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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>FY20 Result&nbsp;— Growing Pains</h2>
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<p><strong>NEUTRAL</strong></p>
<p>Synlait Milk (SML) reported an FY20 result below our forecasts, with first-time FY21 guidance materially disappointing. The investment phase to support diversification, and the next step-change in capacity, has been costlier than anticipated; while FY21 is also not helped by a surprisingly weak period of infant formula (IF) demand from key customer, The a2 Milk Company (ATM). Our visibility on earnings drivers is low (reinforced by recent material earnings shocks) which makes gaining confidence on earnings and valuation difficult — leverage can work both ways. Accordingly, we require a higher margin of safety for a directional stock call. NEUTRAL.</p>
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<h3>Whats&nbsp;changed?</h3>
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<li><strong>NPAT revisions:</strong>&nbsp;Material near-term downgrades (FY21E -17%; FY22E -14%) pushing out growth profile by one year.</li>
<li><strong>Target price:</strong>&nbsp;​​​​​​​NZ$6.00 (from NZ$5.65), with cost of capital input changes offsetting the near-term earnings downgrades.&nbsp;</li>
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<h3>FY20 result in the middle of its guidance, albeit below market expectations; FY21 guidance materially below forecasts</h3>
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<div id="m_7364018125404761439ir4fag">
<p>FY20 NPAT of NZ$75m was down -9% on the prior year and weaker than our forecasts (NZ$80m). EBITDA growth (+13%) did not translate to profit growth given the cost drag of recent investment. Guidance for “similar, or a slight improvement" in FY21 was also materially below our (and market) prior forecasts. We now assume the contribution of recent acquisitions (namely Dairyworks) is offset by higher funding costs and a negative result for finished IF. The latter is a material change, with the unfavourable combination of flat volumes (ATM daigou pressure; not helped by SML carrying higher than usual IF base inventory at year end) and margin pressure from the recent ATM contract renewal (efficiencies to mitigate this are likely difficult without volume growth).</p>
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<h3>Gearing elevated and likely to remain so for longer than anticipated before the free&nbsp;cashflow&nbsp;profile improves</h3>
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<div id="m_7364018125404761439ive3p">
<p>FY20 net debt of NZ$527m increased materially on FY19 and was modestly ahead of our forecasts. The majority of SML's large scale capital investment is complete (with some hangover into 1H21) and we are expecting an improved free cashflow/gearing profile from here. However, gearing is likely to be elevated for longer than previously thought given the weaker FY21 earnings outlook. An additional banking facility has been put in place to assist near-term, while SML doesn't appear to be ruling out other options (“in the current environment we recognise the need to assess our balance sheet and capital management options”).</p>
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<h3>Where to from here? Still a lot we don't know; return to NPAT growth (and improved returns) pushed out to FY22E+</h3>
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<div id="m_7364018125404761439is3ste">
<p>We went into SML's result with a number of questions; many of which are still outstanding. The costly part of the expansion phase is almost behind it and we should begin to see an improved return/profit profile, however, the extent of the prize remains unclear and is dependent on further execution on new customers, which has been slow to date. SML did signal a new multi-national packaging customer which is expected to benefit from FY23+, however, we have no visibility on materiality.</p>
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<div><strong>Chelsea Leadbetter CFA</strong></div>
<div><a href="mailto:chelsea.leadbetter@forsythbarr.co.nz" target="_blank" rel="noopener">chelsea.leadbetter@<wbr>forsythbarr.co.nz</a></div>
<div>+64 4 495 5262</div>
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Synlait Milk FY20 Result&nbsp;— Growing Pains

NEUTRAL
Synlait Milk (SML) reported an FY20 result below our forecasts, with first-time FY21 guidance materially disappointing. The investment phase to support diversification, and the next step-change in capacity, has been costlier than anticipated; while FY21 is also not helped by a surprisingly weak period of infant formula (IF) demand from key customer, The a2 Milk Company (ATM). Our visibility on earnings drivers is low (reinforced by recent material earnings shocks) which makes gaining confidence on earnings and valuation difficult — leverage can work both ways. Accordingly, we require a higher margin of safety for a directional stock call. NEUTRAL.


Whats&nbsp;changed?



NPAT revisions:&nbsp;Material near-term downgrades (FY21E -17%; FY22E -14%) pushing out growth profile by one year.
Target price:&nbsp;​​​​​​​NZ$6.00 (from NZ$5.65), with cost of capital input changes offsetting the near-term earnings downgrades.&nbsp;



FY20 result in the middle of its guidance, albeit below market expectations; FY21 guidance materially below forecasts


FY20 NPAT of NZ$75m was down -9% on the prior year and weaker than our forecasts (NZ$80m). EBITDA growth (+13%) did not translate to profit growth given the cost drag of recent investment. Guidance for “similar, or a slight improvement" in FY21 was also materially below our (and market) prior forecasts. We now assume the contribution of recent acquisitions (namely Dairyworks) is offset by higher funding costs and a negative result for finished IF. The latter is a material change, with the unfavourable combination of flat volumes (ATM daigou pressure; not helped by SML carrying higher than usual IF base inventory at year end) and margin pressure from the recent ATM contract renewal (efficiencies to mitigate this are likely difficult without volume growth).


Gearing elevated and likely to remain so for longer than anticipated before the free&nbsp;cashflow&nbsp;profile improves


FY20 net debt of NZ$527m increased materially on FY19 and was modestly ahead of our forecasts. The majority of SML's large scale capital investment is complete (with some hangover into 1H21) and we are expecting an improved free cashflow/gearing profile from here. However, gearing is likely to be elevated for longer than previously thought given the weaker FY21 earnings outlook. An additional banking facility has been put in place to assist near-term, while SML doesn't appear to be ruling out other options (“in the current environment we recognise the need to assess our balance sheet and capital management options”).


Where to from here? Still a lot we don't know; return to NPAT growth (and improved returns) pushed out to FY22E+


We went into SML's result with a number of questions; many of which are still outstanding. The costly part of the expansion phase is almost behind it and we should begin to see an improved return/profit profile, however, the extent of the prize remains unclear and is dependent on further execution on new customers, which has been slow to date. SML did signal a new multi-national packaging customer which is expected to benefit from FY23+, however, we have no visibility on materiality.




Chelsea Leadbetter CFA
chelsea.leadbetter@forsythbarr.co.nz
+64 4 495 5262




Synlait Milk: FY20 Result — Growing Pains