Too much capacity, too much debt: Synlait Milk thrown a lifeline

Synlait Milk has too much capacity and too much debt. Photo / File

Synlait Milk has been thrown a lifeline by its bankers and its biggest shareholder, China’s Bright Dairy, after missing a key repayment deadline last week.

The company, which has a factory in Pōkeno, near Auckland, and Dunsandel, in Canterbury, has won an extension for a $130 million debt repayment after reporting a $96.2m loss for the first half.

Bright Dairy, which owns 39.01 per cent of the infant formula and ingredients maker, has sent a letter of support.

The letter includes a commitment to participate in a future equity raise and to extend a loan at the request of Synlait.

As part of its recovery plan, chief executive Grant Watson said Synlait would undertake a strategic review of its North Island assets, including Pōkeno and its blending and canning facility in Auckland.

Synlait is progressing with an equity raise, running alongside the strategic review of the North Island assets.

The company has had its consumer goods arm Dairyworks up for sale.

In a conference call with analysts, Watson said the company had come close to selling the asset last week before negotiations fell through.

There had been two other offers.

In its result, Synlait wrote down the value of Dairyworks to $120m from $150m to reflect the value of non-binding offers received.

Synlait remains in discussions with potential purchasers, “but no sale has been completed or is assured”.

Much of Synlait’s problems date back to when it sought to become less reliant on its biggest customer and nearly 20 per cent shareholder, a2 Milk.

The plan involved building a plant at Pōkeno and acquiring other businesses - at a time when conditions were more buoyant than they are today.

“After a significant level of investment over a number of years, Synlait has far too much capacity and too much debt,” Watson said on a conference call.

“Interest rates have roughly doubled in recent years and the birth rate has roughly halved in our largest infant formula market - China,” Watson said.

Now, it was a matter of reducing capacity to materially reduce debt.

Ironically, a thinned-down Synlait would put it back to where it was with a2 Milk, which has also sought to reduce its reliance on Synlait as its sole source of infant formula.

Synlait chief executive Grant Watson.

The result showed net debt was up 8 per cent to $559m in the half year - more than double Synlait’s current market capitalisation.

Synlait has $180m NZX-listed in bonds that fall due in December this year.

The bonds last traded at an eye-watering yield of 39.8 per cent.

Synlait’s bottom line loss came mostly from an impairment charge of $50.3m, driven by under-utilisation of its North Island manufacturing facilities.

The company now expects the 2024 ebitda result to be “significantly down” - in a range of $45m to $60m - from a previous guidance of about $90m.

The worse outlook reflected softening demand and margins across all business units, adverse foreign exchange and product mix and increased operating expenses.

Forsyth Barr senior analyst Matt Montgomerie said over-expansion was not the single source of Synlait’s troubles but that it was “material”.

There are plenty of unanswered questions and big questions at that, but Montgomerie said the company looked to be going down the right track.

“I think it’s the right decision to go down the asset sales path in the North Island, but there is a massive element of risk to that with respect to the sales price,” he said.

“It’s not without significant uncertainty.

“And it leaves Synlait in the same position as it has been in the past, with massive single customer risks, particularly when a2 is wanting to shift volumes away from Dunsandel,” he said.

“It’s a sub-optimal way out but I think it makes sense given the drag Pōkeno has had on the business today, but it still leaves Synlait in a precarious position.”

Montgomerie said selling the plant in the current environment could be tricky given Fonterra - the country’s biggest dairy company - is known to have sufficient capacity, particularly in the North Island, and that most of Synlait’s competitors around the world have enough capacity.

However, Abbott, already a key customer - could be a candidate for Pokeno.

Key points

Synlait’s plan to deleverage its balance sheet and reduce debt has five elements:

• The banking syndicate remaining supportive;
• Extension of the $130m prepayment from March 28 to no later than July 15;
• An additional $30m of short-term funding from March 28 to June 27;
• Amendment of the shareholders’ funds covenant from $600m to $400m;
• Amendment of the interest cover ratio from 2.25 times to 1.75 times for 2024.

Jamie Gray is an Auckland-based journalist, covering the financial markets and the primary sector. He joined the Herald in 2011.