7 Reasons To Buy Trinseo Here And Now - The Nuances And Details From The Earnings Call (NYSE:TSE)

3.96K Followers

Summary

While COVID-19 has created fear, uncertainty and doubt with investors, it has also presented "once-in-a-lifetime" buying opportunities unlikely to last long.
Investors often lump all stocks together as "the market" claiming the market is too high and will "retest the lows." Perhaps true for Large Cap and Growth,but not value.
Polycarbonate will prove to be a huge new opportunity for Trinseo as retailers and restaurants will have to retrofit to accommodate for social distancing. PVH and others have already confirmed this.
Trinseo just reported their quarterly earnings and hosted a call for investors. The tone was clearly positive and the numbers compelling.
This story is both misunderstood and generally neglected by the sell-side, as indicated that there is not a single "Buy" rating and "group-think" is prevalent. This appears as though it is about to change.

This is an exceptional story and all signs are present that we are at the beginning of a multi-year run for Trinseo.

Following a multi-year downturn, Trinseo was poised for a new cycle, enhanced profits and improved execution. With a new 20%+ activist shareholder, a restructured management/executive team, and streamlined business units, Trinseo was seeing the improvement in their business, and the upcoming cycle that industry executives with decades of experience have seen play out repeatedly in the past. And then the COVID-19 hit and pulled indexes down a quick 30% from recent all-time highs earlier this year. But TSE, was already down from mid-$80s to $30 (about 65%), before losing 50%+ down to the mid-teens. Hence, when pontiffs and financial prognosticators were ranting about the massive 30% pullback, and many then saying that the market needs to go lower, and that 30% is not enough to reflect the downturn of the economy, I might agree. But for some sectors, many chemical companies and TSE in particular, when it is already down more than 80% from the 2018 high, it seems pretty clear that a lot of bad news is baked in. In the case of TSE, it is absurd, and simply misunderstood. I have written several detailed articles on TSE (Trinseo Trading with Maximum Fear and Narrowing the Focus - TSE) and commented extensively on news items for TSE, but with the earnings call completed, I would urge serious investors to either listen to the call replay or at least read the transcript. The update is compelling and should remove any anxiety investors might have about buying a big position in TSE.

These are the primary takeaways from the TSE call from May 7, 2020, and could appropriately be called:

"7 Reasons to buy TSE now."

Beat the Quarter and Expectations DESPITE COVID. Trinseo beat Q1 nicely despite significant headwinds in March from COVID. This was despite the company being adversely affected by a supplier issue in the Polycarbonate business.
Already seeing Business Acceleration in China and Europe. The conference call was extraordinarily bullish as the company admitted that while they guided Q2 consistent with their April business levels (which were the trough as the world was shut down from COVID) they said May order levels improved significantly across the board. They are already seeing a significant acceleration in Chinese business both for automotive as well as appliances. They are also seeing improvements in Europe. Remember this company has 85% of its business outside of the US, so as China and Europe are further along with the recovery from COVID, their business should recover faster than others. TSE is already seeing this.
Balance Sheet is Solid and TSE Has Ample Liquidity - No Debt Concerns. The company also showed that they have plenty of liquidity and in an extreme stress case they generate cash above $160 million of EBITDA (consensus is $252 and now, indicated this is going higher so there is no risk here). Investors have asked if TSE will be able to generate FCF in extremely adverse circumstances, and the answer is clearly - YES.
DIVIDEND is Safe and now Yields 9%. The company also mentioned on the call that despite the global uncertainty they are committed to and expect to keep the dividend, which now yields 9%.
No Sponsorship and Not a Single "BUY" Rating from the Sell-Side Despite a Compelling and Very Inexpensive Quality Company. It is clear from the call, that the sell-side does not understand this company (zero buy ratings, although this may change based on the tone in the Q&A section of the call). Investors are concerned about styrene business when they should not be. The styrene market has already troughed, there were two big facilities coming to market and they already have. Styrene margins have improved significantly since they troughed in early 2020 and are now at levels closer to the first half of 2019. This is in part because high-cost players have shut down. If this pricing holds, there will be a lot of upside to numbers from here.
Concerns about Styrene Profits Unwarranted. People are also worried about low styrene profits in Q1, but in addition to the point above about the market having recovered significantly since then, Q1 had an abnormally high hit from a big maintenance turnaround (once every 30 years), so this is also going away going forward.
Bottom Line - What are We missing??? With a 9% dividend yield at trough and ZERO "Buy" ratings from the sell-side on the stock, and the business now reaccelerating, despite COVID-19, why would you not buy the stock?

And for those wondering if they should "chase" TSE after the bounce from $14 to $19, I would argue (1) TSE never should have traded in the teens (and shouldn't). (2) The stock was sold off much harder and more indiscriminately vs. other stocks (especially large-cap), and TSE, therefore, has much more upside potential. If anyone has any doubt, I will say candidly that this ranks among my highest conviction ideas ever.

