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What's the deal with this white stuff? [alternate title: Trying to time commodities cycles]



December 16, 2012 – Comments (2) | RELATED TICKERS: TROX , DD

Good morning everyone.  As anyone who has read my writings will know, in investing I lean heavily towards value, particularly value with some sort of relatively near-term special situation that has the potential to unlock that value.  While I have tried it in the past, mostly successfully in the run up of the price of oil several years ago...I say mostly because while I captured a ton of the ride up here in CAPS and in real life I certainly did not bail at the top and caught a portion of the ride back down, I tend to stay away from investments that rely purely on trying to time the bottom in the market for a particular commodity.  Even more so when I am not intimately familiar with the  market for said commodity.  I know a decent amount about oil, natural gas and certain agricultural commodities like corn as a result of following them for years but I know absolutely nothing about the the market for something called Titanium Dioxide aka T02.

Titanium dioxide has many industrial uses, but its main one seems to be use as a pigment to make stuff white.  When I say stuff I mean things like paint, sun tan lotion, and supposedly even food (yuck please don't get me started on all of the disgusting unnatural stuff that many companies put into our food.  I've been on a much more organic kick lately, but that's a tale for another time).

The market for titanium dioxide followed the global economy into the tubes.  Low pricing for T02 has hurt the major producers of it, including Dupont (DD) [which actually looks relatively attractive after its recent drop, i digress] and Rockwood Holdings (ROC).  These companies however have been able to absorb the blow relatively wel because they are highly diversified.  In fact, I consider Rocwood to be a special situation play and hold it here in CAPS and in real life. The market has traditionally punished ROC when the price of T02 fell, but the reality is that titanium dioxide accounts for for an increasingly shrinking portion of the company's revenue and earnings.   In fact, the company actually wants to spinoff its T02 business so it can focus on better products, like the very attractive lithium market.  The increasing use of batteries in today's world, particularly in hybrid vehicles has made lithium a very attractive place to be.  Interestingly, Rockwood was initially brought to my attention by Barron's Roundtable member Meryl Witmer (I love her stuff.  See my post for a couple of days ago for an interesting story on the successful picks of the Round Table members

As I was saying, while diversified chemical companies have been able to withstand the weak T02 market reasonably well, it has absolutely hammered more pure play titanium dioxide players like Kronos Worldwide (KRO) and Tronox (TROX).

I've tried to go long TROX here in CAPS only, never with real money) twice over the years.  Once in May 2011 saying the short but sweet:

Post-bankruptcy Titanium dioxide producer that should see its share price increase as it eventually lists on a major exchange and is further away from its past problems.

and once in November of this year, getting into more detail:

I've been watching this one since the company emerged from bankruptcy in 2011. Emergence from bankruptcy is a type of special situation that can often result in absolutely amazing returns for investors. That's why so many smart investors have been sucked into buying shares of General Motors even though it is one of the worst run companies that I have personally ever come in contact with. See Six Flags or WR Grace, which almost single handedly made Ted Weschler's stellar career, for excellent examples of success stories.  

TROX's stock has been completely hammered lately. It has fallen from a high of $160 to its current $20 per share. Ouch. So does this mean that it's a good buy at this point? As David Einhorn's joke goes "What do you call a stock that's down 90%? A stock that was down 80% and then got cut in half." A lot of great investors have been cut trying to catch a falling knife.  [note this is actually not quite correct, the company's stock has been crushed but there was a reverse split that made it look even worse than it actually was]

Well, there was an excellent article on the situation over on Seeking Alpha last month.  

Tronox: This 4.4% Dividend Yield Equity Trades At A Bargain 5x Earnings  

Here are a few key quotes:  

Overall Tronox operates 465,000 metric tons of annual TiO2 production capacity. According to competitor Kronos's management, it would cost roughly $1.0BB to build a new 150,000 metric ton facility. That implies a replacement cost for Tronox's pigment capacity alone of $3.1BB. Add in the price tag for the Exxaro acquisition of $1.6BB (the Mineral Sands Segment now), and total replacement cost for Tronox works out to approximately $4.6BB.  

