Back in 2021, shares in FTSE 250 chemicals company Synthomer (LSE:SYNT) traded at £5.52. At the start of this week, the share price had fallen to 61p – a decline of 89%.
The company’s trading update this week caused a further 27% fall. But I think the firm could be through the worst – and the crash in the share price could be a buying opportunity.
A 91% decline
A couple of years ago, things were going well for Synthomer. Earnings jumped from £150m to £400m as surging demand for medical gloves during the pandemic boosted sales of its speciality chemicals.
With all that cash, the company set about expanding. It acquired Omnova (a rival firm) and bought an adhesive resins business from Eastman.
By itself, this is no bad thing, but Synthomer took on significant amounts of debt to finance its acquisitions. And with the pandemic-fuelled demand subsiding, that’s causing a problem.
In its update this week, the company announced that weakened demand had caused cash profits to fall by 56% to £72m. That means its £796m net debt is around 5.5 times EBITDA.
This is a big problem – Synthomer’s loan covenants require it to keep its net debt below 4.25 times EBITDA. So the business has had to turn to its shareholders to raise cash.
The company is looking to raise £276m by issuing shares. Using this to reduce its debt pile should bring net debt down to 3.8 times EBITDA, getting the business out of short-term trouble.
That’s why the share price is down 27% since Monday. Investors are faced with a choice of puting up more cash, or seeing their ownership stake in the overall business reduced.
A buying opportunity?
Clearly, things have not gone well for Synthomer since the end of the pandemic. But I think the two biggest headwinds facing the company might be about to subside.
The first issue is weak earnings. This is primarily the result of excess inventory in surgical gloves, meaning demand has fallen sharply.
Inventory levels are in the process of normalising, though. And as this happens, I expect sales to recover for Synthomer.
The other issue is the company’s balance sheet. The rights issue goes some way towards rectifying this – albeit at a significant cost – but there is another reason for optimism.
Synthomer is in the process of restructuring by selling off some of its noncore operations. The proceeds from this should reduce its debt and further strengthen its financial position.
Lastly, it’s worth noting that there has been significant insider buying recently. That indicates that the company’s directors are also confident in the its long-term potential.
Risks and rewards
If Synthomer’s earnings remain subdued for a prolonged period, investors could again be faced with the prospect of having to put up more cash. That’s the biggest risk, in my view.
On the other hand, though, I think there’s also the potential for big rewards. If the company can manage its balance sheet until demand recovers, the stock could be a bargain.
At £5.51 per share, I think the risks clearly outweigh the rewards. But at today’s prices, it might just be too cheap to ignore.