This article was written by

Prati Management

3.96K Followers

Richard Prati has nearly 40 years of equity analysis and investment experience and spent nearly 20 years on Wall Street in various positions including the co-founding of American Technology Research and ultimately selling the company in 2008. Experience in public and private global equity analysis and investing. BS in Economics from Vanderbilt and MBA from the University of Rochester.

Analyst’s Disclosure: I am/we are long TSE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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TRINSEO UPDATE - - MY ASSESSMENT OF THE MORGAN STANLEY DOWNGRADE OF TSE FROM MAY 28, 2020

As I have received a ton of questions on TSE, and how a big firm like Morgan Stanley could downgrade to a SELL, I am posting this on my TSE-related articles so that those following the name can view my analysis and better understand the issues. I reiterate that TSE is my TOP PICK and very high conviction. Bottom line – I think the Morgan Stanley research report is weak, agenda-driven, poorly researched, uses specious reasoning, flawed logic, and simply gets the math wrong. I think it is an embarrassment to their firm, and as the stock performs, it will become obvious to those following TSE what the agenda was.

I went through the 65-page MS report, written by Angel Castillo, last night in detail for the second time. His argument is really all about the styrene market being oversupplied, everything else is kind of backfill. His call on styrene is that all this capacity is coming on in China (which we knew about and discussed), but that this time the high-cost producers won’t shut down to offset it. He has no data or argument for why (he cites 13% import tariffs from the US, but this is irrelevant as the US doesn’t export much styrene to China anyway, and even if they did, all these tariffs do is change trade flows (US export to Europe and Europe exports to China without a tariff). So basically he is saying, despite the evidence we have to the contrary, (high-cost plants shutting now) this will be different in the future.

Economically, this makes little sense...be that as it may. Mr. Castillo actually shows how utilization for polystyrene is going up (which is true) but he assumes the polystyrene earnings are flat (so styrene profits down because of lower utilization but polystyrene profits don’t get the benefits of higher utilization). For all the other divisions, he basically assumes very little recovery in earnings to justify his sell case (even though we have plenty of data to support the opposite). To me what is most interesting is that his entire case is based on something that has already happened – styrene profitability is already at marginal cost. This is because a lot of the supply has already come on while demand has been weak due to COVID. He has this long report on why oversupply is such a problem but then he shows that in fact, styrene earnings are ALREADY negative and he has them very slowly recovering from losses to break even. He assumes ZERO shutdowns of capacity outside of the TSE plant in Europe. He ignores the boost to profitability for TSE from closing the plant (even though we know it lost a lot of money last year and more in Q1 2020).

Mr. Castillo also ignores the fact that the hit to EBITDA in 2020 from the oil crash will not happen again in 2021. In 2020 there is a $65 million hit to EBITDA from revaluation of raw materials because of the oil crash. Unless you assume oil will go back to the lows and then have a similar crash next year, which would basically take it to zero, in 2021 you will have a tailwind by the absence of this $65 million hit even if crude prices had stayed where they were at the end of Q1 (Brent crude was 22 dollars per barrel on March 31). Since crude has actually already recovered to $35 as of today, not only will you not have this hit, but you will in fact have the opposite effect in the income statement. This is very high level but if crude going from $60 to $22 caused a $65 million headwind, crude just going from $22 to $35 should give TSE a $22 million tailwind (65/38 * 13). This means that if oil stays where it is, 2021 EBITDA will be helped by the absence of the $65 million hit plus the $22 million positive, for a total tailwind of $87 million. The Morgan Stanley analysis just ignores this.

In addition, he ignores the fact that as styrene profitability stays at break-even, CAPEX will go down, boosting free cash flow. I think what will happen is that the rest of the business will recover, and the styrene business will recover somewhat as there are some shutdowns as we are currently seeing. As oil pricing continues to recover, not only will you not get the hit to EBITDA from raw materials timing, but you will actually get a boost to EBITDA (double-positive as the negative impact goes away and then you get a positive impact on top). This means that EBITDA will recover to about $450 million over the next 18 months and then gradually get the lost $100 million from styrenics over the following 2 years. While many investors were spooked by this MS report, I think the company will start exceeding numbers significantly starting this quarter, and people will forget about the Morgan Stanley SELL report, and TSE will head much higher, and inflict a great deal of pain on those are short the stock.

@AnonValueInvestor – As a new user and first-time commenter to Seeking Alpha, welcome. I am delighted to be the author of the article for which you posted your first comment. As I read through your questions, I think it makes sense to break it down into 4 parts – (1) Styrenics assumptions and background? (2) trough numbers overall – could they go lower, and what about full cycle? (3) COVID-19 and its likely and potential impact, and lastly (4) A general why here and now when one might think the numbers could go further south. Let’s go through it.

