BASFY - Trinseo: Weak Fundamentals Under Competitive And Regulatory Pressure

2023-09-26 11:50:44 ET

Summary

• Trinseo PLC shares have been on a solid downward trajectory, losing about 90% over the last five years and about 63.90% YTD.
• The company's weakening fundamentals, including low revenues and net income, high debt, poor cash flow, and fluctuating share price, make it a risky investment.
• Competitive and regulatory pressures further add to the company's challenges, with peers like Dow Inc. and BASF SE outperforming Trinseo in various financial metrics.
• Given the weak fundamentals and the competitive and regulatory framework, I am bearish on the company and rate it a sell.

Investment Thesis

Trinseo PLC ( TSE ) shares have been on a solid downward trajectory, losing about 90% over the last five years and about 63.90% YTD, a sign that this trend is still on solid momentum. I am bearish on the stock, given TSE’s weakening fundamentals. Although TSE is trying some redemption efforts through innovations, diversity, and strategic acquisitions, in my opinion, it will take time before they pay off, which, in my opinion, the risk-reward trade-off isn’t worth it. As a result, I recommend selling its shares and investing elsewhere or waiting until its fundamentals come back.

Weakening Fundamentals

In my view, Trinseo’s fundamentals are deteriorating as a result of competitive and regulatory constraints, as well as plummeting revenues and net income , high debt and poor cash flow, a fluctuating share price, and low dividends. Below is my detailed analysis of each of these aspects:

Revenues and net income : In the second quarter of 2023, Trinseo’s revenue dropped by 32.47% year over year to $962.6 million, and the company posted a net loss of $349 million, down from a profit of $37.3 million a year ago. The company ascribed the downward trend to lower sales volume, unfavorable currency effects, higher raw material costs, and restructuring expenditures. When I evaluate the causes of low performance, I find that they are primarily due to the challenging macroeconomic environment. With this in mind, I am skeptical about the company’s future financial performance because the macroeconomic outlook remains bleak . As a result, I expect the poor economic performance to continue in the coming quarters.

High debt and low cash flow : TSE’s balance sheet shows it has $2.39 billion in total debt and $269.5 million in cash and equivalents. It also has a debt-to-equity ratio of 99.4, indicating significant financial leverage and risk. Furthermore, the company’s operating cash flow was negative $12.9 million in the second quarter of 2023, which was insufficient to pay its $26.8 million in interest expenses, underscoring my concerns about its incapacity to manage its debt level. Given its cash position, the corporation has a net debt of around $2.1 billion, implying substantial share dilution if the debt were to be repaid today. This, in my opinion, is a precarious position for investors, especially given the poor financial performance and cash flows. Furthermore, with this shaky financial foundation, the company lacks financial flexibility to weather the challenging macroeconomic environment, which, in my opinion, is not a promising position for this company.

Volatile share price and Poor dividend : Its share price has fluctuated dramatically during the last year, ranging from $7.43 to $30.53. Furthermore, the company’s stock performance has lagged behind its peers and the industry average.

Furthermore, the company’s dividend yield is only 0.5%, lower than the sector median of 1.67%. Aside from paying a lower dividend than peers, it has also fluctuated dramatically compared to peers and industry medians. From 2018 to 2023, its dividend growth rate was negative, as it lowered its annual dividend from $1.60 per share in 2018 to $0.04 per share in 2023. The average chemical industry dividend growth rate was 6.5%, whereas Dow Inc., BASF SE, Covestro AG, and LG Chem Ltd. were 7.2%, 5.4%, 13.6%, and 10.9%, respectively. Given this context, this company’s dividend is not only lower than its peers, but also declining compared to the industry and peers. Furthermore, given its dismal financial performance, I expect this awful trend to continue.

To conclude this section, I project the company’s shares to continue fluctuating dramatically and to trend downwards due to its weak financial standing. Its beta of 1.24 supports my assertion that this stock will be volatile. Furthermore, the poor dividend history does not appear to improve, as seen by the company’s falling financials; thus, it is plausible to conclude that the dividend’s future is hazy.

