Synlait’s 'delivery in full and on time performance' of its manufacturing and supply agreement with a2 Milk has fallen 'below the level required', according to a2

Shares in dairy company Synlait Milk [SML] have tumbled on NZX after major customer and 20% Synlait shareholder a2 Milk Company [ATM] gave notice of cancelling "the exclusive manufacturing and supply rights enjoyed by Synlait" in respect to manufacturing and supply of infant milk formula (IMF) products.

In a statement released some hours on Monday after the a2 statement, Synlait said it "disputes that The a2 Milk Company has the right to cancel the exclusivity arrangements". The Synlait shares went into a trading halt earlier on Monday after a2 released its statement to give Synlait time to respond. Once Synlait released its statement the shares resumed trading shortly after 3pm and fell over 9% to $1.16 by market close. The share price is down 70% in the past 12 months.

The reason given by a2 for the cancellation was "due to Synlait’s delivery in full and on time performance (DIFOT) during FY23 falling below the level required for Synlait to maintain such exclusive rights, including as referenced in a2’s market announcement on 26 April 2023 and primarily in relation to English label IMF product".

Synlait, which has had a troubled few years, and had previously signalled it may make a loss in the year ended July 2023, is due to release its annual results next week. It on Monday re-affirmed guidance of a result somewhere between a net after tax loss of $5 million and a profit of $5 million. The biggest shareholder in Synlait is China's Bright Dairy Holdings with 39%.

Synlait said in its statement on Monday afternoon that it had successfully completed its planned bank refinancing as of Monday.

The new funding arrangements include a $240 million working capital facility maturing on October 1 2024, and revolving credit facilities of $230 million. In addition, Synlait is required to make a prepayment of at least $130 million by no later than 31 March 2024. Synlait’s new banking syndicate members are ANZ, Bank of China, China Construction Bank, HSBC, and Rabobank.

In its announcement earlier on Monday, a2 said that after market hours on Friday, September 15 it had provided Synlait with written notice cancelling the exclusive manufacturing and supply rights enjoyed by Synlait in respect of stages 1 to 3 of a2’s current infant milk formula (IMF) products (being a2 Platinum® and a2 至初®) for sale by a2MC in the markets of China, Australia and New Zealand. Stage 4 IMF and other a2MC products supplied by Synlait are not subject to exclusivity.

"Synlait has advised that it is considering the notice of cancellation, it reserves its rights, and it will respond formally in due course," a2 said.

The latest developments follow an exchange of views between the companies through NZ earlier this year.

As referenced above in the article, on April 26 of this year Synlait put out a profit warning through the NZX in which it downgraded its after-tax profit forecast made only a month earlier by $20 million saying that  further advanced nutrition demand reductions, "mostly from one of Synlait’s customers" would have a negative impact of $16.5 million, while the remaining $3.5 million was due to higher financing and supply chain costs.

On the same day, a2 then said it was "surprised at the extent of the reduction in Synlait’s guidance range" in Synlait’s announcement, "which indirectly refers to a2MC". It said there was "no material change" to a2's outlook as confirmed at the time of the announcement of its first-half results in February. 

In its cancellation announcement on Monday September 18, a2 said the manufacturing and supply agreement between Synlait and a2 would remain in place notwithstanding removal of exclusivity "and Synlait remains an important supplier of a2MC".

a2 said if Synlait disputes the notice, "the matter will be resolved through good faith negotiations, followed by confidential binding arbitration as provided for under the dispute resolution provisions of the Supply Agreement".

"At this stage, a2MC expects that any such dispute resolution process may take some time to complete. In the meantime, a2MC has advised Synlait that it would agree to maintain Synlait’s exclusivity until any dispute is resolved (assuming it is resolved by the end of 2024), and even once the matter is resolved, a2MC considers that a2MC will continue to have the right, but not the obligation, to fully source its current IMF products from Synlait."

a2 said subject to the outcome of any dispute resolution process, removal of Synlait’s exclusivity "will provide a2MC with the option to produce a2 Platinum® (being the brand of a2MC’s current English label product) at any facility in the future, including Mataura Valley Milk (MVM). MVM is a purpose-built dairy nutritionals facility situated in New Zealand’s South Island and of which the Company owns 75% in partnership with China Animal Husbandry Group (which owns 25%)".

"Having regard to the dispute resolution process, product development cycles and the New Zealand dairy season, any positive impact of the removal of Synlait’s exclusivity on MVM utilisation and profitability is not expected to have a material impact in FY24 or FY25. As previously announced, accelerating MVM’s path to profitability by FY26 or earlier is a strategic priority."

Synlait said in its statement that the "purported cancellation" by a2 "relates only to the exclusivity arrangements". The supply agreement remains in place but may be terminated by either party on three years’ notice.

"The a2 Milk Company has confirmed to Synlait that it will in practice maintain exclusivity with Synlait until such time as the matter is resolved (assuming that both parties will seek to progress the dispute process promptly in good faith, and the dispute process is completed by the end of 2024). The dispute resolution process involves a 20-business day period of good faith negotiation between Synlait and The a2 Milk Company followed by arbitration (if not resolved)," Synlait said.

"Synlait continues to hold the Chinese regulatory State Administration for Market Regulation (SAMR) licence which is attached to Synlait’s Dunsandel manufacturing facilities. The license is for The a2 Milk Company’s Chinese labelled 至初® Infant Formula (stages one, two and three), the company expects to manufacture those products for The a2 Milk Company for products destined for the China market for the period of that licence (currently expiring September 2027)."

See the Synlait Milk profile here.