Company Overview: Synlait Milk Limited is a dairy processing company. The Company is engaged in manufacturing of nutritional solutions, value added products and specialty ingredients. It manufactures and sells milk powder and milk powder-related products. It manufactures specialized milk powders for infant formula manufacture and base pediatric powders for blending into finished infant formula, and finished infant formula products. Its products include infant and adult nutritional formulations, functional food ingredients and specialized products. The infant nutritional powder is a nutritional product. The ingredient products include whole milk powder, skim milk powder and anhydrous milk fat. The specialty product is synlait lactoferrin. The Company has 140,000 metric tons of annual production capacity and packages upto 30,000 metric tons of canned infant formula. It exports its products around the world to Asia, Middle East and Africa and other regions. Its subsidiary is Synlait Milk Finance Limited.
 

SM1 Details

Record Revenue of Over $1 Billion: Synlait Milk Limited (ASX: SM1) is a dairy manufacturer focussed on supplying higher value dairy products to leading milk-based health and nutrition companies. As on 17^th December 2019, the market capitalisation of the company stood at $1.53 billion. Despite an overall drop in the value of the farm gate milk price during the year, the company generated record revenue of NZ$1,024.3 million in FY19, up by 17% from NZ$879 million in FY18. The company has grown from a start-up to a position with annual production volume of 146,000 metric tonnes in 11 years and witnessed a compound annual growth rate of 25% in revenue in the time span of FY09-FY19. During FY19, net profit after tax of the company increased by 10% to $82.2 million, reflecting an increase in high margin sales. During the year, there was a rise in operating and capital costs, which were necessary for future growth. For instance, there was a significant investment in the headcount in order to ensure the right capabilities to run facilities that it is building, such as the advanced liquid dairy packaging facility at Dunsandel. The earnings per share (basic and diluted) rose from 41.60 cents in FY18 to 45.89 cents in FY19. SM1 also demonstrated an impressive ability to keep the business growing with a rise in operating cashflow to $136.7 million from $98.4 million. This was mainly driven by an increase in operating profit and a favourable movement in working capital. With an ongoing growth agenda and clear strategies to enter new categories, the company expects to invest at a rate which at least matches the pattern it has established in the first 11 years. During the year, earnings before interest, tax, depreciation and amortisation (EBITDA) stood at $152.1 million, up by 10% on FY18 result of $138.6 million. This was primarily driven by the increased sales volumes and a comparable product mix. During FY19, consumer packaged infant formula sales went up by 21% on FY18 to 42,907 MT and are in line with the guidance range of 41,000 - 45,000 MT. Another thing which investors need to note is that Synlait Milk Limited’s securities are expected to get listed on NZX Debt market (NZDX), and the proposed listing date has been set has December 18, 2019. 

The company is nearing the end of its second major growth phase and expects FY20 profits to continue to grow, with the rate similar to that of FY19 over FY18. It is also expecting an earnings growth from continued momentum in consumer-packaged infant formula, a full year of operation of the advanced liquid dairy and lactoferrin facilities, the first sales of long-life products, and the progression of Everyday Dairy strategy. 


Revenue and EBITDA (Source: Company Reports)

Top 10 Shareholders: The following table provides a broader overview of the top 10 shareholders in Synlait Milk Limited:


Top 10 Shareholders (Source: Thomson Reuters)

Key Margins: During FY19, EBITDA margin of SM1 stood at 14.9%, slightly higher than the industry median of 14.4%. Net margin of the company stood at 8% as compared to the industry median of 7.3%. This indicates that the company is efficiently managing its costs and is competent of converting its revenue into profits. During the year, return on equity (ROE) stood at 17.9%, higher than the industry median of 13.1%. This implies that the company is delivering decent returns to its shareholders as compared to the broader industry.


Key Metrics (Source: Thomson Reuters)

Recent Initiative to be Net Positive from the Environmental Perspective: The team from Synlait Dunsandel hosted Prime Minister Jacinda Ardern who launched an environmental programme, Whakapuāwai, connecting people through the planting of native trees. The release also added that Synlait Milk Limited is in an ideal position to shape the change needed in the industry.

It also made a deliberate decision not to build another coal boiler, which leads the way to a lower emissions future for New Zealand, working to reach the goal of reducing off-farm greenhouse gas emissions by 50% by 2028.

Recently, the company announced that it has received the infant formula registration from the General Administration of Customs of the Peoples’ Republic of China for its Auckland-based blending and canning facility. The company’s key personnel stated that the team has a robust track record when it comes to providing market access for the customers and securing regulatory approvals for Synlait facilities. The GACC approvals confirm that the company has an opportunity to continue the growth with customers looking to keep expanding in the China market.

