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Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Synlait Milk<br>1H22 Result&nbsp;— Recovery Underway</h2>
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<p><strong>NEUTRAL</strong></p>
<p>Synlait&nbsp;Milk's (SML) 1H22 result showcased robust execution and discipline&nbsp;with a sharp improvement in earnings and material debt reduction, both of which were aided by a number of self-help initiatives.&nbsp;SML's&nbsp;qualitative FY22 guidance for "robust profitability" and FY23 for profitability at similar levels to the years leading into FY21 was retained. The early signs in the road to recovery are positive but there remains a number of factors outside of&nbsp;SML's&nbsp;control, requiring&nbsp;ongoing execution against a challenging backdrop, with the latter unlikely to abate over the medium-term. At ~15x 12m forward PE, SML is trading modestly below its five year average which we believe appropriately reflects the ongoing uncertainties, elevated gearing and changing mix in the business. Retain NEUTRAL.</p>
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<h3>What's changed?&nbsp;</h3>
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<ul>
<li><strong>Earnings</strong>:&nbsp;FY22/FY23/FY24 EPS -16%/+1%/+0%</li>
<li><strong>Target price</strong>: Decreased to NZ$3.45 (from NZ$3.55) with WACC changes and near-term earnings downgrades offsetting valuation roll forward and minor medium-term earnings changes.</li>
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<h3>Key takeaways from&nbsp;SML's&nbsp;1H22 result</h3>
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<ul>
<li><strong>Robust execution against a challenging backdrop</strong>: SML reported 1H22 underlying profit of NZ$14.5m which was modestly below our and consensus expectations, with lower than anticipated Nutritionals gross margins more than offsetting a strong Ingredients performance (combination of volumes and margins). Whilst below our expectations we believe the 1H22 result showcases solid execution in what remains a challenging backdrop.&nbsp; SML retained its vague FY22 guidance for "robust profitability", our revised forecasts assume a modest sequential acceleration in earnings (2H22 NPAT of ~NZ$18m).</li>
<li><strong>Debt reduction a positive takeaway</strong>: SML reported net debt of NZ$389m, down -19% or ~-NZ$90m from 1H21 driven by a number of pre-guided, self-help initiatives, including (1) robust working capital management (particularly inventory reduction), (2) improvement in earnings, (3) capex decline, and (4) the sale and leaseback of its Auckland land and building. Gearing remains elevated (12m rolling net debt to EBITDA of 8.7x) but FY22 guidance is for net debt to EBITDA of 3.5x–4.0x, this is aligned with our forecasts but still requires the ongoing earnings recovery.</li>
<li><strong>Medium-term targets remain intact</strong>:&nbsp;Qualitative FY23 guidance for a return to "similar levels of profitability as years leading into FY21" was retained. This implies NPAT of c. NZ$75–80m. The turnaround phase is likely to be multi-year and FY23 (onwards) is helped by its material new customer, with commercial production&nbsp;due to commence in late 2022. Our forecasts currently take a more conservative stance&nbsp;until there is evidence of continued execution in the underlying business and new initiatives.</li>
<li><strong>SAMR renewal process ongoing</strong>: The re-registration process for SML's key customer, The a2 Milk Company's (ATM) China label product is ongoing. Expectations are now for a re-registration decision by the end of 2022. SML's previous expectation was for August 2022, albeit at this stage we don't believe the delay reflects any notable headwinds in the re-registration process.</li>
</ul>
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Synlait Milk 1H22 Result&nbsp;— Recovery Underway

NEUTRAL
Synlait&nbsp;Milk's (SML) 1H22 result showcased robust execution and discipline&nbsp;with a sharp improvement in earnings and material debt reduction, both of which were aided by a number of self-help initiatives.&nbsp;SML's&nbsp;qualitative FY22 guidance for "robust profitability" and FY23 for profitability at similar levels to the years leading into FY21 was retained. The early signs in the road to recovery are positive but there remains a number of factors outside of&nbsp;SML's&nbsp;control, requiring&nbsp;ongoing execution against a challenging backdrop, with the latter unlikely to abate over the medium-term. At ~15x 12m forward PE, SML is trading modestly below its five year average which we believe appropriately reflects the ongoing uncertainties, elevated gearing and changing mix in the business. Retain NEUTRAL.


What's changed?&nbsp;



Earnings:&nbsp;FY22/FY23/FY24 EPS -16%/+1%/+0%
Target price: Decreased to NZ$3.45 (from NZ$3.55) with WACC changes and near-term earnings downgrades offsetting valuation roll forward and minor medium-term earnings changes.



Key takeaways from&nbsp;SML's&nbsp;1H22 result



Robust execution against a challenging backdrop: SML reported 1H22 underlying profit of NZ$14.5m which was modestly below our and consensus expectations, with lower than anticipated Nutritionals gross margins more than offsetting a strong Ingredients performance (combination of volumes and margins). Whilst below our expectations we believe the 1H22 result showcases solid execution in what remains a challenging backdrop.&nbsp; SML retained its vague FY22 guidance for "robust profitability", our revised forecasts assume a modest sequential acceleration in earnings (2H22 NPAT of ~NZ$18m).
Debt reduction a positive takeaway: SML reported net debt of NZ$389m, down -19% or ~-NZ$90m from 1H21 driven by a number of pre-guided, self-help initiatives, including (1) robust working capital management (particularly inventory reduction), (2) improvement in earnings, (3) capex decline, and (4) the sale and leaseback of its Auckland land and building. Gearing remains elevated (12m rolling net debt to EBITDA of 8.7x) but FY22 guidance is for net debt to EBITDA of 3.5x–4.0x, this is aligned with our forecasts but still requires the ongoing earnings recovery.
Medium-term targets remain intact:&nbsp;Qualitative FY23 guidance for a return to "similar levels of profitability as years leading into FY21" was retained. This implies NPAT of c. NZ$75–80m. The turnaround phase is likely to be multi-year and FY23 (onwards) is helped by its material new customer, with commercial production&nbsp;due to commence in late 2022. Our forecasts currently take a more conservative stance&nbsp;until there is evidence of continued execution in the underlying business and new initiatives.
SAMR renewal process ongoing: The re-registration process for SML's key customer, The a2 Milk Company's (ATM) China label product is ongoing. Expectations are now for a re-registration decision by the end of 2022. SML's previous expectation was for August 2022, albeit at this stage we don't believe the delay reflects any notable headwinds in the re-registration process.



Synlait Milk: 1H22 Result — Recovery Underway