Wednesday, May 22, 2024

Synlait 11.25% bond yield a flashing red light

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Anxiety spiked after full-year guidance slashed, but long-term view somewhat sunnier.
Synlait said it would focus on its ingredients, food service and advanced nutrition product categories.
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The high yield on Synlait Milk’s subordinated bond is a flashing red light, but analysts seem guardedly optimistic about the long-term view. 

The $180 million five-year 2024 bonds – which have a face value of $1.00 – are currently yielding 11.25% with a coupon of 3.83%.

Investors were already jittery, pushing the yield to 9.05% in early April after the company reported a weak first-half result.

Anxiety, however, spiked after Synlait slashed its full-year guidance last week, almost exactly a month later. 

It’s pretty much the highest yield out there and way above comparable bonds from the likes of Infratil and Fletcher Building.

It now expects to report anywhere from a net loss of $5m to a net profit of $5m for the year ended July 31. 

The dairy company previously told the market in late March net profit after tax was going to be in the range of $15m to $25m.

According to Synlait, the massive decline is largely due to a reduction in demand from one of its customers. A2 Milk said it was the customer in question but voiced significant surprise at the size of the downgrade. 

A2 Milk owned nearly 20% of Synlait and the two have a supply contract that runs until 2025. 

The deal provides the exclusive supply of infant nutrition products stages 1-3 for A2 Milk’s Australian, New Zealand and Chinese market requirements up to a specified quantity in each year.

The $20m difference in guidance also tanked the shares, which have fallen 28% from $2.15 a month ago to $1.55 today. 

Analysts, however, remain guardedly optimistic about the longer-term outlook.

Bell Potter’s Jonathan Snape said Synlait “has now been embedded in a three-year earnings downgrade cycle and is not without risk”.

However, if it can deliver acceptable returns on the new Pokeno customer, obtain the necessary new registration in China and new base powder customers, “then there is material operating leverage beyond FY23e profitability levels and this is what drives the expected earnings uplift in FY24-25e”, Shape said. 

Synlait is poised to announce the identity of the new Pokeno customer. 

It also said China’s State Administration for Market Regulation (SAMR) re-registration process remains on track and it expects to commence production in the final quarter of the financial year ending July 31.

Snape is now forecasting a reported net loss of $3.6m in the current financial year, a net profit of $23.7m in the 2024 financial year and a $41.5m net profit in the 2025 financial year. 

Forsyth Barr’s Matt Montgomerie said the downgrade again highlights the significant operating leverage in the business and emphasises the need for it to improve its asset base utilisation to support margin recoveries in its advanced nutrition segment and decrease customer concentration risk.

He also noted that Synlait has received amendments to three of its five covenants for the remainder of FY23 and as part of its ongoing capital structure review it stated it is not considering an equity raise. 

“In light of the covenant amendments we view this as plausible, but it is not without risk (as evidenced by recent events) and is contingent on a large inventory unwind,” he said.

Other analysts have also been sceptical that the company won’t turn to an equity raise. 

There has been some speculation of late that Synlait could look to sell its Dunsandel plant in a bid to pay down debt. The company did not comment on the speculation.

Synlait’s market capitalisation is currently $339m while its net debt is currently $518.6m.

The net tangible asset value, however, has held steady at $3.00 a share or $520m.

In its latest market announcement, Synlait said its banking syndicate remains “strongly supportive”.

The covenant changes will be in place until July 31 and include lowering the earnings before interest, taxes, depreciation and amortisation (Ebitda) to interest cover ratio, and lifting the leverage ratios. 

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