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
Decent Increase in Sales & Volumes in Key Segments: Synlait Milk Limited (ASX: SM1) is engaged in the production of value milk products to its clients. The market capitalisation of the company as on 19 January 2021, stood at ~$948.64 million. During FY20, the company reported resilient top-line performance with an increase of ~27% in revenues to NZ$1.30 billion in FY20 from NZ$1.02 billion in FY19. The revenue growth was driven by a 15% increase in high-value canned infant formula sales, as well as an increase in lactoferrin sales volume by an impressive growth of 46%, compared to the previous corresponding period. There was an increase of 13% in EBITDA to NZ$171.4 million in FY20, compared to the previous corresponding period. Net income stood at NZ$75.20 million in FY20. During the same period, consumer–packaged infant formula sales grew by 15% to 49,180 MT and there was a growth of 46% in Lactoferrin sales to 30 MT.
As per a recent update, Synlait, New Zealand Industrial Park Limited and Karl Ye agreed on a settlement, resulting in the removal of the land covenants in the Pokeno site. The development works out in favour of SM1, as the land can be now put to industrial use and augment the manufacturing capacity of SM1.
FY20 Performance (Source: Company Reports)
SM1 Signs New Deal: The company has recently entered into a manufacturing supply agreement with a global category leader, under which SM1 will manufacture and package nutrition products to this client. The agreement is expected to utilise Synlait’s integrated manufacturing chain, as well as the capacity utilisation of Synlait Pokeno and Auckland. SM1 anticipates to benefit from this deal and have a positive impact on the Group’s earnings from FY23 onwards. It expects capital expenditure of NZ$70 million for this purpose.
Capital Raising to Assist Growth: SM1 has announced an equity raise of NZ$200 million on 10 November 2020, in order to fund its investment phase for the customisation of Synlait Pokeno and Auckland for processing for its new client. The fundraise will also provide comfort to the company by strengthening its balance sheet amidst the volatility in the earnings created by the COVID-19 pandemic. Approximately NZ$180 million is raised at a fixed price of NZ$5.10 per share in underwritten placement and a further NZ$20 million in underwritten share purchase plan.
Decent Growth in Top-Line and Bottom-Line: The company has been delivering decent growth in its performance over the past five years. The revenues of SM1 grew at a CAGR of ~24% to NZ$1,302 million in FY20, from NZ$546.9 million in FY16. This reflects the increase in capacity and business volume of the company in its key product segments. The total sales of the company had improved to 150,432 MT in FY20, compared to 116,402 MT in FY16. NPAT increased to NZ$75.2 million in FY20, from NZ$35.7 million in FY16, growing at a CAGR of 20%.
SM1 Financial Performance FY2016-FY2020 (Source: Company Reports)
Details of Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 63.33% of the total shareholding. Bright Dairy Holding Ltd. is the largest shareholder in the company, with a percentage holding of 32.01%. The A2 Milk Company Limited holds the second maximum interest in the company at 16.28%.
Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)
Key Metrics: The company reported a gross margin of 15.6% in FY20. Net margin was at 5.8% in FY20, down from 8.0% in FY19, reflecting investments in new facilities and acquisitions over the past two years, as well as increased overhead expenditure. ROE was at 13.7% during FY20. There was an improvement in the current ratio of the company to 1.00x in FY20 from 0.76x in FY19. The cash cycle also reduced to 62.9 days, from 91.6 days during the same period under consideration. SM1 had a net debt of NZ$527 million as on 31 July 2020.
Key Margins (Source: Refinitiv, Thomson Reuters)
Key Risks: The company is dependent on a few clients for its business and as such it is exposed to revenue risk. It has revised its demand forecast after the change in guidance of its key strategic client A2M. SM1 expects total consumer-packaged infant formula volumes in FY21 to be ~35% lower than FY20, and hence anticipates FY21 NPAT to be half of that of FY20 results. It will provide a further update on the FY21 guidance in its half-year result on 29 March 2021. SM1 has a revenue base across different countries and therefore it is also exposed to foreign currency fluctuation risk. Volatility in the dairy commodity prices can have an adverse impact on the company’s earnings, by increasing input costs. The Group uses commodity derivative contracts to manage the sales price volatility caused by fluctuations in GDT prices. The company is dependent on its key supply channels for the smooth functioning of its business and any disruption to it can impact the sales and profitability of the company.
Outlook: The company has witnessed increasing profitability over the years owing to the success of its core infant nutrition business. SM1 has diversified its business capabilities with the commissioning of Synlait Pokeno. It plans to diversify its product range and its client base and has taken a step forward with the signing of an agreement with a key strategic new customer. The company welcomes the Supreme Court judgement regarding the Synlait Pokeno site, and expects to modify the land covenants as per its usage of the land. The acquisition of cheese businesses- Talbot Forest Cheese and Dairyworks augurs well for the company as it provides an opportunity in the cheese sector and will aid earnings in the long run with a diversified income base.
Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)
Valuation Methodology: P/CF Multiple Based Relative Valuation (Illustrative)
P/CF Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months
Stock Recommendation: The stock of SM1 had delivered a decent top-line performance in FY20, despite the COVID-19 headwinds in the economy. SM1 gave a negative return of 15.39% in the past three months and a negative return of 5.85% in the past one month. The stock of SM1 is currently trading close to its 52-weeks’ low level of $4.33, proffering a decent opportunity for the investors to enter the stock. On a technical front, the stock of SM1 has a support level of ~$3.947 and a resistance level of ~$5.291. 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). 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 and upside in valuation, signing of an agreement with a new client, expected synergy from acquisitions and the recent capital raise to fund investments, we recommend a ‘Buy’ rating on the stock at the current market price of $4.34, as on January 19, 2021.
SM1 Daily Technical Chart (Source: Refinitiv, Thomson Reuters)
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