South Island dairy processor Synlait Milk will need to consider investing in expanding its blending/canning facility as early as next year given the rapid growth in A2 infant formula sales and the launch of the Munchkin Grass Fed infant formula range, say First NZ Capital analysts.

In a research note ahead of the dairy company reporting its first half results on March 31, First NZ Capital said it didn't think Synlait would be in a position to be specific on the timing of the build yet, but if it is, it was important to provide detail on the risks and costs associated with potentially idle blending/canning capacity.

"Unlike drying capacity, which just requires milk to utilise, there is a greater risk and cost of idle canning capacity," it said. "Here, the challenge for SML is to continue to look at ways to tie customers in to de-risk the capital investment."

Synlait's share price is currently trading at $2.85 and First NZ Capital has a 12-month target price of $3.19.


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It expects Synlait to provide guidance at the first-half results on full-year volumes for its value-add nutritionals given the second half sales skew by its key customer A2 Milk which has had a boom on infant formula sales in Australia and China. Synlait says it is currently working through the production aspect of Munchkin's Grass Fed infant formula and a launch date has yet to be confirmed.

At last year's annual meeting, chief executive John Penno said total sales volume was set to grow from 97,800 metric tons in the 2015 financial year to 122,500 MT in 2016 with more than half of that growth as a result of increased infant formula sales which carry a significant benefit in terms of gross margin.

The analysts said there was only limited scope to upgrade their forecasts for Synlait despite the expected ramp up in nutritional volumes, due to those sales being skewed to one customer, the lack of an established track record of those sales and the need for caution on uncontracted sales volumes.

The three big questions for the Rakaia-based company are likely nutritional volumes post the 2016 financial year, capital investment timing, and medium-term margin expectations.

First NZ Capital forecasts earnings before interest, tax, depreciation and amortisation for the 2016 financial year of $73.3 million compared to $41.3 million the prior year.

Synlait could be "poised at the start of a sustained period of earnings growth", the report said, with more limited capital expenditure than has been required in recent years as part of its value-add strategy.

Milk supply is expected to be slightly down on expectations this season, but the analysts don't expect Synlait to have any trouble securing the growth in milk supply it needs for the 2016/17 season.

Synlait last month cut its forecast farmgate milk price for this season to $4.20 per kilogram of milk solids from $5/kgMS, although it has also forecast a boost in underlying net profit for the March half year significantly above the $419,000 achieved a year ago. Its larger rival Fonterra Cooperative Group has forecast a farmgate milk price of $3.90/kgMS.

More than half of Synlait's milk supply in 2016 is likely to achieve a premium above the base milk price, the company has said. It doesn't detail the premium, apart from saying it's a range of 6 cents to 12 cents per kilogram for its best practice Lead in Pride dairy programme.