Given that Tronox's stock trades at a TEV of $3.5BB, that means investors at today's prices are able to invest in Tronox's titanium ore and TiO2 pigment capacity at only 75% of cost! No wonder management recently issued debt to repurchase stock.  

I strongly believe that the housing market in the United States is improving and will continue to do so. Since 40% of the demand for TROX's pigments comes from North America, and a great deal of that from white paint, this will definitely help the company. Heck even the recent horrible and tragic (my heart goes out to all of those impacted by them) storm in the Northeastern U.S. should lead to an uptick in demand for white paint. These things should help to offset some of the recent weakness in the Titanium Dioxide market.  

One scary aspect of investing in TROX is that a global economic slowdown will definitely hurt the company, and I don't think that one is very possible. However it seems as though much of that is priced into the stock at this point.

Thus far these picks in CAPS haven't done much.  My first one gained 20%, outperforming the S&P by 11%, and my more recent one has been bludgeoned to the tune of 23% in a flat market as bad news about pricing of the commodity has come out.

If you recall earlier I mentioned my admiration of Meryl Witmer and her stock picks.  Well she is in this week's Barron's touring none other than Tronox.  Here's a link to the article:

A Pigment for the Imagination

As sales of a key paint ingredient revive, the shares of Tronox could double or even triple, says investor Meryl Witmer.

Hmmm, double or triple you say.  I like the sound of that, this a pure commodity timing play or is ther more to it than that?  That's what I wanted to find out when I read the article. 

Here's my notes from the piece along with comments:

-  At a recent price of $15.65, Tronox looks cheap, trading at a 37% discount to its stated book value of $25, and for 6.6 times next year's estimated earnings. [Mmmmm, cheap.]

-   Tronox was spun off from Kerr-McGee in 2005, not long before the financial crises hit and demand for titanium dioxide plummeted. Tronox, which had been saddled with significant environmental liabilities from Kerr-McGee, filed for bankruptcy. [A spinoff and post-bankruptcy play, both special situations.  Sounds good.  Though the environmental liabilities aspect of it definitely rubs me the wrong way.]

-   Last summer, Tronox bought the mineral-sands operations of Exxaro Resources (EXX.South Africa), a South African miner, in exchange for a 38.5% stake in itself. The mineral-sands operation includes feedstock used to make titanium dioxide. That makes Tronox the world's largest vertically integrated pigment producer. Once the deal closed in June, Tronox was listed on the New York Stock Exchange. [the vertical integration finally coming on line certainly has the potential to be a special situation-esque type catalyst]

-   The company gets 77% of its sales from the paint and coatings industry, and 20% from plastics. [this is an excellent mix of business because I expect the housing recovery in the U.S. to continue and as I said the unfortunate events surrounding Sandy in the Northeast will definitely lead to increased paint consumption]

-  Meryl Witmer, general partner of Eagle Capital Partners, who recommended Tronox in the 2012 Barron's Roundtable, still likes it, and thinks the shares are dirt cheap. She notes that the company's replacement cost totals roughly $35 a share...As pigment demand normalizes, Witmer says, Tronox could hit $30 to $50, given how volatile its stock has been. [As I said, she likes it]

OK, so there definitely seems to be a little more to the investment case fror Tronox than just a pure commodity play, but let's not fool the market for T02 goes so will TROX.  I keep thinking about initiating a real-life position in this one but haven't been able to bring myself to do it yet.  I'd love to hear others' thoughts on Tronox or the the T02 market.

Thanks for reading everyone.  Happy Holidays!


2 Comments – Post Your Own

#1) On December 16, 2012 at 5:44 PM, constructive (99.96) wrote:

It's odd that the housing trade has been going crazy this past year (HOV up 300%, PGTI up 300%, USG up 200%, HW up 200%, BLDR up 200%, EXP up 150%, MAS up 75%, etc.)

The companies above have almost all been unprofitable since 2008.  TROX and KRO look pretty cheap, and have a better cost structure than these companies I think. 

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#2) On January 04, 2013 at 11:34 AM, laKitKat (< 20) wrote:

there was a 1:5 split and the adjusted high was around $35 not $160. That makes the drop a lot less impressive. It's still a lot but not as dramatic as it looks on Yahoo! charts.



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