Company Overview: Synlait Milk Limited (ASX: SM1) is a dairy manufacturer, which is focused on supplying higher value dairy products to leading milk-based health and nutrition companies. It is one of the leading manufacturers of infant formula products and is engaged in modern manufacturing technology, which is highly automated and is operated by teams of world-class experts. It also has an expertise in nutritional dairy formulations combined with a highly regulated manufacturing environment allowing the company to create products that will deliver true health benefits for all stages of life.
SM1 Details
Expanded Capacity and Increased Sales Volumes: Synlait Milk Limited (ASX: SM1) is a dairy manufacturer, which is focused on supplying higher value dairy products to leading milk-based health and nutrition companies. As on 11 August 2020, the market capitalization of the company stood at ~$1.13 billion. Despite an overall drop in the value of the farm gate milk price during FY19, revenue of the company exceeded $1 billion, reflecting an increase of 17% on the previous year. The company is nearing the end of its second major growth phase, having spent $309.3 million on capital expenditure in FY19. During FY19, the company added 56 new milk suppliers, representing an increase of 20% in its total milk collection in one year. In terms of entering new categories, SM1 completed an investment of $134 million in the advanced liquid dairy packaging facility at Dunsande. With the focus on fresh milk in customer brands, the plant is further capable of producing a variety of products in a variety of packaging formats.
During FY19, the company reported an increase of 16% in sales volume to 149,730 MT and growth of 21% in consumer-packaged infant formula sales to 42,907 MT. In the same time span, operating cash flows of the company increased by 39% to $136.7 million, and net profit went up by 10% to $82.2 million. This reflects the strong underlying performance of the business and its ability to fund an investment programme. The decent results were mainly due to the improvement in operational efficiencies and continued support of its customers. The company has invested in growth and has expanded its capacity and sales.
During 1H20, the company witnessed pressure on its supply chain. However, it managed this risk through strong relationships with raw material suppliers and logistics partners. During the half-year, the company progressed on material customer opportunities that will further diversify the business and fill up new facilities and focused on improving its sales pipeline for infant formula base powder rebuilding.
With a decent track record in navigating complex environmental conditions and continued adherence to the strict criteria of several product quality and safety accreditations, the company seems to be well-positioned to weather the impact of the current uncertainty caused due to the global pandemic. The company has invested in growth and improved operational efficiencies. It retains a decent balance sheet, which will help the company to invest in the new range of opportunities.
FY19 Financial Highlights (Source: Company Reports)
Details of Top 10 Shareholders: The following table provides an overview of the top 10 shareholders of Synlait Milk Limited.
Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)
Key Margins: During 1H20, gross margin of the company stood at 14.8%, and net margin of the company was 4.7%. In the same time span, EBITDA margin of the company stood at 12.4%. Return on Equity of the company for 1HFY20 stood at 5.2%, as compared to 3.5% in 1HFY17. This shows that the company is well managing its capital and is capable of generating profits internally. During 1H20, assets/equity ratio of the company was 2.68x and debt/equity ratio of the company stood at 0.89x.
Key Margins (Source: Refinitiv, Thomson Reuters)
Sustainable Competitive Advantage: The company has made decent progress towards the long-term strategy in the half year and is focused on its growth strategy and exploring opportunities in functional creams. It has unique capabilities that underpin its sustainable competitive advantage. During 1H20, sales of the company increased by 22% to 21,571 MT and revenue of the company went up by 19% to $559 million. This was driven by increased consumer packaged infant formula sales and a lift in commodity prices. During the half year, inventory of the company increased by 9% to 48,144 MT, driven by higher milk processing and larger stock build of infant base powders due to an increase in safety stock requirement from increase sales volumes.
During the half year, milk production increased by 8.5% to 46.7 million kgMS because of the uplift in production of consumer-packaged infant formula to 22,212 MT and shift in product mix towards consumer-packaged infant formula. In the same time span, gross profit has reduced to $82.9 million, driven by increased sales of consumer-packaged infant formula, offset by an increase in overhead costs. Increased incremental interest, manufacturing and SG&A costs associated with the Pokeno and Advanced Dairy Liquid Packaging facilities resulted in a decline in net profit after tax by 30% to $26.2 million. During the half-year, the company continued to invest in major growth and operational projects and hence increased its net debt by $159.7 million to $447.4 million.
Growth in Production Volumes (Source: Company Reports)
Synlait Joins B Corp™ Community: The company has been recognized as Certified B Corporation™, which is a global community of for-profit leaders pledging to use business as a force for good. This has created a new benchmark for the company.
Key Risks: The company’s key risks are split into operational and strategic risks. It is exposed to a variety of risks, including foreign exchange exposure with many product sales being made to overseas markets, primarily denominated in USD. It is also susceptible to movement in dairy commodity prices, the uncontrolled risk from consumer behavior, legal or regulatory breach, significant loss of revenue, profitability and/or earnings, food safety and quality, market access, etc.
Future Expectations and Outlook: The company has clear strategies to grow and enter new categories. It is targeting a return on capital employed of approximately 20% and does not expect to be paying dividends in the foreseeable future. Based on the diversification of the business, the company is likely to benefit from increasing profits in the coming years. It expects continued momentum in consumer-packaged infant formula and a full year of operation of the advanced liquid dairy and lactoferrin facilities to positively impact the performance. SM1 is focused on strengthening its business and seeks to leverage future growth opportunities. The company expects to release its results for the 12 months ended 31st July 2020 on 28th September 2020.
Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)
Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative)
EV/EBITDA Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)
Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months
Stock Recommendation: The core business of the company is performing well and continues to support its growth story. The company is diversifying through investments in complementary categories and markets and is nearing completion of its fourth major investment cycle, having invested $470 million in growth projects over the past 24 months. As per ASX, the stock of SM1 is inclined towards its 52-weeks low of $4.33, proffering a decent opportunity for the investors to enter the market. We have valued the stock using the EV/EBITDA multiple based illustrative relative valuation approach and have arrived at a target price offering an upside of low double-digit (in percentage terms). Considering the current trading levels, decent financial performance, resilience of the business in the softer market conditions and positive long-term outlook, we recommend a ‘Buy’ rating on the stock at the current market price of $6.30 on 11 August 2020.
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SM1 Daily Technical Chart (Source: Refinitiv, Thomson Reuters)
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