Keith Woodford says that Synlait is about to become the dominant New Zealand producer of infant formula

By Keith Woodford*

Synlait is currently undergoing a strategic restructure from a producer of bulk milk powders to a producer of consumer-packaged infant formula. These investments will make Synlait by far the largest New Zealand producer of infant formula.

So far, Synlait is still in the early stages of the transformation, but with a current construction contract with Tetra Pak to double their wet-kitchen capacity to 80,000 tonnes per annum, plus a foreshadowed announcement about doubling canning capacity to 60,000 tonnes, it is ‘all systems go’.

It is only a few months since Synlait was focusing in their public communications on building a fourth dryer on a new yet to be found site. Those plans now seem to be on the back burner. A new dryer may well come into focus again within the next year or so, but right now it is all about moving from volume to value-adding.

The key information comes from the ‘Leadership Statement’ within the latest half-yearly Synlait report, written jointly by Chair Graeme Milne and CEO John Penno, and released 29 March 2017. The general media appear to have missed the key messages which are somewhat buried on Page 9 thereof.

Milne and Penno write that the Australasian sector “is well over-capacity in terms of plant and equipment”, and that “in such an environment, it makes little sense to build new manufacturing assets ourselves”. They then say that “our Board has become increasingly focused on putting the company in a financial position to make strategic acquisitions as they become available”.

Elsewhere in the report, they describe how the need for a new stand-alone blending and packaging plant is not only to increase their infant formula capacity, but also to give them flexibility with the number of brands they can sell into China. If they want the flexibility to supply more than three brands, their site has to be stand-alone from the main Dunsandel site.

So where might this plant acquisition be located?

In answering that, it seems that Synlait’s reference to ‘Australasia’ is not co-incidental. My bet is that they are looking at an Australian blending and packing acquisition.  There may be multiple opportunities, but one stand-out opportunity is the south of Melbourne-based  ‘Blend and Pack’ which is currently on the market and has the relevant China registrations. There may well be others.

There will undoubtedly be competition from other potential purchasers, such as Australian-based Bellamys, which produces organic infant formula. Bellamys is currently in a pickle as it does not have access to a plant which can provide them with the China registrations they will require as from January 2018. Almost certainly, Bellamys will be bidding for these or other canning assets, but right now they are cash-constrained following their mis-steps of the last nine months.

Another option is that The a2 Milk Company (A2M) might choose to purchase an Australian-based canning plant either by themselves or in a JV with Synlait. These two companies are highly dependent on each other, with Synlait the manufacturer and A2M the marketer of the ‘a2 Platinum’ infant formula which drives profits at both companies. It is inevitable they will work together rather than compete.  Each has the financial resources to make a major purchase.

To understand the drivers of Synlait’s infant formula transformation, it is necessary to step back a little.  The starting point it to recognise that whole milk powder (WMP) which we focus on so much within the New Zealand dairy industry is in danger of becoming a declining product globally. It is only developing countries that are major importers of WMP, with China way out in front. Then comes Algeria a very long way behind, and then another big gap to the next group of followers.

Regardless of whether or not New Zealand produces WMP or infant formula, our dairy industry will remain highly dependent on China. It is a case of either producing commodities for China, for which there is minimal growth in demand, or focusing on value-add products for which demand has been growing rapidly.

However, the above statement does need some qualification. For differentiated products like the ‘a2 Platinum’, or ‘Munchkin Grass Fed’, the potential demand does go well beyond China.

Of course, producing infant formula is much more complicated than producing WMP. First there is a need for a wet-mix kitchen, then comes the drying, then comes the dry blend and then the canning.  Also, without development of a highly-regarded brand, none of the manufacturing processes will make any money.

Birth rates in China are currently on the rise, although that may be only short term. Of particular relevance, is that Chinese mothers use infant and toddler formulas through to three-years of age. Hence, the combined demographic of Chinese infants and toddlers using so-called infant formula is some 50 million. The total infant formula usage in China (stages 1, 2 and 3) is upwards of a million tonnes and growing.   To put that in perspective, the next biggest consumer of infant formula is the USA at about 145,000 tonnes.

Whereas WMP has a landed-value in China of about $US3000 per tonne, the infant formula has a value of four times that as it crosses the border.

The major dairy companies of the world are all capable of doing their sums, and so there is plenty of competition. There will be winners and losers. Both Synlait and Fonterra are at a disadvantage in that they lack a long-term track record for infant formula, but Synlait’s strategy is to be a manufacturer on behalf of others who do the marketing. That strategy means they clip the ticket along the way, but do not get the entrepreneurial profits with its associated risks.

Synlait’s current public communications focus is almost exclusively on two brands, these being ‘a2 Platinum’ and ‘Munchkin Grass Fed’ infant formula.  Previous consumer brands such as Akarola, Akara, and Pure Canterbury have largely fallen by the wayside.

Although there has been lots of talk about the American-owned ‘Munchkin Grass Fed’ brand, it is yet to get market traction. It is available in Australia, but apparently without significant success. It is yet to be registered by the American authorities for sale in the USA, although that should be achieved within the next few months.

My estimates are that Synlait currently has access to about 250 million litres of A2 milk and about one third that volume of specialist grass-fed milk. But possibly as much as 90 percent of the infant formula currently produced by Synlait is coming from the A2 milk, with much of the grass-fed currently going into standard milk powder production.

Now that China has stepped back (March of this year) from planned regulations restricting informal online-trading of infant formula, it is evident that Synlait and A2M are ramping up production of ‘a2 Platinum’ as fast as they can.

Reading ‘between the lines’ of the numbers within Synlait’s half-yearly report, it looks like a2 Platinum production is planned to increase from about 6000 tonnes in the first half-year of 2016/17 to about 10,000 tonnes in the current second half. And then in the 2017/2018 year the projections are for something more like 25,000 tonnes, followed by around 50,000 tonnes in the 2018/19 year.  These ‘A2 numbers’ are not explicit, but it is the only sensible interpretation that can be put on Synlait’s overall projections of consumer-packaged infant formula.

*Keith Woodford is an independent consultant who holds honorary positions as Professor of Agri-Food Systems at Lincoln University and Senior Research Fellow at the Contemporary China Research Centre at Victoria University.  His articles are archived at http://keithwoodford.wordpress.com