Dairyworks Ltd (SML) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Synlait Milk Limited and Dairyworks Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Leon Clement, Synlait's CEO. Please go ahead.

Good morning, everybody, and thank you for joining us on this conference call about the Synlait and Dairyworks acquisition that I'm going to take you through a little bit today. We appreciate that this might perhaps provide some of you a little bit of a respite from the uncertainty and gloom that's surrounding markets out there at the moment. So we really appreciate you taking the time to join us. Sitting next to me today is the CEO of Dairyworks, Tim Carter. I'm also joined by our CFO for Synlait, Nigel Greenwood; and Hannah Lynch is in the room, who heads our Corporate Affairs and Investor Relations for us. So look, the purpose of today's call is to step you through the rationale for why Synlait has seen real value in this acquisition. We're going to give you a little bit more detail around the Dairyworks business itself. And Tim Carter will speak to you through that. And then I'll come back on the call, and we'll talk you through the synergies that we see that are available to us and why we believe this creates solid and sustainable and really good opportunity around some of the synergies that we see to continue to grow earnings off this acquisition. I would just like to flag that we'll keep this conference call focused on the acquisition of Dairyworks. We are 4 days away from our half year results. So hopefully, we can give you a really good heads-up on this aspect of our business and come back to the half year messaging next week. So just moving through the presentation, I'm going to talk to the first few slides before handing to Tim. I think it's important that we just touch on the transaction overview and the rationale that we took. So we announced in October 2019 the acquisition of Dairyworks for $112 million. At the time that we announced the acquisition, the multiple that we shared at EBITDA level was 7.5x. That multiple has improved for us to 7.1x. And that's based on the improved momentum and earnings that have come through in the forecast earnings to 31 March. And we will be settling on this transaction on the 1st of April, having received yesterday consent from the Overseas Investment Office, which was the remaining condition for us to satisfy. So we are now in a position where we're able to settle on the 1st of April. And the books up to 31 March is showing us some positive momentum. And this multiple is now looking more like 7.1x EBITDA, which is favorable for us. And Tim will talk a little bit to the momentum that is in the business and how we will be able to pick that up and grow it further. A little bit about Dairyworks. It's been a real challenger in the New Zealand market in recent years, grown some really strong market share positions, particularly in cheese and butter. It's got strong FMCG and branded experience, a very strong position in New Zealand and an emerging position in Australia. So why did we think this was an attractive proposition for Synlait? Well, first of all, we've been speaking a lot about the major diversification and the concentration risk that we carry. And this opportunity gives us instant scale in the Everyday Dairy category, which has been strategic for us. Secondly, we see really strong synergies with the Talbot Forest acquisition that we made and through vertical integration and making sure that we build a really strong, competitive, integrated value chain in the same way that we have with our infant nutrition business. The third reason why this is attractive is it's really complementary to the milk solids that we collect from our farmers and allows us to create more value for that milk pool. As you know, infant nutrition has a predominantly skim bias, which is largely protein. Cheese is protein and fat. And this gives us a good opportunity to capture branded value across a different set of milk solids. And that's really complementary to our business. The fourth reason is this allows us to capture and potentially buy the capability that would otherwise have taken us a long time to build in branded FMCG capability. Dairyworks has great customer relationships, strong innovation and NPV streams and good capability in managing an FMCG business. And for us to move into that space organically would have otherwise taken us a lot longer. And finally, something that naturally we have to satisfy are it's financially attractive and immediately earnings per share accretive. So moving to Slide 3. I will be coming back in detail to the synergies at the bottom of this slide in a bit more detail. But some of the key rationale aspects that sit there, this for us is an attractive sector. When we look at especially the cheese and butter category in New Zealand, it's still largely unintegrated. So we see an opportunity for that integration to drive strong competitive advantage in the sector. We're also seeing consumer preference change quite rapidly. And we see Dairyworks being really well positioned as consumers move to being time for wanting to look at convenience and specialty products, this organization is in a really good position to start to tap those trends. And those trends are leaning towards growth in the sector where there's new value that can be tapped. And finally, the reason we said this is an attractive sector to enter is actually we don't believe that anyone in New Zealand is actually telling a really strong story around the provenance of New Zealand dairy for the export sector. And we see a really strong opportunity for Synlait to start to tell that story in a strong way and leverage the capability and the basket that we're starting to build around these categories so that we can grow that in the markets beyond Dairyworks' footprint of New Zealand and Australia. There's good growth opportunities here as well. Dairyworks is really innovative, agile, has got some great category offerings. And we look to continue to tap that. It's a market leader in New Zealand in its chosen categories and has a really strong emerging presence in Australia. And naturally, we've got the entry with the channel or the category build that we started with our fresh milk line that we now have at Synlait. And we can expand the category offering for Dairyworks and bring that on as part of that. So there's good growth opportunities available for us. And we see a complementary culture here and being nimble and innovative. Both companies are purpose-led. Both companies are based on Christchurch, so there's some good fit here. And there's good financial aspects as well. The equipment and management structure has been recently invested in. There's a really strong value-added cheese produced that we can tap through Talbot Forest and integrate that. As I said at the start, this is an attractive multiple for us that gives us good EPS accretion, and we see a good opportunity to grow it. So look, I will come back to those synergies later on around diversification, where we see the supply chain synergies, how we see the milk pool being complementary and the cultural alignment. But for now I think it's a great opportunity to learn a little bit more about this business and what it brings to Synlait. So I'll hand over to the Chief Executive of Dairyworks, Tim Carter, to talk us through that.

