Synlait’s balance sheet in the spotlight as debt rises

Synlait is still recovering from a 2021 earnings slump. Photo / NZME

Synlait Milk’s balance sheet is back in the spotlight after its first half result revealed a sharp increase in debt.

The infant formula and dairy products maker said its interim net profit fell by 83 per cent to $4.8 million, driven by reduced forecast demand for infant formula including from its biggest customer (a2 Milk).

Revenue fell 3 per cent to $769.8m and net debt jumped by 32 per cent to $518.6m in the six months to January 31.

“Advanced nutrition forecast demand and production has been reduced or delayed following forecast changes by Synlait’s largest customer (a2 Milk) during the first half and more recently by other customers,” Synlait said in its result.

Analysts said the fall in profit was in line with updates given by the company last December and earlier this month, but that the higher debt had come as a surprise.

Synlait’s balance sheet came under pressure in 2020 from disruption caused by Covid-19. The company successfully raised $200m late that year.

Forsyth Barr analyst Matt Montgomerie said the result was largely as expected.

“The key surprise or difference for us is the debt increase relative to our own and consensus expectations,” he said.

“Net debt of $518m was primarily a function of inventory build for the (China SAMR infant formula) re-registration but even so, it is a lot higher than we thought.

“The operating costs blowout too was significantly more than expected.”

In its release to the NZX, Synlait said it was confident it will meet all banking covenant requirements in the second half and beyond.

The company said a review of Synlait’s capital strategy was progressing well and that it would update the market at an investor day on May 8.

Synlait chief executive Grant Watson. Photo / Supplied

Forsyth Barr’s Montgomerie said Synlait’s operating expenditure was “clearly much higher and it feels to me as though the rate of increase isn’t yet over”.

“There are some one-offs, but even putting those aside, general cost increases on top of serving more demand for nutritional customers is just going to put margins under pressure for the business as we look ahead,” he said.

“On the balance sheet, the company seemed reasonably confident on the results call that they should be able to get through the remainder of the year within their banking covenants, but gearing is still very elevated,” he said.

“The alleviation of that debt pressure is reliant on some discipline to control and it’s not without risk.”

Synlait looked to be placing some importance on an improved second half.

“It’s not a 100 per cent given because demand and subsequent earnings are quite volatile as we have seen in the last three months of this business.”

Synlait warned in December that its first-half result would show the impact of delayed shipments of ingredient products, resulting in lower sales volumes due to implementation of SAP business software and lower milk supply in the first four months of 2023.

Despite the earnings decline, the performance of Synlait’s Ingredients and consumer businesses remained strong, it said.

Combined, the business units would contribute more than in the 2022 full year.

Synlait said the ingredients business would not likely experience the one-off foreign exchange gains experienced in 2022.

The consumer business continued to navigate high milk and cheese commodity prices and expansion into overseas markets.

Synlait said it was managing several risks, including the SAMR licence re-registration timeline, a UHT volume ramp-up, a tight labour market, and high inflationary cost pressures.

“These factors could impact Synlait’s current guidance.”

On March 17, Synlait Milk released a full-year 2023 net profit guidance range of $15m to $25m, compared with market expectations at the time of around $50m.

While Synlait’s share price dropped 14c to $2.26 on the first half result, the closely-linked a2 Milk saw its share price gain seven cents to $6.39.

Harbour Asset Management’s senior research analyst Oyvinn Rimer said price reactions showed the two companies’ cycles were different.

“For a2 Milk, their cycle works differently and Synlait, of course, needs to be ready when they get SAMR approval to start manufacturing product for a2 Milk,” he said.

“The timing of cycles works very differently for these two companies,” he said.

“In the long term, they should be in sync,” Rimer said.

“But in the short term, they can have massive swings.”