Competitive and Regulatory Pressure: Major Headwinds

Despite the negative characteristics outlined above, TSE is facing two key headwinds that, in my opinion, will potentially put more pressure on the company, leading to even worse performance in the future. To begin with, there is the competitive pressure. To illustrate, I will use Dow Inc. (DOW) and BASF SE (BASFY) as the company’s peers. From a competitive standpoint, I believe both DOW and BASFY are better off than the TSE. Here are my reasons for that:

DOW and BASFY outperform TSE in revenue, net income, dividend yield, and growth rate. Dow’s sales were $12.6 billion, and its net income was $1.9 billion in the second quarter of 2023, according to the most recent financial report, while BASFY’s revenue was €16.8 billion, and its net income was €1.7 billion in the same time. In the second quarter of 2023, TSE’s sales were $962.6 million, and its net income was negative $349 million. Furthermore, from 2018 to 2023, DOW’s dividend yield was 4.51%, and its dividend growth rate was 7.2%, while BASF SE’s dividend yield was 4.11%, and its dividend growth rate was 5.4%. Conversely, TSE had a dividend yield of 0.47% and a negative dividend growth rate for the same period. These numbers show that DOW and BASFY outperform TSE regarding financial performance and shareholder returns.

Additionally, DOW and BASFY have better returns on equity and lower debt-to-equity ratios than TSE. The debt-to-equity ratio for DOW is 0.77, and its return on equity is 23.9%, while those figures are 0.64 and 15.2%, respectively, for BASFY. Conversely, TSE has a negative return on equity of 67.9% and a debt-to-equity ratio of 99. Based on these metrics, DOW and BASFY are more profitable and efficient than TSE while having lower financial leverage and risk.

Given this background, TSE’s competitors are on a more stable financial footing, which, in my opinion, is attractive to investors. As a result, I think its peers are in a better position to exploit the market than them, sustaining their exemplary performance at the expense of TSE.

Another significant impediment is the regulatory environment. TSE, like any other firm, operates under a regulated framework. Noncompliance with or violation of any of the regulations might have serious consequences. TSE faces several regulatory problems, which I believe will impact the company’s success. Here is one of them and my take on it.

Class action lawsuit: Investors have filed a class action lawsuit against TSE , alleging that the firm made materially false/misleading statements and failed to disclose significant adverse facts about its business, operations, and prospects, including its safety record and hazards at its Bristol plant. In my opinion, its reputation and the trust of its investors could take a serious hit if it loses this litigation. This will affect the business significantly because its public will deteriorate. In addition, if they lose the case, they may have to pay substantial sums to cover legal fees, damages, penalties, or settlements, devastatingly affecting their already precarious financial situation.

With these headwinds, TSE is in a highly vulnerable situation, and I believe the company’s shares will fall. This is because the company’s weak financial footing in a highly competitive and regulated environment will limit its ability to recover. These two factors represent two significant long-term headwinds that will limit the company’s performance.

Not Everything Is Gloomy

I am pessimistic about this stock, but it isn’t all doom and gloom. Some bright aspects of the company could help it recover. Here are some of its positives;

Innovation and sustainability initiatives: It invests in research and development to improve the quality, performance, functionality, and differentiation of its products. For example, the company has introduced INDURO , a highly engineered continuous cast acrylic capped sheet designed exclusively for outdoor applications requiring exceptional weatherability and durability.

Strategic acquisitions and partnerships : Trinseo seeks strategic acquisitions and partnerships in order to broaden its product range, geographic reach, customer base, and market share. For example, in February 2021, the company finalized the €1.14 billion acquisition of Arkema’s polymethyl methacrylates (PMMA) division. This strengthened its position in the fast-growing engineered materials sector. In June 2021, the firm announced a joint venture agreement to develop sustainable polystyrene recycling solutions with Coexpan S.A ., Europe’s leading rigid packaging producer.

While the company possesses several strong characteristics that, if successfully executed, may lead to an upside potential. I believe that its current challenges necessitate more than acquisitions and product development. The organization must devise rigorous turnaround strategies that focus on strengthening its balance sheet as well as enhancing its financial performance. Some of the expected strategies include cost cuts and the disposal of non-profitable assets if any exist. Management reorganization is another method that I expect to be used among others.

My Investment Decision

I am pessimistic about this stock because of its weak financial footing, which will be exacerbated by competition and regulatory pressure. The company has a few positive attributes, but if it wants to solve its challenges, it needs to do more than it is doing right now, in my opinion. In the absence of such promising turnaround strategies, I expect the company’s performance to continue in the current downward trajectory, leading me to a sell recommendation to avoid more losses.

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