New Zealand Professional Investment Services Firm

Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Synlait Milk</h2>
1H20 Result — Cost and Capacity Bite&nbsp;
NEUTRAL
Synlait Milk (SML) reported a material 1H20 profit decline, as pre-guided, and retained recently downgraded FY20 guidance — with its step-change in manufacturing capacity (and associated costs) creating a larger near-term EPS drag than previously anticipated. SML has invested, and is well positioned, for growth; however, there was nothing in the result to provide greater clarity on the medium to longer-term earnings/returns profile. The recent material de-rate in SML sees us more confident in the assumption set this implies. Given the wide magnitude of long-term returns outcomes, recent comments from its key customer, a2 Milk, on diversification and SML's elevated gearing levels, we require a high margin of safety to be confident in a more positive investment view.
<table class="table table-striped"><colgroup><col> <col> <col> <col> <col> <col> <col span="2"> <col span="2"> <col> <col></colgroup>
<tbody>
<tr>
<td style="width: 48pt;">NZX Code</td>
<td style="width: 48pt;">SML</td>
<td style="width: 48pt;">Financials:Jul/</td>
<td style="width: 40.2pt;">19A</td>
<td style="width: 42.6pt;">20E</td>
<td style="width: 43.2pt;">21E</td>
<td style="width: 48pt;">22E</td>
<td style="width: 48pt;">Valuation (x)</td>
<td style="width: 42.6pt;">19A</td>
<td style="width: 42.6pt;">20E</td>
<td style="width: 48pt;">21E</td>
<td style="width: 42.6pt;">22E</td>
</tr>
<tr>
<td style="width: 48pt;">Share price</td>
<td style="width: 48pt;">NZ$4.40</td>
<td style="width: 48pt;">NPAT* (NZ$m)</td>
<td style="text-align: left; width: 40.2pt;">81.7&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">79.9</td>
<td style="text-align: left; width: 43.2pt;">93.6&nbsp;</td>
<td style="text-align: left; width: 48pt;">110.0&nbsp;</td>
<td style="width: 48pt;">EV/EBITDA</td>
<td style="text-align: left; width: 42.6pt;">6.7&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">6.9</td>
<td style="text-align: left; width: 48pt;">6.3&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">5.7&nbsp;</td>
</tr>
<tr>
<td style="width: 48pt;">Target price</td>
<td style="width: 48pt;">NZ$5.65</td>
<td style="width: 48pt;">EPS* (NZc)</td>
<td style="text-align: left; width: 40.2pt;">45.6&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">44.6&nbsp;</td>
<td style="text-align: left; width: 43.2pt;">52.2&nbsp;</td>
<td style="text-align: left; width: 48pt;">61.4&nbsp;</td>
<td style="width: 48pt;">EV/EBIT</td>
<td style="text-align: left; width: 42.6pt;">8.1&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">9.0&nbsp;</td>
<td style="text-align: left; width: 48pt;">8.1&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">7.3&nbsp;</td>
</tr>
<tr>
<td style="width: 48pt;">Risk rating</td>
<td style="width: 48pt;">High</td>
<td style="width: 48pt;">EPS growth* (%)</td>
<td style="text-align: left; width: 40.2pt;">8.9</td>
<td style="text-align: left; width: 42.6pt;">-2.2</td>
<td style="text-align: left; width: 43.2pt;">17.1</td>
<td style="text-align: left; width: 48pt;">17.6&nbsp;</td>
<td style="width: 48pt;">PE</td>
<td style="text-align: left; width: 42.6pt;">9.7&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">9.9&nbsp;</td>
<td style="text-align: left; width: 48pt;">8.4&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">7.2&nbsp;</td>
</tr>
<tr>
<td style="width: 48pt;">Issued shares</td>
<td style="width: 48pt;">179.2m</td>
<td style="width: 48pt;">DPS (NZc)</td>
<td style="text-align: left; width: 40.2pt;">0.0&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">0.0&nbsp;</td>
<td style="text-align: left; width: 43.2pt;">0.0&nbsp;</td>
<td style="text-align: left; width: 48pt;">0.0&nbsp;</td>
