Brokers view: Synlait Milk

GRANT DAVIES
Last updated 05:00 29/03/2014

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Company: Synlait Milk Limited

Sector: Dairy processing

Overview: Synlait Milk Limited announced a half year net profit after tax growth of 79 per cent on Thursday. The market subsequently rewarded the company by slashing over 7 per cent off the share price by lunchtime. This is what happens when expectations are raised prematurely. In January the newly listed milk processor had updated the market, forecasting net profit after tax of $30 to 35 million for the full year. In less than two months this full year profit forecast has been downgraded to $25 to 30m, a 15 per cent drop at the midpoint of these forecasts.

Pros: Whilst the half year result forecast a lower than expected full year profit some investors with a more long-term focus will be pleased to see the company increasing capital expenditure on its new facilities in Dunsandel. Key amongst this increased spending is the company's second large scale infant formula and nutritional spray drier which will now have 25 per cent greater capacity than originally planned. The company has benefited from the Fonterra board's decision to override the farmgate milk manual and set an artificially lower price for farm suppliers. By overruling the farmgate milk price Fonterra have inadvertently lowered the cost of production for Synlait.

Cons: The reason Fonterra's board lowered the farmgate milk price was a relatively unique divergence between cheese and milk powder prices. This is unlikely to continue and we have already seen the cheese and milk powder prices converge. A key reason for the divergence in the first place was the overwhelming demand for milk formula in China. Synlait will be disappointed with its foray into China thus far, noting that regulatory changes in the country has caused disruptions and was a key factor in its earnings downgrade. Other risks include potential damage or shut down of their processing facility, biosecurity events, such as foot and mouth disease or milk contamination that could impact the reputation of New Zealand milk. Any disruptions to the milk supply, such as extreme weather, will also hurt earnings.

Price performance: The share price hit $4.01 before the result. After release the stock traded down over 7 percent to $3.70.

Investment outlook: The company is upping the anti and bringing forward its growth plans. It is not for the faint at heart as the company is up against some big names in the milk powder market.

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*A Broker's View is written by Grant Davies, authorised financial advisor at Hamilton Hindin Greene Limited. This article represents general information provided by Hamilton Hindin Greene, who may hold an interest in the security. It does not constitute investment advice. Disclosure documents are available by request and free of charge through www.hhg.co.nz.

- Fairfax Media

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