(1) Styrenics JV. Profitability in styrenics has structurally changed since 2010 as all the new supply has been on purpose styrene monomer supply. Before 2010 styrene supply was all a by-product of propylene oxide styrene monomer plants, where styrene is merely a by-product of the propylene oxide production. Since propylene oxide was very profitable, people built POSM plants even when styrene margins were low or loss-making. Since 2010, all the supply has been purpose-built styrene plants in which are higher on the cost curve, even in the current environment when PO demand is weak. The on purpose capacity is actually loss-making as you have as over 10% of it now coming offline. The POSM supply base is struggling because propylene oxide is oversupplied so they can barely make money with POSM plants – actually, you have seen some POSM plants running at lower rates recently, partly helping the styrene spreads since the trough in Q1. The outlook for PO is worse than for styrene when it comes to demand, so you may actually have POSM capacity coming off too which would help styrene further. Secondly, Amsty is fully vertically integrated into polystyrene which is a marker with a very positive supply-demand outlook. 7% of PS capacity just came out of the European market early this year.
(2) My trough earnings are actually lower than 08 / 09 given the change in the mix. If you look at latex, they did 127 million in EBITDA in 2008 and 115 million in 2009. In 2019 they did 80 million. Yes, they have lower volumes today as the mix is moving away from lower margin graphic paper. While percentage margins were 120% lower in 2008, EBITDA per ton was higher (top line in 2008 was inflated by much higher crude prices). Synthetic rubber was 28 million, which is lower than the 41 million in 2019, but the mix was very different with a much bigger portion being structurally higher-margin SSBR than commodity ESBR today than back then. Volumes are also higher now as they have added capacity. If you look at it like-for-like, we are the same trough on an EBITDA per ton. Performance plastics is hard to compare as the business has been significantly restructured, including exiting the US polycarbonate market while growing a number of higher margins downstream products. Back in 2008, the cost structure for this business was very different as it was owned by Dow Chemical. My estimate is that like-for-like this business did 110 million, which is 20 million lower than in 2019.
(3) COVID-19 makes everything more challenging to calibrate. Beyond the distressed valuation, TSE sells into end markets that will be helped by Covid with the exclusion of the auto end market. Both the tires they make and the performance plastics they make are highly leveraged to EV (like 3x as much content in EV car as opposed to petro engine). Even if you take the view that more people will work from home and that new car sales will be lower, this will be more than offset by the ramp in EV cars.
(4) I am trying to help you gain a comfort level with my assumptions, model, numbers, and estimates, but in the end, you need to do your own work to have the conviction and comfort I have with the scenario and thesis I have shared. People ask if this could be a value trap, or could go much lower. I have considered it carefully. I don’t think so. The company pays a 9% dividend and has reduced the share count through stock buybacks from 49 million shares to 38 million in 4 years. Despite lower earnings now, because the stock is so much lower they can actually buy back a lot more stock per year. Even using the historical number, that is almost a 17% cash return per year when you factor in the dividend plus the buyback. I think this is pretty good while you wait for the stock to revalue. I cannot understand the fear of investors when it comes to stocks like TSE. I have run through the worst-case/trough scenarios and cannot find a company with more upside and a better risk/reward profile. Thus, my confidence is high, and I am “all-in.” Good luck and hope that helps.

I was introduced to this company after reading one of your previous article. While there is certainly a case for buying the stock at this time, some of what you write in this article seems totally of touch with reality.

1. TSE certainly did not beat the quarter. The results were simply bad. Even after removing the impairment charges they still came up short of the 0.07$EPS expected by analysts.

2. I did listen to the earnings call. Management is far from “extraordinarily bullish” and you are either twisting or misunderstanding what was said. They have reported the month of April to be an absolute disaster regarding orders from the automotive sector, seeing decreases of 60% for April. The sequential improvement in orders for May, June would still bring Q2 to 50% y-o-y decrease overall in that segment. This is coming from their mouth BTW. You pointed in your article that your followers should listen to the earnings call instead of listening to the sell side. I would agree and I urge you to listen to it again as well.

3. Balance sheet is reasonably tidy that much is true. FCF for Q1 was negative though. Q2 will most likely be as well. Seeing we are at the start of a major worldwide recession and that a significant portion of their segments will not do well, can the increased margins on styrene, sales in the medical field and food-packaging segment compensate for the rest? Possibly but its far from a sure thing. Management themselves are saying that they cannot provide guidance and that things will depend on a potential recovery.

4. Yes, dividend seems safe for this year thanks to the tidy balance sheet and the fact that it’s probably the only thing keeping the stock price from falling apart further until the world gets back to a recovery. They will certainly do all they can to keep the dividend intact and this is my main reason for holding the stock.

As a summary:

Overall, we have a decent balance sheet, a significant and (most likely) safe dividend and they have a nice track record of being able to make money in a healthy economy. All together this makes it somewhat suitable to buy at these levels. However I find it very misleading to your readers to paint a picture of a super high quality company destined for an imminent turnaround and misunderstood by everyone and every analyst except yourself. There clearly is no imminent turnaround for them in this environment and it will most likely take a while before you see a significant improvement in results. If you are happy to wait and collect the dividend in the meantime go for it. But I would certainly urge everyone to dig deeper before deciding for yourself what sort of amount you find appropriate to allocate to TSE.