Trinseo: Synergies, diversification, big Make It Buy plan (NYSE: TSE)


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Trinseo PLC (New York Stock Exchange: TSE) expects significant synergies from several acquisitions and may soon announce new funds from a divestment. In my view, if management is smart enough, TSE’s valuation could soon head north. In the best case, I would like expect more acquisitions, which could lead to even less volatility in EBITDA margin and greater market capitalization. Yes, I see risks. However, at the current share price, Trinseo looks undervalued.

Trinseo PLC

Previously owned by Dow Inc. (DOW) and Bain Capital, Trinseo PLC is a global materials solutions provider and manufacturer of plastics and latex binders. The fact that the company was previously owned by a large private equity firm DOW is very advantageous. Employees know well how to navigate business transformations and operate globally.

Trinseo’s most valuable asset is the fact that the business is well-diversified across different jurisdictions, including the United States, Europe, and Asia. It is also very advantageous that the management sells products to different industries, including construction, automotive, packaging, consumer electronics, and textiles. With this business model, I think the future revenue line will be less volatile.

10-K

10-K

I also think it’s very appropriate to check Trinseo’s business model right now. The company is in a process of consolidation and transformation. If more mergers and sales are released, we will most likely see increases in Trinseo’s market valuation.

Trinseo Q1 2022 financial results

Trinseo Q1 2022 financial results

If Trinseo’s new strategy is successful and the company sells the styrenics businesses, I expect a fair price of $63

Under normal circumstances, I believe the company’s strategy will be successful. Trinseo intends to invest in high-growth, high-margin business models. If Trinseo obtained synergies from the acquisition of PMMA and the acquisition of Aristech surfaces, I would expect additional free cash flow:

Trinseo Q1 2022 financial results

Trinseo Q1 2022 financial results

At the same time, management intends to sell the styrenics business, so we could expect a certain amount of cash on the balance sheet from the sale in 2022:

We have taken steps to execute on our publicly disclosed strategy to transform the company into a specialist materials and sustainable solutions provider, including the acquisition of PMMA and the acquisition of Aristech Surfaces, the sale of our synthetic rubber business and the exploration plan for the disposal of our styrenic activities. We plan to continue to prioritize investments in higher growth, higher margin and lower earnings volatility areas such as engineered materials and CASE applications, and to reduce the importance of more volatile assets and low growth in our portfolio.

In November 2021, we announced our intention to explore the divestiture of our styrenic businesses, which include our Raw Materials, Polystyrene and Styrenic Americas reporting segments, for which we launched a formal sale process in January 2022. Source: 10 -K

In my view, if management continues to diversify Trinseo’s business activities, the company’s financial numbers may be less volatile. Therefore, in my view, investors are likely to perceive less operational risk. Demand for shares may increase, which could reduce the cost of equity and the weighted average cost of capital. In sum, I believe that greater diversification and less volatility would lead to greater implied capitalization.

In my base case, I assumed sales growth between 9% and 2% from 2023 to 2026. Additionally, with an EBITDA margin of 12% to 14% and a conservative operating margin, profit 2026 operating income is expected to be approximately $499 million.

Hohaf Investments

Hohaf Investments

In the past, changes in working capital were close to $49 million and -$23 million, and investments were also equal to $99-200 million. Finally, the D&A was closer to $51-167 million. These numbers are relevant because I have used them in some of my DCF models.

TSE working capital, capital expenditures and total depreciation

Y-Charts

With effective tax close to 22% and conservative investments and changes in working capital, 2026 free cash flow is expected to remain close to $491 million.

Hohaf Investments

Hohaf Investments

Since the company has traded at nearly 4.9 times EBITDA in the past, I used that number as the exit multiple. If we also used a cost of capital close to 6.64% like the other advisors, the net present value of the terminal value would be $2.7 billion.

Hohaf Investments

Hohaf Investments

TSE EV to EBITDA

Y-Charts

Under the previous conditions, I got an implied equity valuation of $2.309 billion and an implied price of $63. Thus, we would be talking about a double digit IRR.