Synlait Bond Offer To Repay A Portion of Bank Debt: The company has recently issued unsecured, subordinated fixed-rate bonds for NZ$180 million, maturing on 17^th December 2024. The interest rate has been set at 3.83% per annum. The net proceeds will be used to repay a portion of the Synlait Guaranteeing Group’s bank debt and will also provide diversification of funding sources to support Synlait’s growth strategy.

Analysis of 5 Year Performance: Synlait Milk Limited has a track record of delivering earnings growth by deploying towards differentiated value chain to meet the needs of the customers. This has translated into growth in net profit, which exceeded growth in overall production volumes as SM1 has moved up the value chain. In the span of 5 years, the total production volumes of the company went up by around 50% and net profit increased by 650%.


5-Year Performance (Source: Company Reports)

Strong Balance Sheet with Investment in Major Growth Projects: Continued support from customers and improvement in operational efficiencies delivered a strong financial result in FY19. The company made a significant investment in major growth projects and operational projects and spent $309.3 million on capital expenditure in FY19. Synlait Milk Limited is targeting investment-grade financial metrics and total leverage ratio below 2.5x over the long term. In FY19, the company’s investment towards major growth and operational projects continued, which led to the rise in net debt by $219 million to $333.6 million. Even so, the balance sheet remains strong, and SM1 retains significant headroom within its banking facility covenants.

Extension of Supply Agreement with The A2 Milk Company: It has been recently announced that SM1 renegotiated aspects of the comprehensive manufacturing and supply arrangements with The a2 Milk Company. Notably, the changes reinforce the long-term partnership of both companies. As per the release, supply agreement for a2 Platinum® and other nutritional products, which was announced on July 3, 2018, provided for the minimum term of 5 years, with rolling 3-year term from August 1, 2020. The primary components of revised agreement include (1) 2-year extension to the term of agreement, providing for the new minimum term to, at the earliest, July 31, 2025, (2) increase in volume of the nutritional products over which SM1 has exclusive supply rights, (3) increased committed production capacity from SM1, and (4) pricing terms.

The company also announced the conditional purchase of Dairyworks for $112 million, reflecting an approximate 7.5x EBITDA multiple based on the last twelve months earnings. This will provide another meaningful move towards the delivery of Everyday Dairy strategy. 

What to Expect from SM1 Going Forward: The company is focusing on commissioning the long-life dairy beverages line, with relevant export license and shelf-life testing underway. It also expects the first sales of long-life products in the second half of FY20. The acquisition of Talbot Forest Cheese (TFC) will help the company to optimise the value chain and will allow more nutritional products to be manufactured at Dunsandel, reducing milk sales to external parties. The company expects the production of 5,000 MT in FY20. SM1 also anticipates a greater uplift of approximately 20% in overhead expenses resulting from the full-year impact of FY19 staffing hires, and further investments in growth opportunities.
SM1 is well-positioned to grow earnings off the current asset base and expects the growth in profits and earnings from a continuation of strong momentum from the second half of FY19, wherein it sold 24,932 MT of consumer-packaged infant formula. It is also targeting a long-return pre-tax return on capital employed (ROCE) of greater than 20%. The company also announced that CFO Nigel Greenwood would step down next year. The strong balance sheet has provided a range of new opportunities for investment that have been progressed during this past year. 

As part of the company’s strategy to build a world-class value chain, the company has highlighted its latest investment which is Dry Store 4 that will streamline logistic activities while bringing offsite South Island storage back to site, supporting future growth and generating strong supply chain efficiencies. The project is expected to cost $32 million and delivers a strong investment return based on the planned efficiency gains.


Key Valuation Metrics (Source: Thomson Reuters)

Valuation Methodologies:

Method 1: EV/Sales Multiple Based Approach

EV/Sales Multiple (Source: Thomson Reuters), NTM: Next Twelve Months

Method 2: EV/ EBITDA Multiple Based Approach

EV/EBITDA multiple (Source: Thomson Reuters), NTM: Next Twelve Months

Note: All the forecasted figures have been taken from Thomson Reuters

Stock Recommendation: As per ASX, the stock of SM1 is trading close to its 52-week low level of $7.950, proffering a decent opportunity for accumulation. The company is generating high returns on capital employed and is creating value for its investors with an increase in earnings per share. The company is also ensuring that it fulfills its environmental responsibilities and keeps on delivering decent financial results (as seen during the year). Taking the backdrop of decent financial performance, favourable outlook, improving margins, and trading levels, we have valued the stock using two relative valuation method, i.e., EV/Sales multiple and EV/EBITDA multiple, and arrived at a target price of lower double-digit growth (in percentage terms). Hence, we recommend a “Buy” rating on the stock at the current market price of $8.520, down by 0.117% on December 17, 2019.
 

SM1 Daily Technical Chart (Source: Thomson Reuters)

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