Thanks, Leon. So just on Slide 5, and I'll take the opportunity to give you a little bit more detail on who Dairyworks are. What you can see on Slide 5 is the position or the leadership position we have in New Zealand currently. If you look at cheese, we're #1, #2 in butter and an emerging presence across ice cream and powder. Now in cheese, we're close to 50% of the market that we operate in and 25% in butter. So this positional platform, a great place to work from. If we move to the middle, we have a great recognized portfolio of brands within New Zealand. Dairyworks, all based around convenience that Leon touched on earlier, the culinary and products that deliver on that. We have 2 other brands, Alpine and Rolling Meadow, which are exclusive retailer brands, which allows us to differentiate all those retailers to the consumers and customers, which is a great position to have. And then Deep South is our ice cream brand is a great provenance story and good potential there. I think if you move to our customer base, we're playing where the market is. And you can see there across the customer base, we're with Countdown; Foodstuffs on the PAK'nSAVE, New World, Four Square banner; within foodservice out-of-home, have distributor relationships with Davis, Bidfood, Gilmours and Trents; and then through the end users, McDonald's and the likes. The other one in there is Woolworths Australia. We really have a great emerging presence in the Australian market under the Dairyworks brand. If you move to Slide 6, this just to gives you an overview of products, process and sales. And I think that the middle column there around the product and product types, what we can see here is we have a portfolio that's really meeting consumer and shopper needs that again Leon touched on. It's more than just a block cheese business. We're into grated cheese. We're into sliced cheese, snacking. And that's the trend where consumers and shoppers are shopping and looking for. No difference as to butter as we diversify here out of 500 grams. And this is 100-gram, 227 and value-add portfolio. This is all made -- it allows us to do this is from our manufacturing side. We've got great investment into the various lines that we have. Our capability at the back end is matching the consumers and the needs that they have. So that allows us to either lead the market or really push it to those consumer needs with the agility that we have in our business. And what you can see to the far right is the channels that we operate in. We're in supermarkets, the grocery trade, foodservice and then export Australia and in 15 other markets. So we have a great route to market and a great platform to start from. So moving to Slide 7. It just gives you a breakdown of our business. I guess the previous slides that I've talked to really allows us the potential to expand. You can see our geographical split, predominantly New Zealand but an emerging business in Australia that I've talked about that's growing and the rest of the world, a smaller piece. Channel split, it's very much grocery but a really growing foodservice out-of-home. You know those trends are emerging with people eating a lot more out of home. And we're driving penetration into those channels and into those sub-channels that are here in New Zealand. Australian grocery, which I touched on there with Woolworths Australia. And that's a fast-growing segment for us as we export. And then you can just see the category split, 47%, a big chunk is cheese. But certainly, butter is growing and you've got a wider, decent ice cream and milk powder and the like. So again, I want to reiterate, we've got a great platform for growth for us to grow those geographically, channel or category. Slide 8 just shows, I guess, our track record of delivery. We're constantly moving, innovating and challenging at Dairyworks. And it's a big part of our DNA. And it's what's driven us and allowed us to grow those market positions. And you can see it's not one place. If you look through the last 19 years, it has been a track record with its brand growth as we've worked through Alpine, Rolling Meadow, launched a full range at the Dairyworks. Capability and automation has been really critical. We've invested often ahead of the curve to allow us to meet those consumer needs. Innovation is what we do, the heart of what we do. We do it quickly, and we meet those consumer needs. And we would need it, too, has made [indiscernible] through that 19-year history. So we're constantly moving. It's a fast-moving business and a fast-moving segment, something that we really enjoy doing. I guess Leon touched on this as well. We have a management team with extensive FMCG experience and capability right across the board that allows us to lead in the industry. And you can see, given we're Christchurch based, which brings to the Synlait 230 employees here based in Christchurch. So Leon, with this overview, I'll hand back to yourself.

