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Synlait reports worse-than-expected annual loss amidst A2 Milk dispute

Kiwi dairy group Synlait (ASX:SM1), currently embroiled in a contentious disagreement with shareholder and customer A2 Milk, has surprised observers by reporting a more significant annual loss for the year ending July 31 than even its pessimistic forecast five months ago had predicted.

On Monday, Synlait Milk disclosed an annual loss, attributing it to “an extremely challenging year.” However, the company anticipates improved profitability in the coming year, as it embarks on 12 months of restructuring, asset sales, and cost-cutting measures that will exert additional pressure on its bottom line.

In addition to these challenges, the ongoing dispute with A2 Milk is expected to persist until either an arbitrated settlement, a court case, or a new agreement satisfying the major shareholder’s objections is reached.

For the year ending July 31, Synlait reported a loss of NZ$4.3 million, a stark contrast to the NZ$38.5 million profit recorded in the previous fiscal year. This was accompanied by a 3% drop in annual revenue, totaling NZ$1.6 billion.

The reported result fell at the lower end of the guidance issued in April, which suggested a potential range from a NZ$5 million loss to a NZ$5 million profit.

CEO Grant Watson, who assumed his role in January last year, attributed the poor financial performance to various factors, including reduced customer demand, CO2 shortages, extreme weather events, the COVID-19 pandemic, and rising costs, particularly in energy due to inflation and the implementation of the company’s new enterprise resource planning system.

A concerning sign of growing pressures on the company was a 21% increase in net debt to over NZ$413 million as of July 31, far exceeding the company’s market value of NZ$281 million. The rising debt costs compounded as central banks raised rates in an attempt to control inflation.

Synlait’s chair, Simon Robertson, outlined plans for the coming year, including the sale of its Dairyworks and Temuka cheese businesses, cost reduction initiatives, expansion in advanced nutrition and foodservice sectors, and an enhancement of operational performance. The company’s commentary suggests an expectation of higher earnings before interest, tax, depreciation, and amortization (EBITDA) as advanced nutrition volumes increase at its Pokeno factory. However, potential substantial losses remain a possibility following asset sales, impairments, and other associated costs.

Despite the optimistic EBITDA earnings forecast, Synlait acknowledges significant challenges in the year ahead, including volatile market dynamics in China, global economic conditions, and ongoing inflationary pressures affecting costs and customer demand.

The primary challenge confronting Synlait remains the resolution of its dispute with A2 Milk, which has served notice to cancel the exclusive manufacturing and supply agreement for its key infant formula product, citing non-compliance with the agreement’s terms. Synlait disputes A2 Milk’s right to cancel the exclusivity arrangements, leaving the dispute’s duration uncertain.

In the event that asset sales and trading performance fail to generate sufficient revenue and profits, Synlait may face mounting pressure to consider a deeply discounted equity issuance as a means to reduce its debt burden.

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