Synlait Milk Limited

Company Overview: Synlait Milk Limited (ASX: SM1) provides high-value dairy products to milk-based health and nutrition companies. It operates primarily in the geographic region of New Zealand, but sells its products to various other countries, including China. In FY20, New Zealand and Australia formed around 65% of the sales, while China and Rest of Asia contributed around 24% of the sales revenue.

SM1 Details

Acquisitions and Sale of Increased Product Volumes to Aid Growth: Synlait Milk Limited (ASX: SM1) manufactures and sells milk powder-related products, liquid milk, cheese, etc. to its customers. The market capitalisation of the company as on 9 February 2021, stood at ~A$924.60 million. As per a recent update, the company has increased its forecast milk price to $7.20 kgMS from $6.40 kgMS, for the 2020/2021 season. The decision was made owing to an increase in dairy commodity prices over the last few months and the company anticipates that it will remain around the present levels for the rest of the milk season. It will provide an update on its next milk price in May 2021.

The company delivered a resilient performance in FY20, with growth of ~27% in revenues to NZ$1.30 billion from NZ$1.02 billion in FY19. Growth in sales was aided by the increased volume in consumer–packaged infant formula sales to 49,180 MT, an increase of 15% over the pcp, and 46% increase in lactoferrin sales to 30MT. EBITDA grew by 13% to NZ$171.4 million during the same period under consideration. SM1 reported an NPAT of NZ$75.2 million in FY20. Borrowings of the company stood at ~NZ$102.83 million as on 31 July 2020.

FY20 Financial Performance (Source: Company Reports)

Favourable Judgement Regarding the Pokeno Site: In a recent update, the Supreme Court of New Zealand has given its judgement regarding the historic covenants at the company’s Pokeno site. SM1, New Zealand Industrial Park Limited and Karl Ye had reached a settlement before the issue of the judgement, resulting in the removal of the land covenants.

Oversubscription of Share Purchase Plan: The company has recently announced that its NZ$20 million share purchase plan has been oversubscribed, reflecting strong demand among the shareholders and belief in the company’s fundamentals. The SPP is a part of SM1’s equity raising campaign announced on 10 November 2020, in addition to ~NZ$180 million underwritten placement of new shares to institutional shareholders. The placement of ~NZ$180 million of new, ordinary shares was fully subscribed at the fixed price of NZ$5.10 per share.

Onboards New Multinational Customer: SM1 has signed and agreed to manufacture, blend, and package nutrition products for an established category leader. The company believes that the given strategic partnership will provide a broader market and category exposure in the Asia Pacific region. It is planning to utilise Synlait Pokeno and Auckland’s capacity for this purpose, with a capital expenditure of NZ$70 million, spread over two years. The company expects the agreement to have a positive impact on its earnings from FY23 onwards.

Improved Sale of Product Volumes: There has been an improved sale of key product volumes for the company, reflecting a growing demand for its milk products. The uplift in sales was aided by the investments made in the prior years, as well as from manufacturing efficiencies.

Key Product Sales Volume (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders together form around 63.33% of the total shareholding while the top 4 constitute the maximum holding. Bright Dairy Holding Ltd. and The A2 Milk Company Limited are holding a maximum stake in the company at 32.01% and 16.28%, respectively, as also highlighted in the chart below:

Data Source: Refinitiv, Thomson Reuters, Chart Created by Kalkine Group

Key Metrics: The company has reported decent performance over the years, with an improvement in revenue and gross profit. Net margin of the company stood at 5.8% in FY20. There was an improvement in the current ratio to 1.00x in FY20 from 0.76x in FY19. There is a gradual trend of reduction in the cash cycle days of the company over a period of five years. It reported a debt-to-equity ratio of 0.90x in FY20.

Revenue and Liquidity Profile (Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group)

Key Risks: The company generates revenue from the sale of products across different geographies, and as such is exposed to currency risk. It takes the help of dairy commodity derivatives to hedge against the movement in dairy commodity prices. The operations of the group expose it to credit risk, and it does a detailed credit check on its trade and business customers. SM1 derived revenues of ~64% from the top three external customers in FY20, thus making it vulnerable to client concentration risk. The addition of a new client will help it to diversify its client base and dependence.

Outlook: The company is focused on diversifying its business and has acquired Dairyworks in April 2020. It will look to bring Talbot Forest Cheese and Dairyworks together to realise enhanced synergies and create a unique value proposition. The company has made several key investments in the past few years and expects to benefit from it in the near future. The company expects decent EBITDA and operating cash flows going forward, aided by synergy achievement in its acquired entities.

Valuation Methodology: P/CF Multiple Based Relative Valuation (Illustrative)

Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group 

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks.  

Stock Recommendation: The company reported gross profit per MT of NZ$1,359 in FY20, an increase of 7% over the previous year, owing to favourable product mix. As per ASX, the stock of SM1 is trading close to its 52-weeks’ low levels of A$4.15. The stock of SM1 gave a negative return of ~9.44% in the past one month. On a technical analysis front, the stock of SM1 has a support level of ~$3.964 and a resistance level of ~$5.255. We have valued the stock using a P/CF multiple-based illustrative relative valuation and have arrived at a target price of low double-digit upside (in % terms). We believe that the company might trade at some discount as compared to its peer average, considering its exposure to currency risk, exposure it to credit risk, revenue exposure to a few clients and the risks associated with it, along with stiff competition from peers. For the purpose, we have taken peers such as A2 Milk Company Limited (ASX: A2M), Bega Cheese Limited (ASX: BGA), and Fonterra Shareholders' Fund (ASX: FSF). Considering the current trading levels, positive judgement on the Pokeno site, diversification of client concentration and expected synergies from acquisitions, we recommend a ‘Buy’ rating on the stock at the current market price of $4.12, down 2.601%, as on 9 February 2021.

SM1 Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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