Great. Thanks, Tim. Okay, I'm just going to work through in a little bit more detail some of the synergies we see that follow on from Slide 11. So the 4 synergies that we are going to just go into a little bit more detail are: diversification; supply chain synergies and integration opportunities we see with Talbot Forest Cheese; the opportunity to better optimize our milk pool; and the cultural alignment that we've identified as we've gone through this transaction. So moving to Slide 12, the message around diversification. Look, I've said before that it's actually really hard to diversify when your core business is growing as fast as ours is. So to do this in an organic way is often challenging in any business that's trying to build a greater exposure to different earnings streams. So acquisition is a really sensible way for us to look at achieving this. And I've also talked before about our concentration risk, not just being around customer but around category, around site and around market. And our strategy is to address those things in many ways. So what you can see on the chart there is that Dairyworks brings us material diversification around category. We have a small exposure to Everyday Dairy at the moment through our fresh liquids dairy business. And you can see the step change that, that gives us almost immediately once we bring Dairyworks into the family. It also gives us a material entry into what we're calling our business-to-consumer business. As you know, most of our business is a B2B basis. So dipping into the B2C side is important to us and allows us to capture more of the value as part of what we do. And finally, the revenue by geography split. Although that split, it looks relatively similar and it just looks like it's growing, you will note that a large portion of the product we're seeing in infant nutrition goes via Australia and New Zealand up to China. So there is a far greater underlying material shift in terms of exposure to the New Zealand and Australian market. And we see that as being [indiscernible] on our geographies. So we think those slides are representative. And I think we should be able to give you a bit more flavor to that. But look, I think the charts are there to show the diversification that this materially brings to Synlait. Moving to Slide 13. I think it's important that we do speak through why we do see vertical integration of this industry as a big opportunity and how we see it working. It's important to understand that Talbot Forest, for those of you who perhaps haven't understood that as well or haven't visited Talbot Forest, once you go inside, you'll see that Talbot Forest is predominantly a factory that is set up to take raw milk and produce 20-kilo blocks of cheese. New Zealand has a small brand, which we've talked about, and some strong foodservice and consumer products. But actually a large portion of what we purchased in the Talbot Forest was an upgraded factory that gave us the ability to take raw milk and produce high-quality cheese. Dairyworks, on the other hand, has always purchased that high-quality block cheese from other suppliers and turn them into really, really successful consumer-led snacking and convenience-led products in cheese and butter. So when you look at the diagrams there, you can see that the current supply chain maps for Talbot Forest and Dairyworks have a level of duplication in them. And the areas that you can see are the maturation and storage facilities, which both businesses have. And you can see that both businesses have secondary processing and packaging facilities. Our opportunity is to integrate those 2 businesses, to have Talbot Forest taking high-quality Synlait milk, which we can differentiate and tell a provenance story on, produce high-quality block cheese, mature in one single site and move to the Dairyworks secondary processing and packaging in the Dairyworks line and to sell through to the end consumer. So there's some really strong synergies around how we can integrate these supply chains. And personally, I believe that we will have a highly competitive integrated cheese supply chain that currently doesn't exist in New Zealand, when you look at the other players. Moving to Slide 14. We've talked about the opportunities to optimize our milk pool. The chart on the right there is a helpful comparator. As I said before, infant nutrition is largely skim-based. And currently, a large portion of the fat that we collect, we process for commodity return, either in AMF or if you want to look at the protein and fat similar composition aspects of, say, cheese that will go into whole milk powder. Now the whole milk powder and cheddar bars that are shown on that chart are representative of the GDT reference prices. They do move around and sometimes provide arbitrage opportunities for us. And yes, that's an ingredients game. But the big