Roy Davidson, 30 August 2018


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, Middle East and Africa.

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. Under new Chinese regulations, SML is only able to produce finished products for three brands (with each allowed three different products). a2 Milk’s success has flowed through to Synlait, allowing it to operate near full capacity and shift its product mix towards higher value infant formula products. Synlait has been looking to further diversify and de-risk its business in recent times. It has announced a new manufacturing site in Pokeno, a new canning line in Auckland (NZDC), and a new liquid dairy packaging facility at Dunsandel, underpinned by a 10-year supply agreement with Foodstuffs South Island. Following the purchase of NZDC, SML can now expand the number of infant formula brands it can manufacture, from three to six under Chinese CFDA regulations.

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) food safety event, 2) regulatory change in key sales channels 3) loss of key customers.