Peter Ball, 25 May 2017

Stock Comment - Synlait SML

Synlait (SML) is a dairy manufacturer based in Canterbury producing a range of milk products. The company’s key customers include a2 Milk, Nestle, Danone, Mead Johnson, Munchkin and Bright Dairy. Bright Dairy also own almost 40% of SML, while a2 Milk and Munchkin both own around 8%.


SML produces three categories of product; powders and creams (whole milk powder, skim milk powder, anhydrous milk fat, infant formula blend), consumer packaged (finished canned infant milk formula for a2 and Munchkin), and specialty ingredients (lactoferrin). The company sells its products into a range of end markets with Asia (excluding China) comprising 42%, Middle East and Africa 27%, and China 10%.

Of its core products, consumer packaged infant formula provides the highest gross margin, generally four times that of infant formula blend and up to six times that of SML’s ingredients products. SML recently conducted an equity raising to enable it to embark on its next stage of investment, increasing capacity to meet the demand of its nutritional customers, especially a2 Milk which has seen strong demand for its products. The investment will see capacity double from 33m cans currently, to 67m by FY19. As consumer packaged infant formula is higher margin, as the share of revenue from this business grows, we expect group margins to lift in the coming years, resulting in return on invested capital lifting from 11% currently to a target of 16% by 2020.

SML has manufacturing agreements with its consumer packaged infant formula customers that specify a minimum volume. SML then has first right of refusal to produce additional volumes above this level. Consequently, demand for infant formula from SML’s customers is a key driver of earnings. SML currently produces for a2 Milk, Munchkin, and is looking to add its third in the near future, ideally a large multi-national. Under new Chinese regulations, SML is only able to produce finished products for three brands (with each allowed three different products). We expect strong volume growth for infant formula to continue, and note that with a third customer on board, SML’s exposure to volumes from a2 (currently 80% of capacity) will decrease.

SML provides an exposure to the New Zealand dairy sector as well as growing infant formula demand. The investment case is predicated on SML successfully completing its next phase of capital expenditure, resulting in increased margins and returns. Overall, we see the company sitting between a2 Milk and Fonterra on the risk/return spectrum, and investors should note that while SML invests in capacity it will not pay a dividend.

Risks to SML include; 1) infant formula demand, 2) food safety, and 3) execution of its capital expansion programme.