play here is that we can move those milk solids into a much higher value because we're participating in a consumer-led business. So you can see there's a Dairyworks cheese prices that are there, the average selling prices per tonne. And we can see the sorts of retail prices that are being achieved to some of their offers. So look, a really great opportunity to monetize the fat and protein streams that we have within our milk pool and move further up the value chain. And then finally, on Slide 15, I think this is a synergy that we discovered as we went through due diligence on this when we started to meet the team and look through the business and look at the cultures. And what we've realized is actually these businesses have been on similar paths with a similar culture in different sectors. Synlait was a disruptive and innovative business, moving and building integrated manufacturing on our infant nutrition. Dairyworks was a disruptive and innovative business based in Christchurch, building a strong FMCG presence in cheese. So we saw that commonality as we started to engage. Both businesses are purpose-led. They both have a business model around being a challenger to market and being disruptive and innovative in what they do. And there was a really common element to the way in which customer relationships are built and formed for the long term and for strategic value for both parties. So that's a really important element for us as we started to look at the fit here. And as we went through the process, we increasing saw what a strong fit this is and how we can bring together some of those opportunities. So let's advance through some of the overall synergies that we see. I'll just flip now to Page 17 just to give you a sense of the transaction summary and some of the details that sit within that. There are some complexities here, so bear with us as we just talk through it. I think I've covered well the multiple, which we're seeing that the price reflected on the last 12 months of forecast earnings to 31 March will be 7.1x EBITDA. There are 2 key dates here. The effective date of the transaction, that's the 30th of September, so that was when we agreed with the Dairyworks business on what the effective date would be. Because the point at which we announced, there was a risk that it would shift differently between both parties. And they needed it to be in agreement around how we would run the business in that interim period whilst we satisfied the conditions. What we've established then is a lockbox mechanism to have the business move through to settlement for the 1st of April. And what is important to understand is that the business earnings that are forecast to be approximately $7 million between the 30th of September and the 1st of April, half of the benefit of Synlait, that will remain in Dairyworks after settlement. Then the next thing to look at is, well, what's going to happen and what is our forecast view post the 1st of April? And how might this impact our overall outlook? Well, as we come off the sort of normal seasonal curve and we come through peaks in December and January, the outlook for the contribution on an EBITDA level for Dairyworks to Synlait is approximately $4 million. Once we take into account borrowing costs and depreciation, the impact contribution for that is $2 million for the 4 months of this financial year that we will officially own Dairyworks. We also have, I guess, some opportunity to just start the work on the Talbot Forest integration between now and the end of the financial year. That's going to require a little bit of restating of the Talbot Forest business and some of the opportunities we would otherwise would have seen will be used and invested in this year, so we go into next financial year in good shape. So on that basis, we feel that the current range that we've put out there for the total business of between $70 million and $85 million for our earnings guidance remains appropriate and we remain comfortable with that. Again, we can go through more detail on that for the half year results, when we have that call and roadshow next week. I will mention that the combined Dairyworks and Talbot Forest investment does satisfy some of those requirements for pretax return on invested capital of 20% once we realize those synergies. So we're very happy to take you through that in the future. So look, that's effectively the content we wanted to cover. In summary, we feel really excited about this acquisition. There's some really good rationale for us to be picking it up around diversification, around moving into a more value-added stream and around some of the synergies that we feel we can realize over time. So really strong, stable and growing earnings stream that is [indiscernible] for us to pick up. So look, we'll finish the content call there and open the call now for questions.

