Bright White at the End of the Tunnel for Europe

By Keith Speights - June 11, 2012 | Tickers: DD, HUN, KRO | 0 Comments

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Little Orphan Annie sang that the sun would come out tomorrow. With regards to Europe, I’m not sure about her timing, but her premise will ultimately prove to be correct. Europe will recover. Its economies will pick up steam. The sun will come out.

It isn’t too soon to for investors to be looking for opportunities to profit from Europe’s recovery. One potential stock for consideration is Kronos Worldwide (NYSE: KRO). Kronos is a leading producer of titanium dioxide, the inorganic pigment sometimes called “the perfect white.” Here are some key reasons to take a look at Kronos as a play on a European rebound.

European Connection

Obviously, to benefit from any recovery in Europe a company needs to have a significant presence in the region. Take a look at Kronos’ geographic sales breakdown.

Kronos estimates that it is the largest producer of titanium dioxide in Europe. The company is especially strong in Germany. It seems safe to conclude that good news for Europe will be good news for Kronos.

Macro Factors

Titanium dioxide is used in a wide variety of ways. Nearly every item that is white uses the substance to obtain or enhance its whiteness. Uses include paint, coatings, plastics, paper, chemicals, medicine, food, and sunscreen. Many consider the whitening qualities of titanium dioxide to be unmatched by alternatives. It currently accounts for around 70% of all global pigment production.

Demand has increased at a steady compounded annual growth rate of between 3% and 4% since 1990. These growth rates are expected to continue for the next several years. Expanding economies and larger middle class consumer bases in developing countries will be a driver of future growth.

While demand is steadily growing, supply has remained relatively flat. Although Kronos and some of its peers have increased capacity marginally through removing bottlenecks, the supply of titanium dioxide was reduced in 2008 and 2009 when plants in several countries were shut down.

DuPont (NYSE: DD), the largest titanium dioxide producer globally, is planning to increase its production capacity by 350K metric tons over the next few years. However, most experts anticipate that this capacity expansion will not have any real impact until after 2014.

The net effect on Kronos and others has been that prices charged to customers have increased tremendously in the last year. Kronos reported price increases of 40% in 2011 as compared to 2010. Higher prices are expected to continue into 2012 and possibly beyond. With the prospect of higher prices combined with the eventual European recovery, Kronos should be in good position to be a prime beneficiary.

Sparkling Performance

Kronos has shined recently in several financial areas. Revenues and net income are consistently growing. Two other important measures for investors are increasing also – shareholder equity and operating cash flow.

Profit margin over the past 12 months is over 19%. Return on equity is a solid 43.64%. The most recent quarterly results were also impressive. Sales were up 34% compared to the same quarter in the prior year. Net income more than doubled. Both figures beat estimates.

Kronos has been steadily reducing its debt over the past three years. Its debt to equity ratio now stands at 0.46. It is also returning cash to shareholders in the form of dividends. The forward dividend yield is 3.6% with a comfortable payout ratio of 17%.  

White Sale

The top producers of titanium dioxide are DuPont with 20% of worldwide production capacity, Cristal with 12%, Kronos with 10%, Huntsman (NYSE: HUN) with 9%, and Tronox with 8%. Of these, DuPont, Kronos and Huntsman are publicly traded in U.S. markets.

All of the major titanium dioxide producers have experienced a decline in share prices to some extent. This is partially in response to world economic news, but also stems in part from a temporary customer destocking of inventory. The good news for investors is that two of the stocks appear to be valued attractively as a result. The table below shows how they stack up.

Huntsman seems extremely undervalued based on these metrics. Kronos looks to be on sale as well with low trailing and forward P/E values and a relatively low PEG ratio. The stock is trading over 50% below is 52-week high. The low end of analyst target estimates is $22 per share, reflecting upward potential of at least 30% from current price levels.

Not everyone is as optimistic, at least in the near term. Kronos has a short percent of float over 25%. Interestingly, this percentage is greater than the percentage of shares held by outsiders. Insiders hold over 80% of the company’s outstanding shares.  This implies that some insider-owned shares are being loaned to short sellers.

There is no reason to think that those inside the company have negative outlooks, though. During the past six months, insiders have bought over 1 million shares representing around 5% of the company’s float. There have been no insider shares sold during this period. Perhaps those shareholders inside Kronos like the thought of making money off the short traders who are not as intimately knowledgeable of the company’s prospects.

Bright Days Ahead

Overall, I think that Kronos looks like a good alternative to profit from a rebound in Europe when it materializes. The company derives over half of its revenues from Europe. It has shown solid growth in the key financial metrics. Macro trends appear to be in its favor. Shares are attractively valued. Insider trading is positive.

Of course, the question remains when Europe will bounce back. Kronos will likely continue to lag in stock performance in the meantime. But the sun will come out eventually and Europe will see brighter days. So will Kronos. Bet your bottom dollar – there will be sun.

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