The A2 Milk Company Ltd (ASX: A2M) share price is in focus after it announced it was cancelling its exclusive agreement with Synlait Milk Ltd (ASX: SM1).
A2 Milk is one of the largest infant formula producers in the Asia Pacific region, while Synlait is a dairy product manufacturer.
A2 Milk Company share price
Agreement cancelled
A2 Milk has announced that after market hours on Friday 15 September, it gave Synlait written notice that it was cancelling the exclusive manufacturing and supply rights for the stages 1 and 3 infant formula products, which are sold in China, Australia and New Zealand.
Stage 4 infant formula and other A2 Milk products supplied by Synlait are not subject to exclusivity.
Why is A2 Milk cancelling?
A2 Milk said that it is cancelling the arrangement because Synlait’s delivery in full and on time performance during FY23 fell “below the level required for Synlait to maintain such exclusive rights”.
Synlait Milk share price
However, the manufacturing and supply agreement between the two companies will remain in place, and A2 Milk said that Synlait remains “an important supplier” of A2 Milk. I think this is important for both the A2 Milk share price and Synlait share price.
A2 Milk said it consider that pricing terms and other key terms of the supply agreement between the parties “will continue to apply”.
The supply agreement continues on a rolling term until either party gives three years’ notice of termination to the other party.
A2 Milk also said it considers that Synlait “continues to be contractually bound to supply up to the same prescribed infant formula” volume per year.
Removing the exclusivity would enable A2 Milk to produce a2 Platinum at any facility, including at the company’s Mataura Valley Milk (MVM). Any positive impact of the removal of Synlait’s exclusivity on MVM utilisation and profitability is not expected to have a material impact in FY24 and FY25.
The company re-iterated that accelerating MVM’s path to profitability by FY26 or earlier is a “strategic priority”.
Synlait’s response
A2 Milk revealed that Synlait is considering the company’s cancellation notice. If Synlait disputes the notice, the matter will be resolved “through good faith negotiations, followed by confidential binding arbitration”.
At this stage, A2 Milk said it expects that any dispute resolution process “may take some time to complete”. In the meantime, A2 Milk has advised Synlait that it would agree maintain Synlait’s exclusivity until a dispute is resolved (assuming it’s resolved by the end of 2024).
Even once the matter is resolved, A2 Milk said it will continue to have the right, but not the obligation, to “fully source” its current infant formula products from Synlait.
Final thoughts on the A2 Milk share price
I can understand why A2 Milk is making this move. It wants to increase its profitability, particularly at MVM – it spent a lot of money (NZ$270 million) on that asset.
The A2 Milk share price has fallen 33% since the start of 2023. It’s now a lot lower, and the Chinese market is becoming trickier (with less babies being born, and less born in the last couple of years).
It could deliver decent returns from this lower A2 Milk share price, but it’s not the sort of investment I’d go for.