Company Overview: Synlait Milk Limited (ASX: SM1) is a dairy processing company, which manufactures nutritional solutions, value added products and specialty ingredients. It has various product categories namely, infant nutrition, lactoferrin, fresh milk and cream, cheese, butter, plant-based product, and UHT bottle. SM1 has a presence in the markets of China, Australia, New Zealand, and the Asia Pacific. It is one of the leading manufacturers of infant formula products and is engaged in modern manufacturing technology, 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
Capital Raise to Fund Projects: Synlait Milk Limited (ASX: SM1) produces a range of nutritional milk products to its clients and customers. The market capitalisation of the company as on 01 December 2020, stood at ~$1.08 billion. The company has recently closed its NZ$20 million share purchase plan, which was oversubscribed, totalling ~NZ$59 million. The applications will be scaled on a proportionate basis and the surplus application amounts paid will be made to applicants on or before 8 December 2020. Synlait Pokeno- its second integrated processing facility was commissioned recently, which is expected to create additional supply chain efficiency and site diversification. SM1 is raising equity to finance the investment phase and customisation of Synlait Pokeno and Auckland. It is expected that processing and packaging customisation at Synlait Pokeno and Auckland will have an indicative expenditure of NZ$70 million over two years.
The company provided decent financial results in FY20 and reported a revenue growth of 27% to NZ$1,302 million in FY20 from NZ$1,024.3 million in FY19. It was aided by a 15% increase in high value canned infant formula sales and a 46% increase in lactoferrin volumes. Sales volume of 150,432 MT was broadly in line with that of FY19, but there was a shift in the product mix from commodities to canned infant formula. Gross profit per MT was 7% higher at NZ$1,359 in FY20 from NZ$1,268 per MT in FY19. Higher utilisation in consumer packaging facilities of Dunsandel and Auckland resulted in an improvement of NZ$24 per MT in consumer-packaged gross profit. The lactoferrin margin per MT saw an increase over FY19, because of better pricing environment and facility upgrades. The total production during FY20 was at 158,045 MT, reflecting an increase from 146,322 MT in FY19.
Total net debt for the group increased to NZ$527 million in FY20 from NZ$333.6 million in FY19. This resulted in a higher leverage level (Net Debt/EBITDA) to 3.08x in FY20 from 2.19x in FY19. There was a free cash outflow of NZ$119.5 million from operating and investing activities in the same period. Operating cash flows were down by NZ$30.9 million to NZ$105.5 million in FY20 from NZ$136.6 million in FY19, due to increased working capital requirements in infant formula product, as well as requirements for Dairyworks and Talbot Forest Cheese. Cash and cash equivalents stood at ~NZ$5.88 million as on 31 July 2020.
The company seems well placed to take advantage of synergies from its acquisitions. The company is of the opinion that its underlying EBITDA and operating cash flows will continue to improve, aided by a full year of Dairyworks earnings and the integration of Talbot Forest Cheese.
FY20 Financial Highlights (Source: Company Reports)
Details of Top 10 Shareholders: The following table provides an overview of the top 10 shareholders of SM1 Limited. Bright Dairy Holding Ltd. is the largest shareholder in the company, with the percentage holding of 39.01%.
Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)
Key Margins: SM1 had reported increased revenue numbers in FY20, but its margins have declined when compared to FY19. This can be attributed to the impact of COVID-19 on its business. Gross Margin decreased to 15.6% in FY20 from 18.2% in FY19. Net Margin also declined to 5.8% in FY20 from 8% in FY19. During FY20, ROE of the company stood at 13.7%, lower than the Industry Median of 18.5%. At the end of the same period, current ratio of the company improved to 1.0x from 0.76x. Cash cycle improved to 62.9 days in FY20 from 91.6 days in FY19. The company may report better return ratios when the economies begin to function at pre-COVID-19 levels.
Key Margins (Source: Refinitiv, Thomson Reuters)
Increasing Capacity and Focus on Acquisitions: The company has continued to invest in its business with the construction of assets and acquisition of businesses. SM1 is focused on its strategy of growing both, Nutritional (infant and lactoferrin) and Everyday Dairy businesses. This can be seen in its improved financial metrics over the years. The total sales volumes were in line with FY19. The company saw increased traction in its consumer-packaged business in FY20, with sales volume going up by 15% to 49,180 MT. Gross profit in this segment went up by 18% to NZ$40.5 million in FY20 from NZ$34.3 million in FY19. The company completed the purchase of Talbot Forest Cheese on 1 August 2019 and acquired 100% of the shares of Dairyworks on 1 April 2020. In a recent update, SM1 has issued 6,429,752 ordinary shares at a price of A$4.83 per ordinary share.
Gross Profit by Category (Source: Company Reports)
Key Investment Risks: The group is exposed to financial and market risk, including currency risk, interest rate risk, and commodity price risk. It uses certain derivative instruments to hedge itself from possible risk exposures. Further, the company depends on acquisitions to expand its capacity, and this might lead to synergy risks post-acquisition. COVID-19 disruption, changes in consumer preferences, channel dynamics, and supply chain disruptions are some other key challenges faced by the company.
Outlook: Notwithstanding the COVID-19 pandemic, the company expects its capacity to grow over time and is likely to have a positive impact on its gross profit and returns ratios in the long run. SM1 has continued to deliver customer expectations on quality and quantity, and the demand for milk and related products have increased during 1QFY21. It expects consumer-packaged infant food formula volume in FY21 to be lower than FY20.
SM1 expects FY21 NPAT results to be slightly lower than FY20, as it continues to focus on attaining manufacturing efficiency and optimise its assets. In recent news, the company has entered into a manufacturing supply agreement with a reputed client, where it will manufacture, blend, and package nutrition products. It expects commercial production to start from mid-2022. SM1 looks to benefit from the order and expects to increase its profitability from this deal from FY23.
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: The company has seen increased traction of demand with the onset of COVID-19 and is augmenting capacities to meet the future growing demand. As per ASX, the stock of SM1 is trading close to its 52-weeks’ low levels of $4.33, proffering a decent opportunity for the investors for accumulation. The stock of SM1 gave a negative return of 9.96% in the past three months but a positive return of 0.59% in the last one month. On a technical analysis front, the stock of SM1 has a support level of ~$4.688 and a resistance level of ~$5.821. We have valued the stock using the EV/Sales multiple based illustrative relative valuation and have arrived at a target upside of lower double-digit (in % terms). Considering the current trading levels, decent financial performance, increased demand for its products, and focus on capacity addition, we recommend a ‘Buy’ rating on the stock at the current market price of $5.06, down by 0.785% on 01 December 2020.
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SM1 Daily Technical Chart (Source: Refinitiv, Thomson Reuters)
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