[Operator Instructions] Your first question today comes from Chelsea Leadbetter with Forsyth Barr.

I guess perhaps if I start with coming back to Slide 13 and you talked through integration and, I guess, how you're thinking about that. Can you give us a little more context around perhaps the timing that we should be thinking about here to kind of get it to where you're talking about and also what that could mean in terms of quantum of cost synergies, et cetera?

Yes. I think I can give you a bit of color to that, Chelsea. Look, I think that we have an integration plan that will kick off almost immediately that has been well-thought-through. The Dairyworks team will be leading that integration plan. We have a strong general manager in place at Talbot Forest in Andrew Bull. And that integration plan will kick in effectively now. Once settlement takes place, we can start to move forward with that. We are hoping to have a good deal of the first part of integration done before we have the next financial year, so 1st of August this year as we come into that. Obviously, there's work that needs to be done. And in fact, realizing the full synergies, I suspect, will take some 12 to 18 months as we look at some of the full opportunities end-to-end. Look, I think that we see a reasonable opportunity to grow or add to the earnings base that is there. I can give you a sense from a quantum, it's not sort of doubling the current EBITDA. It's probably not quite another half turn, but it's somewhere between that. So look, I think there's a good material addition to the base earnings that we see a strong potential there as well as the momentum we've got in the business.

Okay. Appreciate the color. And I guess just a second question, in terms of understanding, I guess, the growth outlook that you're thinking about for Dairyworks, and perhaps maybe if you can give us some context on what that looked like historically, any splits between sort of price versus volume and anything you can provide there? And then perhaps, how do we think about this going forward, both in terms of how you view category growth rates but also in terms of how you're thinking about Dairyworks itself?

Yes. I could have a quick go. And then Tim, do you want to go as well?

Yes.

Yes. Look, I think the effectiveness of the sector comes from a couple of things, I suppose. Whilst we know the maturity of the New Zealand dairy market is relatively stable, but we have the cheese category is one that is transforming relatively quickly into convenience sectors. And that's driving a lot of growth and value as opposed to volume consumption. We have seen a strong return to butter as being quite favorable globally. And that's played out quite well in the New Zealand sector as well. The other growth opportunities are into Australia. And there's a strong forming relationship with Woolworths Australia. So Australia is just starting to see the Dairyworks packaging on shelf. And that's going really well and driving momentum in the business. So I think those are some of the underlying category drivers that we see. Longer term, we are eyeballing perhaps cheese being a fairly strong potential in China, very niche relative to other categories in terms of consumption. But look, China is really starting to be intrigued by cheese as another source of dairy nutrition. And we think that's an opportunity we can test it around. So Tim, I don't know if you've got anything you want to add to that around some of the specific [indiscernible].

No. I think Leon has nailed it. We feel it will be about the mix change. And we talked about that value-add slices, grated, snacking and the like. We really see that growth -- that segment growth beginning to accelerate. If you look at the shelves in Australia versus New Zealand, it is quite different. New Zealand is more prominent around block, where Australia is prominent around the convenience side. And that's where we're hitting, we can see that coming through. The volume growth, penetration will come from Australia. Right now there, Woolworths Australia shoppers, there's penetration on 1 in 10. There's some great upside that we've got there, so they're driving a lot of the volume growth that's going through the business.

[Operator Instructions] Your next question comes from Adrian Allbon with Jarden (sic) [ Craigs Investment Partners ].

I've got a couple of questions. Firstly, just on the integrated cheese proposition and achieving the 20% sort of return on capital on a pretax basis, can you just sort of break out for us like how much are sort of coming from new growth sort of the export, albeit based on Australia and in longer-term China, which you just outlined, versus the vertical integration part of it?

So let me just understand the question, Adrian. You're saying how much are we expecting -- in terms of future earnings growth, how much is going to come from top line growth versus integration?

Yes. So ask another way, you're confident that the hurdle rate that you've told the market before that you target, you can satisfy, how much as investors do we have to believe that you have to grow the top line through export market?

I can come back to you then on the specifics. But my sense is a large portion of our calculation has not considered -- it's more on the integration that we put into this. So I would say we've calculated on the base earning streams that we're inheriting and the synergies that we see in terms of taking cost out of the supply chain. And there's a very conservative assumption around future growth that would satisfy the 20% and all that. And Nigel is sitting next to me, nodding his head, so...

