February 20, 2018 / 8:26 PM / 6 months ago

UPDATE 3-New Zealand's a2 Milk logs record H1 profit as China demand smashes expectations

* H1 net profit up 150 pct, 20 pct ahead of estimates

* Shares jump 26 pct to hit record high

* a2 in new supply agreement with Fonterra (Recasts and writes through)

By Tom Westbrook and Colin Packham

SYDNEY, Feb 21 (Reuters) - New Zealand’s a2 Milk Co Ltd booked record half-year profit on surging demand for its infant formula in China, beating market estimates and vindicating a two-pronged business strategy that has seen it succeed where others have stumbled.

Its shares shot up 26 percent to an all-time high as revenue from direct sales in China more than tripled, helped by the popularity of a milk powder product that does not contain the A1 casein protein - a protein a2 claims can cause upset stomachs.

Unlike rival Bellamy’s Australia and vitamin maker Blackmores Ltd, it also has benefited from maintaining strong relationships with big “diagou” customers, who buy domestically then export to China themselves.

Adding icing to the cake was a supply deal with the world’s biggest dairy producer, New Zealand’s Fonterra , to provide milk, powder and formula as well as distribution and sales support for new a2 markets in Southeast Asia and the Middle East.

“Smashes it out of the park...again!” ran the headline on a research note published by Citi analyst Sam Teeger, as the run-up in its shares lifted the NZ50 share index a hundred points higher.

Net profit for the six months to end-December more than doubled to NZ$98.5 million ($72.3 million), more than 20 percent higher than a consensus estimate from analysts. A2 added that unexpectedly high first-half margins will hold for the rest of the year.

“Today’s announcement was nothing short of spectacular, they just continue to power through with their strategy,” said Oyvinn Rimer, director at Harbour Asset Management, a2’s second-largest shareholder.

His fund bought in to a2 about a decade ago, when the shares were worth around 10 NZ cents. Rimer said he’s holding onto the stock and was upbeat about the Fonterra deal.

“That could potentially facilitate similar-type growth in other jurisdictions. You’d be pretty brave to get rid of it.”

One key thing that a2 has done differently to some competitors was to price its products consistently and not undercut diagou buyers - an important unpaid salesforce for the company although it does not disclose the proportion of Australia and New Zealand sales to diagou.

“We haven’t walked away from diagou, which has been one of the pitfalls of competitors who haven’t understood the channel,” said a2’s Asia-Pacific Chief Executive Peter Nathan.

The new deal with Fonterra sent shares in a2’s existing supplier Synlait Milk Ltd sliding 6 percent. Synlait’s agreement to provide a2 with products for its largest markets in Australia, New Zealand and China remains unchanged.

$1 = 1.3618 New Zealand dollars Reporting by Tom Westbrook and Colin Packham in Sydney; Additional reporting by Shashwat Pradhan in Bengaluru; Editing by Stephen Coates

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