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<br>FY21 Guidance Cut</h2>
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<p><strong>NEUTRAL</strong></p>
<p>Synlait&nbsp;Milk (SML) has further downgraded FY21 guidance, with 'new' management revisiting assumptions for pre-existing areas of uncertainty and challenges. Revised guidance is seemingly conservative and it is not difficult to forecast future earnings materially ahead of what appears to be a low-point in FY21. However, low visibility, a multitude of moving parts and heightened uncertainty limits our confidence and means there is a high margin of error in earnings forecasts. Return on capital is also unlikely to return to prior highs, in our view. Current valuation metrics are not demanding, however, given the uncertainty and risk we require a much higher margin of safety.&nbsp; NEUTRAL.</p>
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<h3>What's changed?&nbsp;</h3>
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<li><strong>Earnings</strong>:&nbsp;FY21E materially cut, consistent with guidance. Medium-term also lowered -9% to -15%.</li>
<li><strong>Target price</strong>:&nbsp;Lowered to NZ$3.45&nbsp;(-11%).</li>
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<h3>FY21 guidance lowered, again</h3>
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<div id="m_-5334906454732623528id9fr">
<p>SML has lowered FY21 guidance, now signalling expectations for an NPAT loss of -NZ$20m to -NZ$30m. This is materially below prior guidance (~NZ$0m) and market expectations. The change reflects revised assumptions and appears to be 'new' management taking a more conservative stance on the risks/areas of uncertainty, rather than a further deterioration in the business or new issues. Key downgrade drivers (evenly split): (1) ingredient sales delays (up to 10,000 MT) due to shipping constraints —&nbsp;a timing issue, (2) lower pricing&nbsp;for ingredients products, (3) a more conservative approach to year-end inventory volumes and valuation.&nbsp;</p>
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<h3>Where to from here? Still no clearer</h3>
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<p>FY21 has been a dismal year&nbsp;with a plethora of (now) well-publicised issues, amplified by one-offs, the rapid pace of change and timing (at the end of its expansionary&nbsp;capex&nbsp;phase). The path from here is still no clearer, with a high margin of error in earnings forecasts, not helped by low external visibility on key drivers, a volatile backdrop and high leverage.&nbsp;Our base case is for some recovery in FY22E, with an&nbsp;alleviation of temporary issues seen in FY21, some self-help initiatives and an&nbsp;improved infant formula situation.&nbsp;We assume a further step-up in FY23E, aligned to our a2 Milk volume forecasts and first-time impact of&nbsp;SML's&nbsp;new multi-national customer.</p>
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<h3>Elevated gearing; temporary covenant waiver provided</h3>
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<div id="m_-5334906454732623528i1ajl">
<p>SML has removed one current risk, stating it "does not intend to undertake a capital raising" and securing covenant waivers for FY21. Our revised forecast is for net debt to EBITDA of ~3.2x in FY22E, above its internal long-term target (~2.5x) albeit within covenants (total leverage ratio ~4x). This assumes (1) execution on earnings recovery initiatives, (2) a reversal of temporary timing impacts seen in FY21 (which led to elevated inventory) and (3) a modest capex outlook. These assumptions (particularly #1) are not risk-free.&nbsp;</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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<div><strong>Matt Montgomerie</strong></div>
<div><a href="mailto:matt.montgomerie@forsythbarr.co.nz" target="_blank" rel="noopener">matt.montgomerie@forsythbarr.<wbr>co.nz</a></div>
<div>+64 9 368 0124</div>
</div>
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Synlait Milk FY21 Guidance Cut

NEUTRAL
Synlait&nbsp;Milk (SML) has further downgraded FY21 guidance, with 'new' management revisiting assumptions for pre-existing areas of uncertainty and challenges. Revised guidance is seemingly conservative and it is not difficult to forecast future earnings materially ahead of what appears to be a low-point in FY21. However, low visibility, a multitude of moving parts and heightened uncertainty limits our confidence and means there is a high margin of error in earnings forecasts. Return on capital is also unlikely to return to prior highs, in our view. Current valuation metrics are not demanding, however, given the uncertainty and risk we require a much higher margin of safety.&nbsp; NEUTRAL.


What's changed?&nbsp;



Earnings:&nbsp;FY21E materially cut, consistent with guidance. Medium-term also lowered -9% to -15%.
Target price:&nbsp;Lowered to NZ$3.45&nbsp;(-11%).



FY21 guidance lowered, again


SML has lowered FY21 guidance, now signalling expectations for an NPAT loss of -NZ$20m to -NZ$30m. This is materially below prior guidance (~NZ$0m) and market expectations. The change reflects revised assumptions and appears to be 'new' management taking a more conservative stance on the risks/areas of uncertainty, rather than a further deterioration in the business or new issues. Key downgrade drivers (evenly split): (1) ingredient sales delays (up to 10,000 MT) due to shipping constraints —&nbsp;a timing issue, (2) lower pricing&nbsp;for ingredients products, (3) a more conservative approach to year-end inventory volumes and valuation.&nbsp;


Where to from here? Still no clearer


FY21 has been a dismal year&nbsp;with a plethora of (now) well-publicised issues, amplified by one-offs, the rapid pace of change and timing (at the end of its expansionary&nbsp;capex&nbsp;phase). The path from here is still no clearer, with a high margin of error in earnings forecasts, not helped by low external visibility on key drivers, a volatile backdrop and high leverage.&nbsp;Our base case is for some recovery in FY22E, with an&nbsp;alleviation of temporary issues seen in FY21, some self-help initiatives and an&nbsp;improved infant formula situation.&nbsp;We assume a further step-up in FY23E, aligned to our a2 Milk volume forecasts and first-time impact of&nbsp;SML's&nbsp;new multi-national customer.


Elevated gearing; temporary covenant waiver provided


SML has removed one current risk, stating it "does not intend to undertake a capital raising" and securing covenant waivers for FY21. Our revised forecast is for net debt to EBITDA of ~3.2x in FY22E, above its internal long-term target (~2.5x) albeit within covenants (total leverage ratio ~4x). This assumes (1) execution on earnings recovery initiatives, (2) a reversal of temporary timing impacts seen in FY21 (which led to elevated inventory) and (3) a modest capex outlook. These assumptions (particularly #1) are not risk-free.&nbsp;



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





Matt Montgomerie
matt.montgomerie@forsythbarr.co.nz
+64 9 368 0124



Synlait Milk

Synlait Milk: FY21 Guidance Cut