Synthomer - The Race Just Started - Model Update

All,

Please find our updated analysis of Synthomer here.

Note: Beta testers can check Synthomer on the Beta portal here.

With loosened covenants and maturities extended (at the expense of the SUNs), the race towards deleveraging has just started. Cash is king, and Synthomer has sufficient of it for now, but generating cash is a different story. Combine this with tightening covenants over time, and you are left with one question: how? While this seems like an easy question, we don't have an answer to it at the moment. Therefore, we remain sceptical and continue to question whether management's ambitions are achievable anytime soon. 

Investment Rationale

  • We are not taking a position at the moment but are putting Synthomer on our watch list for a potential short once a clear catalyst can be identified. We see clear downside risk for the SUNs for which we see fair value at 74%, with downside protection in the mid-50s and only limited upside in case of a refinancing at par, which we don't think is likely. We therefore view the current trading level as c. 15% too rich and risk profile skewed to the downside.

  • Currently, we see potential upside risk to results in H2 due to the Iran conflict, and the bonds already yield 13.5%, so this is not a cheap short, and therefore we remain on the sidelines for now.

  • The conflict in the Gulf has supported Synthomer in H1 (management describes it as £6m one-off EBITDA impact in H1) and there is potential for further upside beyond management's full year guidance given the renewed tensions in August/September. However, we remain sceptical whether Synthomer will see any continued benefits once supply chains are fully restored.

  • While we don't see any near term liquidity issues, we see a race towards the maturity wall in H1 2029 with covenants tightening gradually until then. Due to the continued poor cash generation of the business, we see deleveraging being largely driven by divestments.

  • After the drop-down transaction in April this year, DCF fair value is c. 70% and 88% on a sum-of-the-parts (distressed) basis.

  • The next financial release from the company will be in October, and we will monitor closely any continued benefits from the Iran conflict or if we see the experienced benefits starting to reverse.

  • Our view would change if management is able to increase margins into specialty territory before refinancing becomes a topic.

Key Conclusions

  • Synthomer needs to expand its margins; in the short term, the positive impact from the Iran conflict might make results look better than they should be with demand weakness continuing to weigh on growth and profitability. In the longer term, Synthomer needs to up-tier its products to Speciality chemicals with margins >15%. We are sceptical.

  • Volume growth was positive but still muted in H1, and we expect management to meet its modest H2 guidance.

  • Post the LME operation and the UKEF/RCF extensions, there are no liquidity issues in the near term despite the continued poor cash generation.

  • We question the speciality chemical tag as, outside of Adhesives, EBITDA margins are well below the 15% typically associated with speciality chemicals.

  • In the last 5 years, Synthomer has incurred £175m in cash costs with only limited success in improving margins.

  • Industry-wise, Synthomer’s competitors are often part of larger conglomerates with vertical integration benefits, which leaves Synthomer more exposed to changes in input prices.

Miscellaneous

  • The security given to the banks as part of the drop down buys time for Synthomer, but gives them control over any future process. The RCF/UKEF facilities will mature before the SUNs, which will require both to be tackled in 2028. The 80% government guarantee for the banks should keep them reasonable.

  • The new covenant package gives more time to the company to reduce debt without needing to go back to the banks.

  • Margins remain low and are unlikely to improve quickly; to secure a refinance of the SUNs, progress needs to be made here. The Gulf conflict will help this year but not thereafter.

  • The LME reduces the potential recovery for SUN’s holders from 92% to 88% using the distressed SOTP valuation and from 80% to 70% using the DCF model (assuming one turn higher EBITDA multiple for the US business than for the whole of Synthomer based on the distressed SOTP).

  • The impact is not terrible, but it puts the banks firmly in control of any restructuring discussions.

Here to discuss the name with you,

Martin Hoelzl

Martin HoelzlSYNTHOMER