I'm trying to get my head around revenues and/or volumes from customers other than A2 for SML. Apologies in advance for the long post.
Summary, in my estimates:
- A2 make up about 84% of total milk sales, excluding cheese
- A2 projected to be around 80% of total $ sales after recent acquisitions
- Recent cheese acquisitions gave a GP contribution before overheads of 3.4% of the cost of investment vs cost of external finance 3.49%
- I estimate Liquid Milk production is running at about 25% utilisation => white elephant with return lower than the cost of external finance unless other customers can be found urgently
- Increasing inventories are likely due to cheese which will put pressure on working capital, as total volumes and cost/MT are both increasing.
Background
Per the AR2019 p8 Chair Review: "Our current business can be fairly described as essentially focused around one sector, one market and one customer, that being infant formula for China via The a2 Milk Company." It take this to mean the VAST majority (99%+?) of sales are to A2.
SML invested $134m (AR2019, p6, 8 & 11) to expand the production facilities at Dunsandel to process liquid milk for their first customer, Foodstuffs South Island in early April 2019 (AR2019 p8, 11, 14). They also invested $37.8m acquiring Talbot Forest Cheese Ltd (AR2019 p55).
Per the AR2019 CFO Review p14: "This year we commissioned our advanced liquid dairy packaging facility at Dunsandel supplying Foodstuffs South Island. The plant was commissioned in early April, and in the four months following, the facility produced 8,840,469 litres. Gross profit from fresh milk was ($3.5 million) reflecting some initial commissioning challenges and low fixed overhead recoveries. In FY20 we expect to stabilise performance and bring it back in line with expectations."
Liquid Milk Volumes
Assuming the plant opened 6 April 2019, that gives a maximum 117 days of production. 8.84m litres produced equates to 75,560 litres produced per day. Extended over a year that gives an indication of Foodstuffs SI demand of 27.58m litres per annum. Per AR2020 p14 the production capacity is "110ML" which I assume to mean 110m litres per annum. Without any other customers, or change in demand from the sample period April-July 2019, this gives a utilisation rate of 25% (being 27.58/110). It's no surprise SML needs to find other liquid milk customers...!
The company reported total sales of 149,730MT in 2019 and 150,432MT in 2020 (AR2020 p24) with a note at the bottom stating "Synlait Milk Limited only and fresh milk is excluded in FY20 and FY19 (part year in FY19)". I am assuming MT is metric tonnes and it appears these are whole numbers, not thousands or millions.
1 litre of milk averages around 1.03kg plus or minus depending on the fat content. Assuming 116 of 117 days liquid milk production in 2019 was sold (assuming what is produced today is sold tomorrow), that equates to around (75,560 x 116 * 1.03/1000) 9,028MT of liquid milk sales. As a percentage of total tonnage sold this would imply (149,730/158,758) 94% of total milk volume sales in 2019 were to A2, excluding cheese.
Extending this to 2020, let's assume liquid milk sales of 75,560 x 366 x 1.03/1000 = 28,485MT. As a percentage of total milk sales (excluding cheese, and assuming the remainder is A2) this implies A2 is 84% of total milk volumes sold (being 150,432/178,917).
Cheese & Liquid Milk Impact
Dairyworks Ltd was also acquired 1 April 2020 at a cost of $112m (p60 AR2020) which further muddies the waters.
What is interesting to note is this comment from AR2020 p25: "The Everyday Dairy category represents the acquisition of Talbot Forest Cheese and Dairyworks, along with the Advanced Dairy Liquid Packaging Facility at Dunsandel. Gross Profit from this area is net $0.4 million, a result reflecting some initial commissioning challenges in the Advanced Dairy Liquid Packaging Facility at Dunsandel and low fixed overhead recoveries as we move from commissioning phase to a focus on increasing utilisation. Dairyworks and Talbot Forest Cheese are tracking to expectations generating Gross Profit of $2.6 million combined in FY20."
Is the $0.4m the total GP for just liquid milk from Dunsandel? Or is it the 3 business units combined which would imply a GP loss for liquid milk - surely not? Either way, that is a far cry from the $3.5m reported for the 4 months ended July 2019. A GP contribution of $0.4m on an investment of $134m is risible. It is likely the GP was slaughtered by increased depreciation and wage costs which form part of Cost of Sales (AR2020 p37) but what explains the rest of it - lower volumes?
Furthermore, if the GP for Talbot and Dairyworks combined is $2.6m on an investment of (118 + 37.8) $155.8m then that is a contribution before fixed costs of 1.7%. Admittedly Dairyworks is only 4 months so adjusting the investment (not the GP given it is not disclosed), gives a contribution before overheads of 2.6 / (118/3 + 37.8) = 2.6 / 77.1 = 3.4%.
Contrast the contributions before overheads of 0.3% and 3.4% with the cost of funding which is 3.49% (AR2020 p46). Liquid milk processing appears to be a white elephant for now. Is the "low overhead recoveries" indicative of liquid milk sales in 2020 that were lower than expected based on the 4 months ended July 2019? SML urgently needs to implement synergy cost savings across all 3 business units.
Note Talbot contributed revenues of $11.5m (AR2020 p60) and Dairyworks $81.5m (AR2020, p61) annualised to $245.3m.
Restating revenues for Dairyworks to a full year of $245.3m gives annual revenues of $1,465.8m. Taking off Talbot $11.5m and Dairyworks $245.3m leaves revenues of $1,209m. Assuming liquid milk sales to FS SI are about $1.40 per litre (being $1.80 retail - GST - est. 10% margin) gives revenues of around ($1.40 x 28,485/1.03) = $39m, leaving A2 sales of $1,170m.
Conclusion
This gives me
A2 being ~80% of forward sales (being $1,170/$1,465.8).
I also looked at inventories which appear to be blowing out but a lot of that will be the higher average cost of cheese plus the longer maturation periods, so these numbers will be moving upwards which puts pressure on working capital. It's not necessarily a bad thing, just a slightly different business model compared to previous years.
Edit: re-reading the CFO Review, it appears the GP of $3.5m is actually a loss given it is in brackets.