UBS Downgrades Brenntag to Neutral: Navigating Leadership Changes and Profitability Challenges

In a notable shift, UBS Global Research has lowered its assessment of Brenntag (ETR: BNTGY), moving from a 'buy' stance to a 'neutral' rating. This change reflects growing concerns about the company’s struggles to tap into the profit potential that analysts had initially anticipated.

The downgrade, which represents a significant pivot since UBS first initiated coverage in December 2022, is driven by Brenntag’s disappointing financial performance and uncertainties surrounding its ongoing restructuring efforts. Analysts from UBS previously had high hopes for the company's proposed divisional split, announced last December, which they believed would unlock substantial value. However, they are now skeptical about the likelihood of fully realizing those benefits.

Adding layers to this uncertainty, both the CEO and CFO of Brenntag are set to depart within the next year, leaving the firm’s strategic execution in limbo. This situation, coupled with the broader challenges faced by the chemical distribution sector, has led UBS to reevaluate its confidence in Brenntag's growth trajectory. The firm's projections have been adjusted downward by 8%, resulting in a revised price target of €60, down from €80.

UBS analysts also present a mixed bag of potential futures for Brenntag. On one hand, there's a bullish scenario where improved profitability could propel the stock to €105 per share. On the flip side, if the restructuring does not yield the desired results, the company could face a stark downside risk, with projections suggesting a price plunge to as low as €35 per share.

Despite these challenges, it's important to note that Brenntag has been navigating a demanding market landscape, particularly grappling with tight margins. In fiscal year 2023-24, the company has seen a decline in gross profit per unit, which has adversely affected overall sector margins. Notably, the rising selling, general, and administrative (SG&A) expenses per unit—now over 40% higher than in 2020—are seen as a primary source of this pressure. This stands in contrast to peers in the industry, where SG&A figures have remained relatively stable.

The surge in Brenntag’s SG&A costs is attributed to the company's investments aimed at enhancing capabilities within its Specialties division. Nevertheless, UBS points out that when compared to competitors like IMCD (AS: IMCDY) and others, Brenntag still has considerable ground to cover in growth, technical expertise, and portfolio quality.

In the medium term, UBS forecasts Brenntag’s EBITA could surpass €1.5 billion, although this is contingent upon making necessary adjustments to curb excess SG&A expenses or accelerate gross profit growth. The analysts caution that the initial advantages from the division of sales forces and incentive structures for the Essentials and Specialties arms may have inadvertently resulted in cost duplications and operational inefficiencies that the forthcoming management team will need to rectify.