The prospects for both dairy companies run in tandem because Synlait produces most of A2 Milk’s infant formula and A2 now has a 17.4% stake in Synlait.
Both reported the doubling of sales and profits for the 2018 financial year when their share prices nudged $13 but A2 has since fallen to $10 and Synlait to $9.
A2 lost its number one position in sharemarket capitalisation, down from $9 billion to $7.5b, allowing the dairy giant Fonterra, with its much bigger asset and milk supply base, to draw level.
Fonterra’s supply share and tradable unit prices have also fallen by 8% over the past month, from $5 to $4.65 and its market capitalisation is also about $7.5b.
The fall in Fonterra’s sharemarket fortunes followed its declaration of a $196m loss in 2018 and the cancellation of an end-of-year dividend.
Fonterra has about 1.6b shares and units issued and net tangible assets about $1.50 each whereas A2 has 735m securities issued with an asset backing around 70c each.
The share prices of the three dairy companies wobbled alarmingly on October 10-11 when the Dow Jones Industrial Average of the top United States companies fell by 5% over two days.
A2 lost more than $1 in one day’s trading on the NZ sharemarket then recovered 80c the next day. Fonterra lost 20c over the week.
Synlait lost $1 as well but over four days then recovered 30c on the Friday.
Both A2 and Synlait are speculative stocks with prices that rose by $10 over the past two years before the recent retreat.
Neither A2 nor Synlait pay dividends and re-invest their earnings into business growth.
The uncertainties over both companies surround the impact of China’s pending e-commerce regulations to come into effect on January 1.
That covers ongoing plant and product registration, which Synlait is working through, possible labelling requirements for Chinese language and the collection of tax from licensed e-commerce operators.
A2 makes 84% of its revenue from the sale of infant formula and a similar percentage of the infant formula sales go through the daigou route to China – cans bought in Australia on behalf of Chinese consumers either by freelancers or internet-based businesses then posted or airfreighted.
The complex supply chain includes roughly equal proportions of grey channel daigou and more traceable and taxable cross-border e-commerce through third-party intermediaries using several massive Chinese websites such as Tmall, Taobao, WeChat and Weibo.
Only 5% of A2 infant formula sales are for Australian and NZ consumption and a further 12% are sold through the more conventional supply route to 10,000 mother and baby stores in China.
For Synlait, 90% of its infant formula production goes to A2, a volume that doubled last year but is forecast by market analysts to level out.
Craigs Investment Partners have said A2 investors should be aware of the potential regulatory and competitive risks to the e-commerce sales.
Nevertheless, A2 has good long-term alternative growth prospects in liquid milk, cheese and yoghurt.
“Despite A2 being one of our largest listed companies and having multiple growth options it remains a higher-risk proposition that may not suit all investors,” Craigs said in a note to clients in September.
Forsyth Barr said the e-commerce law should be a positive for A2 in the medium to long term but it might create some volatility in the near term.
“Greater regulation and a reduced price advantage may drive market consolidation, leading to fewer, more reputable resellers.
“We expect the main impact will be on smaller daigou operating through Taobao and WeChat stores as they will face greater regulation and cost as well as a reduced price advantage.”
A2 Milk issued a market update on its trading in the first quarter of the 2019 financial year.
Under the heading China infant formula regulatory environment it summarised the changes to come without saying how it proposes to tackle them.
“Key regulatory milestones continue to be actively managed and achieved,” was its comment.
Synlait is required to obtain certification for its new Pokeno facility and a re-registration for Dunsandel and those applications are progressing well.
