Synlait's latest result could have been substantially better had it not been for moves to diversify its interests away from the company that is both its biggest customer and a 20 per cent shareholder — a2 Milk.
The Canterbury-based dairy company and infant formula maker said its annual net profit dropped by 9 per cent to $75.2 million, reflecting the impact of acquisitions made over the last two years.
Synlait last year bought Dairyworks for $112m, in line with its move into everyday dairy products and complementing its earlier acquisition of cheese maker Talbot Forest.
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By coincidence, a2 Milk announced on the same day that the Melbourne lockdown had significantly impacted its "daigou" sales to China — tourists and overseas residents sending product back home — which would result in a decline in revenue over the first half.
Synlait said it was experiencing higher than normal stock levels in its current half, so it looks likely that it too has become caught up in a2 Milk's daigou downdraft, thereby neatly illustrating why it needs to branch out.
"We are investing the money to make sure that we do diversify our organisation and building out from the very close strategic partnership that we have with a2 Milk," chief executive Leon Clement told the Herald.
"But that does not mean we love them any less," he said.
Clement talked about "building out the family" to have an organisation with diversified earnings streams, a range of customers, of assets, and of markets and categories.
"Whilst it's more complex to run an organisation like that, it certainly delivers a far more sustainable and resilient organisation," he said.
Clement said if the company could have chosen to "stay more narrow", it would have been a better result.
"At a net profit after tax level this year, the cost to create opportunities for us is around $20-25m — borrowing costs, net depreciation and the operating costs of some of the spare capacity that we are holding.
"But I don't think our shareholders would be any more pleased. They want to see us build long-term sustainable earnings and drive shareholder returns in that way," he said.
"We are responsible for making sure that we are not exposed to a single customer or a single market."
Clement said that was even more relevant today, given the current level of global uncertainty and potential for economic downturn.
While Synlait has been branching out, a2 Milk has largely been doing the same thing in trying to reduce its reliance on Synlait, which makes all its infant formula.
It is currently seeking to buy Mataura Valley Milk to make its own infant formula.
"I think both companies are moving forward with diversification," Clement said.
"They are very reliant on Synlait for the support of their core business, as we are on them.
"But yes, we are both pursuing our own diversification strategies."
Clement does not see it as an "either or" strategy. "It's an 'and' strategy."
a2 Milk would continue to be a very important partner.
"We are suddenly not becoming friends. The strong strategic partnership will continue."
Where to from here
So where to from here?
"We went into Synlait's result with a number of questions, many of which are still outstanding," said Forsyth Barr analyst Chelsea Leadbetter.
"The costly part of the expansion phase is almost behind it and we should begin to see an improved return/profit profile, however, the extent of the prize remains unclear and is dependent on further execution on new customers, which has been slow to date," she said in a research note.
Synlait has signalled a new multinational customer which is expected to provide a benefit from 2023.
On a2 Milk, Leadbetter viewed the first-half decline as "blemish to its consistent track record of profit growth".
"The key question now — is this a temporary issue, or something more permanent? Although there is a lot we still don't know, we view this as temporary," she said.
Both a2 and Synlait's share prices weakened after their announcements.
Futures market pricing suggests all is not lost with Tiwai Point.
Likewise, the share prices of the two most affected companies, Meridian and Contact, have enjoyed a rebound based on optimism that Rio Tinto's Tiwai Point aluminium smelter might not close next August, as planned.
The Labour Party has put forward a proposal to extend the life of the smelter by three to five years, while an economic transition for Southland is developed. There is also a renewed sense of optimism that the key sticking point for Rio Tinto — electricity transmission charges — could be resolved.
ASX-traded futures pricing for the third quarter of 2021 — the time that Tiwai would supposedly be shut — were last trading at $122 per gigawatt hour, up from $90/hour in early September, before news of a possible extension came out.
Greg Sise, managing director at EnergyLink, said the futures market was factoring in "a fairly high probability" that the smelter would stay for a period of years.
"In other words, they are factoring in a closure some time in 2024," he said.
"Prices were lower, but when it came out that the Government was in discussions, the futures prices did move up significantly," Sise said.
However, he said that at $122/hour, the power price contract was still lower than would normally be the case, indicating the uncertainty surrounding the smelter's future.
Futures pricing slumped by about 35 per cent when Rio Tinto announced its closure plan but the rebound since then has not escaped Tiwai's main supplier, Meridian.
Meridian chief executive Neal Barclay told the Herald: "I think the market is anticipating that between us, Rio, the Government and Transpower that we will find a way to keep the smelter open."
"I would have thought that there was more of a balanced chance of success," he said.