Stock Takes: Red ink? What to expect from Synlait, Pacific Edge’s awkward moment

It’s been a challenging year for Synlait Milk, having been caught in the downdraft of its main customer, a2 Milk.

For Synlait, there have been resignations at the top, a refinancing, and $200 million recapitalisation.

Then there have been four earnings downgrades driven by a fall in demand from a2 Milk, which has required the company to pivot into lower-margin ingredients.

All of this follows on the heels of a big spend-up by Synlait on acquisitions and on new plant at Pokeno.

The dairy processor said in May that it was heading towards a $20m to $30m loss for the July year – from a $75.2m profit in the previous year – and market expectations are broadly in line with that.

While Synlait has worked hard to diversify away from a2 Milk, it will remain the key in the short term, says Oyvinn Rimer, a senior research analyst at Harbour Asset Management.

“Obviously, a lot of Synlait’s near-term recovery relies on a2 Milk turning the corner, and we have not seen that yet,” Rimer said.

“The result is going to be weak, and they have a lot of debt.”

Synlait has already moved to protect its balance sheet.

Early this month, the company entered a sale and leaseback agreement for its canning premises at Māngere on favourable terms.

It also announced a restructuring plan, which will involve cutting staff numbers by 15 per cent.

Rimer said that come Monday, Synlait could reveal more balance sheet-saving measures.

In terms of its over-reliance on a2 Milk as a customer, the market will be interested in a progress report on how a supply agreement with an as-yet-unnamed large, global, customer, is progressing. Synlait has said it expects the deal to be earnings positive for the company from 2023.

In the short run, however, demand from a2 Milk will be key.

“Short term, Synlait really is an a2 Milk derivative – it’s the key driver of their earnings, and it is still pretty tough,” Rimer said.

“The key issue for Synlait is getting more earnings streams outside of a2 Milk.”

Longer-term, there is the issue of a2 Milk diversifying away from Synlait with its majority holding in Mataura ValleyMilk, which will make infant formula.

“At the moment they have a lot of eggs in one basket,” Rimer said.

“The assets that they have acquired have been funded by debt, so the balance sheet is not going to look good,” he said.

Rimer said a2 Milk’s issues came at the worst possible time for Synlait.

“In the rear-view mirror, the result is going to look pretty bad and the future is uncertain, but it could change quickly.

“A2 Milk has been starving the market of inventory for some time, so at some point there will be a restocking cycle, meaning they will have to come back to Synlait and reorder,” Rimer said.

The consensus of forecasts for revenue is $1.265 billion, with a 17 per cent spread between the lowest and highest estimate, suggesting a high level of uncertainty as analysts try to estimate Synlait’s sales.

The market is likely to be focusing on the ebitda (earnings before interest, tax, depreciation and amortisation) as this relates to debt covenants and is typically how the market assesses the indebtedness.

The consensus is an ebitda of $50.5m.

Expectations are for the company’s net loss to come in a$23.5m.

The outlook statement and trading update will be more important to give investors a sense of potential improvements.

Debt and diversification

Forsyth Barr said gearing, diversification and inventory will be the key themes for Synlait, along with its business outlook and progress with its restructure.

“Our base case is for some recovery full year 2022, with an alleviation of temporary issues seen in 2021 and self-help initiatives— albeit risk remains that it takes longer than anticipated to turn the corner and/or see benefits of various changes being made,” Forsyth Barr said.

The broker noted that Synlait had also recently extended and refinanced its debt facilities, including a temporary lift in its working capital facility.

In May, Synlait said it did not intend to undertake a capital raising.

“Gearing is still likely to be elevated near-term — we look for any insight on available measures to address this, particularly should the earnings recovery take longer than anticipated,” Forsyth Barr said.

Pacific's issue

Pacific Edge’s capital-raise announcement has been described as an awkward situation coming just weeks after the company said no capital raising had been approved by its board when details of a share offer were mistakenly released on the ASX.

The cancer diagnostics firm on Thursday announced it would raise up to $80m through a $60m placement and $20m retail share offer.

Mark Lister, head of private wealth research at Craigs Investment Partners, said: “It does look a little awkward doesn’t it? It is not necessarily something the company’s got wrong. They will have a team of very highly paid, well-remunerated investment bankers that they will have employed to manage this process and it is really on that group to get the process right, get the comms right and deal with it.”

Lister said if it reflected badly on anyone it was probably the bankers that could learn something for next time.

“Call it a fat-finger, or accidental reply all or hitting send when they shouldn’t have – we have all done it. But they maybe didn’t manage the comms after that as well as they could have.”

Lister said Pacific Edge was a small company and it was the people advising it who could have dealt with the matter a bit differently.

“That is by the by now.”

Lister said the $80m capital raise was material for the size of the company.

“I don’t really have a strong view on the company and its prospects. It’s a really interesting business and I hope they succeed because I think they have got some great products they are hoping will make a difference in people’s lives, so hopefully they get there.

“I’m always a big fan of small New Zealand companies taking their product to the world. We want to see them follow in the footsteps of the Xero’s and the other businesses that are doing that.”

Lister said he hoped the company could put the botched process behind it and refocus on getting the money it needed to grow.

Pacific Edge has said the majority of the funds raised would be used to accelerate growth in the company’s key United States market.

It also plans to use the money to further develop and grow the commercial process in Southeast Asia, targeting primary- and secondary-care physicians.

Pacific Edge shares last traded at $1.47 and are up 84c over the year.

Tower downgrade

Insurance company Tower has revised its guidance for its underlying net profit after tax for the September year to between $19m and $21m, from between $22m and $24m, due to a higher-than-normal number of house fires.

“Large house claims in 2021 are continuing to be above long-term averages, particularly over the last quarter, including four total-loss fires in the past week,” it said.

Tower said full-year 2021 large house claims now number 97, totalling about $21.3m, compared with 56 in 2020 totalling $10.4m.

“While operational improvements and growth strategies at Tower remain on track, this revision reflects ongoing challenges raised at the interim result announcement in May continuing to influence financial performance in the second half,” Tower said.

Industry-wide inflation is also a continuing source of pressure on both motor and house claims, it added.

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