Elie Rosenberg is a value investor based out of Dallas, Texas. He is the founder and editor of Value Slant

Tronox (TROX) – Going VerticalTronox (TROX) shares present an opportunity to invest in the only fully integrated producer of titanium dioxide. TROX has flown under the radar due to the market overlooking a post-reorg equity still trading on the pink sheets and uneconomic selling by post-reorg equity holders after the company did not opt for a quick sell out upon emergence from bankruptcy. The recently announced acquisition of the Exxaro mineral sands assets will allow TROX to capture value across the Tio2 supply chain and give them the most competitive cost structure in the industry. Over the next year TROX should be boosted by a range of macro and company specific catalysts, and yet the company is trading at just 2.4X 2012E EBITDA and less than 5X 2012 estimated free cash flow.


Company Profile

Tronox is the world’s fifth largest producer of titanium dioxide pigment (Tio2). Tio2 is a white pigment that is mainly used in paint, plastics, and paper to provide opacity and brightness. The company has plants in the US, Australia, and the Netherlands. On September 26, Tronox announced the acquisition of the mineral sands assets of Exarro, which are located in South Africa and Australia. Mineral sands are the source of the feedstock ores that are used to create Tio2 pigment. This acquisition makes Tronox the world’s only fully vertically integrated producer of Tio2 pigment.

Company History

Tronox was formed as a spin-off from Kerr-McGee in 2002. Kerr-McGee loaded the spin-off with a host of legacy environmental and tort liabilities related to discontinued chemical operations. The combination of a large debt load, legacy liabilities, and macro downturn led Tronox to file for bankruptcy in January 2009. Tronox emerged from bankruptcy in February 2011 recapitalized and having completely shed the legacy liabilities.

There was widespread speculation on the part of both shareholders and industry analysts that Tronox would be acquired by one of the other major Tio2 players after emerging from bankruptcy. Huntsman (HUN) had placed a bid on TROX in bankruptcy that was rejected, and Kronos (KRO) had spoken publicly about their desire to acquire TROX assets. TROX stock ran up to 160 in July, I am guessing largely on the basis of buyout speculation (the only other pure play comp, KRO, was trading significantly lower at the time). But in September TROX announced they would be acquiring Exxaro’s mineral sands for 38.5% of TROX stock, which nixed any hopes for a buyout. The post-reorg equity holders did not respond favorably to the deal, sending the stock from 130 to as low as 78. I think this reaction had more to do with the hopes for a quick liquidity event being dashed than the merits of the deal itself. The stock price has since largely recovered to pre deal announcement levels, but positive Tio2 industry trends and the enhanced industry position of TROX post deal have still not been reflected in the stock price.

Tio2 Pigment Industry Trends

I analyzed the tio2 pigment industry trends in my analysis of KRO, so please see there for more detail. In brief, titanium dioxide is an oligopoly industry with very favorable supply/demand dynamics for the foreseeable future. A substantial amount of industry capacity was permanently shut down in the 08/09 recession leading to a supply shortage. It takes 3-5 years to construct a greenfield plant, and prices are still not at levels which will spur significant new investment. Pigment pricing has risen about 40% in the past year, and is expected to keep rising in the fourth quarter and into 2012. The third quarter continued the current trends with producers selling everything they could make and prices continuing to rise. The fourth quarter typically sees some slight downward seasonality in volume (due to being off-season for paint sales), but all of the major producers have still announced price increases for Q4 implementation.

I’d like to expand on two points more fully:

What happens to the Tio2 industry if we go into another recession? The Tio2 players did poorly in 08/09, but I think they are much better positioned this time around. Tio2 pricing is much more supply than demand driven. Demand for Tio2 is fairly price inelastic. Looking at historical pricing, the industry has long cycles more heavily impacted by the relative production capacity of the industry than general macroeconomic factors. For example, pricing was actually up 7% from 2007-2009 even though volumes were off about 15% from peak to trough. The problem in 08 was that selling prices and profit margins were so low (and had been for almost 20 years) that the decline in volume and deleveraging of fixed costs wiped out the entire profit (and then some) of the pigment producers. With prices now having almost doubled, the pigment producers are much better equipped to deal with a decline in volume than they were in 08. They can give up some volume and fixed cost leveraging and still be at least minimally profitable. Additionally, customer inventories are still tight (HUN stated 45 days on their Q3 call) so the industry will probably not see the dramatic destocking we saw in 08. That means the volume drop off will also probably not be as great in another downturn of similar magnitude.

The specter of additional Chinese capacity- The only major additions to capacity over the next several years are expected to come from China (aside from DuPont’s 350 thousand metric ton brownfield expansion). Estimates range from 700 thousand to 1 million metric tons of announced capacity being added by 2016.  But there are several mitigating factors:

  • It is doubtful that all of the announced capacity will be built
  • Even if the capacity is built Chinese plants do not typically run at “nameplate” capacity
  • Tio2 demand will grow in line with GDP in developed markets and much faster in emerging markets, which even in a minimal global growth scenario should add 100-200 thousand metric tons of demand a year.
  • Most importantly, nearly all of the incremental capacity will be sulfate process Tio2. At the present time Chinese Tio2 does not compete with that of the major producers. This is clear in looking at the bifurcated market pricing trends in the Chinese market. In the last two months, domestic pricing for Chinese Tio2 has fallen almost 30%, while prices of imported Tio2 from the major Western producers continue to rise.

Tio2 Feedstock Industry Trends

Tio2 pigment is produced from either rutile or ilmenite ores, which are mainly mined in Australia, South Africa, and Canada. The ores differ in their Tio2 content, with rutile being 95% Tio2 and ilmenite 45-65% Tio2. The Tio2 content of ilmenite can be upgraded to produce either synthetic rutile or titanium slag, depending on the chemical process employed. The Tio2 feedstock producers are heavily concentrated like the pigment producers, with the top five producers accounting for 62% of production in 2010.

Pricing for rutile and ilmenite had been flat for years until 2011. In real terms pricing had declined even as input costs for energy and labor were rising. Additionally, the feedstock producers had typically sold their products under “cap and collar” contracts that

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