After a laborious re-registration process, Synlait Milk can now make Chinese-labelled infant formula for its main customer, a2 Milk.
The green light from China’s regulator, SAMR, is pivotal for the ongoing success of the manufacturing and supply agreement that Synlait and a2 Milk have.
While there was little doubt that Synlait would be successful, the news was nevertheless greeted with a sigh of relief from both parties, not to mention investors.
For a2 and Synlait, China’s infant formula market – the world’s biggest - is vital.
“It’s a very important milestone for us to continue to secure market access to the registered China label market in China, which accounts for about 86 per cent of the total infant formula market in China,” a2 Milk’s chief executive, David Bortolussi, said in an interview.
But why all the fuss about a label?
Any commentary about a2 Milk is always peppered with references to Chinese label and English label formula.
As it happens, there are big differences between the two, aside from the language on the can.
Firstly, they are two different products.
Different countries have their own rules around what can and can’t go into infant formula.
In a2′s case, its China label infant formula is different; it contains lactoferrin, known in the industry as “pink gold”, while the English label does not.
Lactoferrin is an expensive multifunctional natural protein, which is said to offer immune benefits, and which is widely used in food and pharmaceutical products.
The second difference between the two labels is that they arrive in China by different means.
English label product arrives via the cross border e-commerce (CBEC), through the likes of JD.Com and TMall.
There is daigou, otherwise known as the suitcase trade, for which a2 Milk owes much of its early success in China to before Covid put the kibosh on air travel.
Then there is online-to-offline (O2O) commerce - a business strategy that draws potential customers from online channels to make purchases in physical stores.
These days, most of the English label product arrives in China via the CBEC channel, while the O2O and daigou channels are broadly similar in size.
China label product is more likely to have arrived through the normal export-import routes, and distributed throughout the country “offline” - through traditional mother and baby stores - as well as through domestic online retail sites.
“Our China label business, which has been growing rapidly (by over 40 per cent in the first half of this year) now accounts for approximately half of A2 Milk’s infant formula business in total,” Bortolussi says.
“In terms of market access, this is why the registration approval is so important to us – it allows us to access the vast majority of the market, which is the registered market in China.”
The timing of registration was complicated by the introduction of a new “GB” food standard by China.
The original registration expired in September last year, and that was renewed by SAMR at that time.
“The complexity is because a new GB standard was introduced to the registration process.
“They do not always go together – new GB standards and re-registration – so the new GB standard applies from February 22 of this year onwards.
“That’s why the full SAMR process, and approval of our formulation, together with Synlait Milk, was so important because now we are able to start manufacturing China label, and the re-registration effectively goes through to September 2027.”
Bortolussi said a2 was always confident that Synlait would gain SAMR approval, but that it was a matter of not taking it for granted.
One of the reasons why the English label product is popular in the unofficial channels is price – it’s cheaper.
Lactoferrin - a point of difference between English and China label product - does not come cheap, as its nickname suggests.
It’s been known to trade up to US$3000 ($4800) a kg (around US$700 a kg now), so it comes as no surprise that dairy companies are keen on making it.
Last month, Hokitika-based Westland Milk, a subsidiary of China’s dairy giant Yili, started construction of a $70m lactoferrin facility.
“The investment will enable Yili to rank amongst the top three leading global companies in the lactoferrin category, with a market share of about 10 per cent,” the company said at the time.
Fonterra and Synlait are also big lactoferrin producers.
For cash-strapped Synlait, successful re-registration was welcome news after reporting a string of earnings downgrades.
The company is now looking at divesting assets - Dairyworks and Talbot Forest Cheese - to pay down debt.
Synlait also holds high hopes for what a new, as yet unnamed, customer, may bring in terms of lessening its reliance on a2 Milk.
The company now expects its 2023 net profit after tax could range from a loss of $5m to a net profit of $5m, but has in the past said it is not considering a capital raise.
A2 Milk - which has 20 per cent of Synlait (China’s Bright Dairy has 39 per cent) - has given the thumbs-up to Synlait’s asset sales plan.
“As a shareholder, we support Synlait’s announcement to divest the Dairyworks and Talbot Forest Cheese businesses to focus more on its core nutritional products business and to pay down debt with the proceeds,” Bortolussi said.
Craigs Investment Partners’ head of institutional equities research, Stephen Ridgewell, said re-registration for Synlait’s SAMR registration was “obviously very important for them, given the capital structure review”.
“We have more confidence in the earnings recovery of Synlait into next year,” he told the Herald.
“There are a number of uncertainties though. There is the ramp-up of production for the new multi-national customer.
“We think that there is more comfort in the earnings profile for Synlait, but there are still a number of hurdles to go through.”
Ridgewell, in a research note, said Talbot is currently mothballed and Synlait will be lucky to get half the $30m or so that it paid for the asset, or even to find a buyer.
He said Dairyworks is a better prospect.
The business includes a number of household cheese brands including Dairy Works, Alpine, and Rolling Meadow.
Synlait acquired the asset for $112m in late 2019.
Current earnings for Dairyworks are not disclosed, though prior management commentary indicated that earnings are now above that at time of acquisition, Ridgewell said.
“In total then, potential proceeds from divestment could amount to about $100m. However, it is important to note there are a number of dairy assets for sale at present, and a ‘fire sale’ is likely to lead to a less than optimal outcome,” he said in a research note.
Synlait is in talks with its banking syndicate to both extend and increase the size of its bank debt facility, with the $180m Synlait retail bond expiring in late 2024 and unlikely to be renewed, Ridgewell said.
“If Synlait is able to sell Dairyworks and Talbot for a reasonable price, this will reduce the probability of an equity raising.”
Jamie Gray is an Auckland-based journalist, covering the financial markets and the primary sector. He joined the Herald in 2011.
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