Yes. No. It's heavily that the incremental returns on this acquisition and the combined are heavily weighted on the integration benefits, which are more certain and more now versus the assumptions around the level of incremental growth that the combined business will create over time.

Okay. Just also help us with the modeling side of this. Can you give us a feel of how much volume this business produces or how much the cheese category is likely to produce? And then like how that sort of dovetails into what you expect on the milk side of things as well?

So from a volume perspective, we basically produce 20,000 tons a year, that's up 15% year-on-year. So that kind of gives you a little bit of a switch in terms of the growth that we are getting.

I would add to that, Adrian, that I think we don't see Talbot Forest being at least in the early years, the sole supplier to Dairyworks. So Dairyworks continues to have a broad range of supplier relationships. We will start to work with Talbot Forest to start to ramp up supply into Dairyworks and integrate that value chain. But not all of that will come to Talbot.

Okay. And so just to understand, so like the Dairyworks is about 20,000 metric tons, Talbot is about 5. And Talbot's got a bit more capacity to do more than 5, I think that's about 12. And then the multiplier is coming from Synlait, whatever was done, into Talbot and initially the existing milk supply into sort of -- or the initial, I guess, fresh product into Dairyworks.

Yes. That's -- I think our assumption is about right there. I would be careful not to take that 20,000 ton of overlap straight back against Synlait's milk pool. It's more sensible to model that our Talbot Forest moving from 5 to 12, which we see is the capacity -- we could push Talbot a bit further to 16 and we could look at expansion if that was seen as necessary. But there's still -- like I said, there's still an opportunity to source outside of the Talbot network and we see ourselves doing that into the future.

And yes, that's good. And hopefully, you can provide more color on more sort of detail around the results next week.

Okay.

And just final question, I guess, with Talbot -- I'm sorry, with Dairyworks settling and with the farm purchase last week, I guess, when you round out the '20 year, right, you fill up the balance sheet quite heavily like, I think, like just broad math, the net debt to EBITDA kind of gets up to sort of the 2.8x on your guidance. Like as we look into '21, like should we be expecting a very long lower CapEx year? Because like '20 is going to turn into -- it sort of feels like it's turning into a $70 million sort of CapEx year.

Yes. Look, if you recall, when we actually -- look, none of this is new. We actually talked about this through the year-end and then our -- also on the bond issue roadshows that we did that we do anticipate that our overall leverage ratios will be higher than we would normally feel -- well, higher than the sort of the top end of the range that we'd like to work on at about 2.5x. We signaled that they will be higher than that. And because of the sheer level of incremental investments were made in FY '20, but that over time, we will work our way back to within our capital structure strategy range of 1.5 to 2.5x leverage. So at this stage, yes, you should expect that we'll have a high leverage at this year-end, but that given our anticipated cash flows going forward and now on investments, that we'll come back within the range pretty quickly.

Okay. But just to be clear on that, Nigel, like what we should also expect is that '21 would shape to be a significantly lower CapEx year?

Slightly, lower. Yes, that's the correct assumption, Adrian. We don't sort of see any other large incremental CapEx opportunities coming into '21. We'll be moving into our normal maintenance cycle and strategically focusing on making sure we drive returns and optimize the assets that we've invested to create these strong future opportunities. So it's a fair assumption to say we'll be backing off investing in new opportunities and focusing on getting good returns to what we've already invested in.

Your next question comes from [ Sam Yu ], a private investor.

I just wanted to ask, since you guys have a lot of a2 milk supply, is it possible to assume that you could use that in producing a2 cheese and ice cream and any of those sorts of products?

Look, it's possible to assume that we could do it. It's not something that we're exploring as part of us. We collect both a2 milk and normal milk in our network, so not all of the milk we collect are a2. And as I said before, a large part of this is about building diversification and propositions. Unless it could be something we could explore, even with our current customer base, it's not something that's a large part of our [indiscernible] or a key part of the rationale for this transaction.

Thank you. There are no further questions at this time. That does conclude our conference for today. Thank you for participating. You may now disconnect.