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. The firm’s manufacturing process is highly automated and is operated by teams of world-class experts. It also has an expertise in nutritional dairy formulations combined with highly regulated manufacturing environment allowing the company to create products that will deliver true health benefits for all stages of life.
SM1 Details
Decent Growth in Topline and Improved Operational Efficiencies: 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 27 October 2020, the market capitalization of the company stood at ~$880.68 million. Despite the challenges posed by the global health pandemic, SM1 made decent gains by implementing and executing strategy throughout the financial year. During the year, the company achieved geographical site diversification and also broadened its product range.
During FY20, the company reported sustainable, diverse, and recurring revenue base with an increase of 27% in revenue to NZ$1.3 billion. SM1 retains decent and profitable fundamentals with EBITDA showing growth in its core business, up by 13% to NZ$171.4 million. Higher revenue and EBITDA demonstrate the core business strength, driven by the strong relationship of the company with A2M, increased sales from a full year’s production from its expanded lactoferrin facilities, and the company’s ability to extract margins from the raw milk. In the same time span, NPAT of the company was NZ$75.2 million, reflecting a fall on FY19 results. This was mainly due to higher manufacturing overheads and financing costs absorbed while investing for future growth.
Growth in EBITDA and ROCE (Source: Company Reports)
The company has a decent growth prospects resulting in higher net debt to NZ$527 million with an increase in debt leverage ratio to 3.1x in FY20. While the business plan of the company remains fully funded, higher debt of the company will ensure resilience in the current COVID-19 environment and will help the company to maintain decent capex governance.
FY20 Net Debt Position (Source: Company Reports)
The company has a track record of delivering decent returns on capital by investing in a differentiated value chain to meet the needs of the customer and has maintained a rapid pace of growth with elevated profits. The company progressed on significant customer prospects which are likely to further diversify the company and fill up new facilities. The company remains focused on improving its sales pipeline and has invested in growth and improved operational efficiencies. It retains a healthy balance sheet, which will help the company to invest in the new range of opportunities and expand its capacity and sales.
Details of Top 10 Shareholders: The following table provides an overview of the top 10 shareholders of Synlait Milk Limited. Bright Dairy Holding Ltd. is the largest shareholder in the company, with a percentage holding of 39.02%.
Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)
Key Margins: During FY20, gross margin of the company stood at 15.6% and net margin was 5.8%. In the same time span, EBITDA margin of the company stood at 13.3% as compared to the industry median of 17.1%. During FY20, Return on Equity was 13.7% relative to the industry median of 18.5%. Looking into the balance sheet, the company witnessed an improvement in current ratio to 1.0x, up from 0.76x in FY19. During the year, assets/equity ratio of the company was 2.46x, higher than the industry median of 2.02x and debt/equity ratio of the company was 0.90x.
Key Margins (Source: Refinitiv, Thomson Reuters)
Expanding the Synlait Network: The company retains decent drivers for growth for Dairyworks and Talbot Forest Cheese. It is benefitting from synergies offered by business and supply chains and is growing its presence in Cheese and butter in Australian markets. It is on track to deliver sustainable earnings stream with EBITDA in the range of NZ$15 million to NZ$20 million in the next two years with the realization of growth momentum and synergies. The company has also established second integrated processing capability in North Island and is focusing on transitioning to a higher margin product mix and utilization rates. The new multinational customer long-term supply agreement is likely to have a positive impact on earnings from FY23.
Dairyworks Limited Sells Deep South Ice Cream: The company has recently announced that its subsidiary, Dairyworks Limited has sold its Deep South Brand and associated ice cream operations to Talley with effect from 12 November 2020. This will allow the company to focus more on its core business and will help to explore new opportunities with high shareholder value.
Growing Capacity: During FY20, the company witnessed a growth in its capacity and reported an increase of 8% in total powders production to 158,045 MT. In the same time span, consumer-packaged infant formula production went up by 18% and its lactoferrin facilities approached its full capacity with gross production of 33MT. Improved asset utilization rates, efficiency and overhead recovery rates are likely to have a positive impact on gross profit and increase ROCE.
Growth in Capacity (Source: Company Reports)
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 to overseas markets, creating a primarily USD exposure risk. 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 earnings, food safety and quality, market access, etc. The company largely exports its products to China, which is highly regulated and thus needs to obtain registration for both the factory and the product.
Future Expectations and Outlook: The COVID-19 pandemic has created a significant global uncertainty and may impact the performance of SM1 in the coming time. However, the company has clear strategies to grow and enter into new categories. It is aiming the return on capital employed of ~20%. Based on the diversification of the business, the company is likely to benefit from increasing profits in the coming years. It expects sustained momentum in consumer packaged infant formula, a full year of operation of the advanced liquid dairy and lactoferrin facilities. It is focused on strengthening its business and is seeking to leverage future growth opportunities. The company is likely to witnessed continued growth in underlying EBITDA and operating cash flows and is targeting a slight improvement in NPAT.
Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)
Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)
EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)
Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months
Stock Recommendation: With a strong track record at navigating complex environmental conditions and continue to meet 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 core business of the company is performing well and continues to support its growth story. As per ASX, the stock of SM1 is inclined towards its 52-weeks low level of $4.33, proffering a decent opportunity for the investors to enter the market. On a technical front, the stock of SM1 has a support level of ~$4.658 and a resistance level of ~$6.238. We have valued the stock using the EV/Sales multiple based illustrative relative valuation approach and have arrived at a target price offering an upside of lower double-digit (in % 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 $5.10, up by 3.869% on 27 October 2020.
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SM1 Daily Technical Chart (Source: Refinitiv, Thomson Reuters)
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