<td style="width: 48pt;">Price/NTA</td>
<td style="text-align: left; width: 42.6pt;">1.7</td>
<td style="text-align: left; width: 42.6pt;">1.9&nbsp;</td>
<td style="text-align: left; width: 48pt;">1.5</td>
<td style="text-align: left; width: 42.6pt;">1.3&nbsp;</td>
</tr>
<tr>
<td style="width: 48pt;">Market cap</td>
<td style="width: 48pt;">NZ$789m</td>
<td style="width: 48pt;">Imputation (%)</td>
<td style="text-align: left; width: 40.2pt;">100</td>
<td style="text-align: left; width: 42.6pt;">100</td>
<td style="text-align: left; width: 43.2pt;">100</td>
<td style="text-align: left; width: 48pt;">100</td>
<td style="width: 48pt;">Cash div yld (%)</td>
<td style="text-align: left; width: 42.6pt;">0.0&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">0.0&nbsp;</td>
<td style="text-align: left; width: 48pt;">0.0&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">0.0&nbsp;</td>
</tr>
<tr>
<td style="width: 48pt;">Avg daily turnover</td>
<td style="width: 48pt;">117.2k (NZ995k)</td>
<td colspan="3" style="width: 130.8pt;">*Based on normalised profits</td>
<td style="width: 43.2pt;"></td>
<td style="width: 48pt;"></td>
<td style="width: 48pt;">Gross div yld (%)</td>
<td style="text-align: left; width: 42.6pt;">0.0&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">0.0&nbsp;</td>
<td style="text-align: left; width: 48pt;">0.0&nbsp;</td>
<td style="text-align: left; width: 42.6pt;">0.0&nbsp;</td>
</tr>
</tbody>
</table>
Key take-outs
<ul type="disc">
<li>1H20 result all about the cost drag:&nbsp;SML&nbsp;reported a -3.5% decline in 1H20 gross profit (with a large step-change in overheads offsetting a +22% sales lift for infant formula&nbsp;[IF]), which when combined with materially higher costs (opex&nbsp;+27%, interest more than doubling) led to&nbsp;NPAT&nbsp;down -30% to NZ$25m. Material investment in&nbsp;opex&nbsp;and&nbsp;capex&nbsp;primarily reflects capacity expansion underway, with investment ahead of being operational.</li>
<li>No new customer announcements:&nbsp;SML&nbsp;has material capacity to fill and indicated it is well progressed on new customers, although did not announce anything. The range of feasible outcomes remains very wide in terms of the potential return profile.</li>
<li>COVID-19:&nbsp;Minimal impact to date.&nbsp;SML&nbsp;is well positioned given products manufactured are largely consumer staples.</li>
<li>Elevated gearing:&nbsp;Net debt lifted to NZ$447m in 1H20 (from NZ$288m in 1H19) and we forecast net debt to&nbsp;EBITDA&nbsp;of 2.9x in FY20E, above the company's long-term target of &lt;2.5x. The company is nearing the end of material investment (in capacity and diversification), focus now turns to&nbsp;driving efficiencies and utilisation of existing assets.​​​​​​​</li>
</ul>
Key revisions — incorporating&nbsp;Dairyworks&nbsp;(+ve), outweighed by&nbsp;lower long-term IF volume assumptions (-ve)
The 1H20 result provided better colour on the near-term path. Our&nbsp;EPS&nbsp;forecasts lift +1–3% over the near-term, primarily due to incorporating&nbsp;Dairyworks&nbsp;(higher&nbsp;EBITDA&nbsp;which outweighs a lift in funding costs and depreciation). However, a reduction in long-term finished IF volumes for key customer, a2 Milk (ATM), materially lowers our&nbsp;DCF. We view&nbsp;SML&nbsp;as the key long-term partner for&nbsp;ATM, however, now assume 25% of its volumes from FY26E are not manufactured by&nbsp;SML&nbsp;(prior 10%) following&nbsp;ATM's&nbsp;recent commentary on risk mitigation/diversification. This is the key driver of our&nbsp;lower target price at NZ$5.65.
There is a high margin of error in any&nbsp;SML&nbsp;forecasts or valuation, with our&nbsp;visibility on key earnings drivers minimal —&nbsp;particularly contract specifics and the new customer pipeline.&nbsp;
Chelsea Leadbetter CFA chelsea.leadbetter@forsythbarr.co.nz +64 4 495 5262