Hohaf Investments

Hohaf Investments

A failed strategy and failed acquisitions would imply a fair price of $28

If Trinseo fails to divest certain business segments because management cannot sell them at an appropriate price, Trinseo’s business strategy may fail. The company’s most recent acquisitions could also fail because merger integration is not properly done or synergies are not realized. As a result, shareholders may decide to sell their shares, which would cause share price volatility. In the worst case, management might not find cheap financing and the cost of capital would increase:

We also cannot be certain that we will be successful in identifying investment opportunities in the assets which we believe are most relevant to the transformation of our portfolio, that these opportunities will be available at a price and on terms acceptable to us, or not at all, or whether we will face difficulties due to timing or the availability of funds.

Even if we are able to integrate successfully, such integration may not result in the realization of the cost and revenue synergies and benefits that we currently expect, nor can we guarantee that these benefits will be achieved at scheduled time or not at all. Source: 10-K

Engineering projects undertaken by Trinseo also involve many risks. If management cannot correctly forecast the costs and profits of building facilities or manufacturing lines, in my opinion, future free cash flow would be lower than expected. If equity researchers notice that profitability declines over time, the company’s valuation will decline. As a result, the share price could fall:

Capital projects and other growth investments may have long lead times during which market conditions may deteriorate between the date of capital expenditure approval and the conclusion of the project, negatively impacting returns projected. Delays or cost increases related to capital programs and other expenditures involving the engineering, procurement and construction of facilities or manufacturing lines or the development of new technologies could materially adversely affect our ability achieve the expected operating results. Source: 10-K

In the worst case, I assumed a 30% decline year over year and a slight increase from 2024 to 2026. The median sales growth is 4%. Note that a decline of about 30% has been observed in the past, so it is quite likely.

Turnover of Trinseo PLC

Y-Charts

Additionally, with an EBITDA margin of 15% to 10% and a median of 10%, 2026 operating profit is nearly $270. According to my model, the operating margin would decline by approximately $590 million in 2022.

Hohaf Investments

Hohaf Investments

I have also included an effective interest rate of 22%, working capital changes of $25 million and capital expenditures of almost $105 million. My results include free cash flow of approximately $305 million in 2026 and a free cash flow margin of approximately 10% and 6.5%.

Hohaf Investments

Hohaf Investments

If a cost of capital of 7.55% is included, the free cash flow discount would be between nearly -415 million dollars in 2023 and 262 million dollars in 2026. Finally, with an exit multiple of 5x, the terminal value would be approximately $1860 million.

Hohaf Investments

Hohaf Investments

If we subtract net debt, the implied market cap would be close to $1.72 million and the implied fair price would be $28.

Hohaf Investments

Hohaf Investments

Best case scenario: more acquisitions after investing the company’s $448 million in cash

With $448 million in cash and a 1x-2x A/L ratio, management will most likely be able to acquire many more competitors. Banks will likely offer financing if the mergers make sense and the merged company becomes much larger. Keep in mind that you can lend more money to a larger organization.

Trinseo Q1 2022 financial results

Trinseo Q1 2022 financial results

Trinseo reports $2.3 billion in debt, which doesn’t sound like a lot of leverage. I assumed free cash flow of almost $500 million in 2022. If free cash flow volatility decreases, companies will be able to take on more debt.

Trinseo Q1 2022 financial results

Trinseo Q1 2022 financial results

In a scenario where Trinseo acquires a sufficient number of competitors, I’m looking at 15% sales growth in 2023 and 10% sales growth in 2024. If we also assume a higher EBITDA margin, I think that Trinseo could achieve free cash flow of over $1.05 billion.

Hohaf Investments

Hohaf Investments

With the above assumptions, a cost of capital of 5% and an exit multiple of 5.55x, the implied price would be $165. I do not believe that this financial model is so improbable.

Hohaf Investments

Hohaf Investments

Conclusion

Currently expecting to benefit from the results of several acquisitions, Trinseo is also expected to report new cash following the sale of its styrenics business. Under normal circumstances, I expect earnings to be less volatile and free cash flow to increase. If the company’s strategy is successful, we could really see a rise in the share price. If we also see even more acquisitions, an increase in EBITDA margin and greater sales growth could send the stock price above $100. I see some risks. However, Trinseo looks undervalued given my free cash flow expectations.

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