunsandel, with the other third at Pōkeno and Māngere.
Looking back, Watson says Synlait’s problems began when customers in China — fearing the worst with the onset of Covid — began filling their pantries with formula, and driving a huge spike in demand.
As that was happening, the highly influential daigou channel closed, so it was a combination of demand coming off and the wrong market signals coming through.
“Inventory built up, demand came off, and there was a re-adjustment for both a2 Milk and Synlait to get back into balance,” he says.
But Watson says that when the “tide goes out” like that, it’s a good opportunity to have a look at the entire operation.
“The business needed more focus and more accountability to build the momentum back up to make sure that the growth that we will deliver over the coming years is good quality growth.”
As for the problems with SAP, a sophisticated German technology platform, Watson says: “As with any company that launches SAP, there is a period of disruption and that’s what we have seen.
“Certainly, in the last couple of months, we have seen, operationally, the performance of the business unlock and we are very much getting back to business as usual.
“For me coming in, it’s about getting to know the business, having a hard look at the strategy — and we have made some key changes there — structure of the business units and had a hard look at the leadership team.”
In terms of the market dynamic in China, Synlait works very closely with a2 Milk in understanding what is happening in the People’s Republic.
Watson says a2 has strong plans in place to effectively double its market share position.
All infant formula players face stringent SAMR registration in order to sell in China and Watson says the process will mean fewer players in the Chinese market.
“It looks as though, on balance, there will be more domestic players and fewer foreign players — time will tell.”
That SAMR registration is the highest priority in the business.
“It is so critically important for a2 and for the health and performance of the business.
“We have completed our part of the technical review.
“We are working with MPI [Ministry for Primary Industries] to get the audit date planned for.
“Roughly speaking, we would be looking to produce product by the middle of the year.”
In the interim, there was plenty of product cover in place for a2.
“So there is a clear plan in place — the two companies are closely lined up.”
While the birth rate in China is falling, Watson says urbanisation and the country’s growing middle class are still trends that favour not only infant nutrition, but also value-added dairy products generally.
Synlait’s new mystery multinational customer would support the company’s diversification and growth strategy.
“If you look at it, very simply it’s advanced nutrition. Of course, we are well exposed to paediatric nutrition.
“This helps us get into healthy ageing, so that’s a great place for us to operate in.
“We will go from one large customer [a2] to two large customers and potentially they could get larger than a2 over time,” he says.
The mystery customer has a big focus on southeast Asia, which will help Synlait’s geographical diversification.
“Currently, we are big in China, and big in Australia and New Zealand, so there is good diversification there,” says Watson.
Producing plant-based products for the new customer would offer some diversification away from dairy as well.
The initial phase of production for the new customer is on track to take place in the first quarter of this calendar year.
Synlait expects its debt-to-Ebitda ratio to be down to near 2-2.5 times by the end of this financial year.
“There has been a huge amount of work gone into strengthening the balance sheet and there is more work to do in that space.”
Since its 2013 listing, Synlait has never paid a dividend, but the company has not ruled one out in the future.
Watson says Synlait will work its way through the capital review process this calendar year and come up with a revised position on debt, equity, reinvestment and dividends.
“Our big focus right now is lifting up revenue through the various opportunities that we are pursuing in our strategy and getting debt paid down.”
As Synlait looks to diversify, so too does its ally, a2 Milk.
A2′s chief executive David Bortolussi has made it clear that he wants to add more to its value chain.
Watson acknowledges that it makes sense for a2 to further diversify.
“But we have got a very strong relationship with them and great capacity in terms of what we do for them.
“From our perspective, the relationship [with a2] is in good shape. It’s a strong partnership and they are the second largest shareholder in our business as well.
“It’s been a very challenging couple of years — a combination of inventory problems, financial performance, a number of reasonably large restructurings going back a year or two.”
Covid, and a very tight labour market, have made the dynamics challenging.
“As of today we are making good sense of operating in post-Covid, new way of working.
“The momentum is really heading in the right direction but we acknowledge that it has been a bumpy couple of years.
“This year will be about stabilising the business.
“Next year will be about accelerating the business. And the years three to five will be about potentially extending to the opportunities that would create, compelling value for the business.
“The momentum of the business is really starting to build again.
“It is about being absolutely focused and not getting distracted.”
In terms of geographical diversity, Watson says the new customer will give Synlait more exposure to southeast Asia.
“Where there are tactical trading opportunities in the other 30 or 40 counties where we trade, of course we will pursue them.”
Synlait’s geographical exposure is roughly 25 per cent in China, 25 per cent southeast Asia, 25 per cent Australia and New Zealand, and 25 per cent with the rest of the world.
Watson says he is realistic about where the company has come from and where it is now.
“We are one year into a two-year recovery,” he says.
“And we have got our work cut out”.
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