Synlait Milk
1H20 Result — Cost and Capacity Bite&nbsp;
NEUTRAL
Synlait Milk (SML) reported a material 1H20 profit decline, as pre-guided, and retained recently downgraded FY20 guidance — with its step-change in manufacturing capacity (and associated costs) creating a larger near-term EPS drag than previously anticipated. SML has invested, and is well positioned, for growth; however, there was nothing in the result to provide greater clarity on the medium to longer-term earnings/returns profile. The recent material de-rate in SML sees us more confident in the assumption set this implies. Given the wide magnitude of long-term returns outcomes, recent comments from its key customer, a2 Milk, on diversification and SML's elevated gearing levels, we require a high margin of safety to be confident in a more positive investment view.
         


NZX Code
SML
Financials:Jul/
19A
20E
21E
22E
Valuation (x)
19A
20E
21E
22E


Share price
NZ$4.40
NPAT* (NZ$m)
81.7&nbsp;
79.9
93.6&nbsp;
110.0&nbsp;
EV/EBITDA
6.7&nbsp;
6.9
6.3&nbsp;
5.7&nbsp;


Target price
NZ$5.65
EPS* (NZc)
45.6&nbsp;
44.6&nbsp;
52.2&nbsp;
61.4&nbsp;
EV/EBIT
8.1&nbsp;
9.0&nbsp;
8.1&nbsp;
7.3&nbsp;


Risk rating
High
EPS growth* (%)
8.9
-2.2
17.1
17.6&nbsp;
PE
9.7&nbsp;
9.9&nbsp;
8.4&nbsp;
7.2&nbsp;


Issued shares
179.2m
DPS (NZc)
0.0&nbsp;
0.0&nbsp;
0.0&nbsp;
0.0&nbsp;
Price/NTA
1.7
1.9&nbsp;
1.5
1.3&nbsp;


Market cap
NZ$789m
Imputation (%)
100
100
100
100
Cash div yld (%)
0.0&nbsp;
0.0&nbsp;
0.0&nbsp;
0.0&nbsp;


Avg daily turnover
117.2k (NZ995k)
*Based on normalised profits


Gross div yld (%)
0.0&nbsp;
0.0&nbsp;
0.0&nbsp;
0.0&nbsp;



Key take-outs

1H20 result all about the cost drag:&nbsp;SML&nbsp;reported a -3.5% decline in 1H20 gross profit (with a large step-change in overheads offsetting a +22% sales lift for infant formula&nbsp;[IF]), which when combined with materially higher costs (opex&nbsp;+27%, interest more than doubling) led to&nbsp;NPAT&nbsp;down -30% to NZ$25m. Material investment in&nbsp;opex&nbsp;and&nbsp;capex&nbsp;primarily reflects capacity expansion underway, with investment ahead of being operational.
No new customer announcements:&nbsp;SML&nbsp;has material capacity to fill and indicated it is well progressed on new customers, although did not announce anything. The range of feasible outcomes remains very wide in terms of the potential return profile.
COVID-19:&nbsp;Minimal impact to date.&nbsp;SML&nbsp;is well positioned given products manufactured are largely consumer staples.
Elevated gearing:&nbsp;Net debt lifted to NZ$447m in 1H20 (from NZ$288m in 1H19) and we forecast net debt to&nbsp;EBITDA&nbsp;of 2.9x in FY20E, above the company's long-term target of &lt;2.5x. The company is nearing the end of material investment (in capacity and diversification), focus now turns to&nbsp;driving efficiencies and utilisation of existing assets.​​​​​​​

Key revisions — incorporating&nbsp;Dairyworks&nbsp;(+ve), outweighed by&nbsp;lower long-term IF volume assumptions (-ve)
The 1H20 result provided better colour on the near-term path. Our&nbsp;EPS&nbsp;forecasts lift +1–3% over the near-term, primarily due to incorporating&nbsp;Dairyworks&nbsp;(higher&nbsp;EBITDA&nbsp;which outweighs a lift in funding costs and depreciation). However, a reduction in long-term finished IF volumes for key customer, a2 Milk (ATM), materially lowers our&nbsp;DCF. We view&nbsp;SML&nbsp;as the key long-term partner for&nbsp;ATM, however, now assume 25% of its volumes from FY26E are not manufactured by&nbsp;SML&nbsp;(prior 10%) following&nbsp;ATM's&nbsp;recent commentary on risk mitigation/diversification. This is the key driver of our&nbsp;lower target price at NZ$5.65.
There is a high margin of error in any&nbsp;SML&nbsp;forecasts or valuation, with our&nbsp;visibility on key earnings drivers minimal —&nbsp;particularly contract specifics and the new customer pipeline.&nbsp;
Chelsea Leadbetter CFA chelsea.leadbetter@forsythbarr.co.nz +64 4 495 5262

Synlait Milk: 1H20 Result — Cost and Capacity Bite