Can a Turnaround in TiO2 Make Money for You?
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It's been a tough last nine months for the titanium dioxide pigment (TiO2) industry. The business has been in a steep and steady decline since early 2012 record results. But with a history of major booms and busts, should investors start preparing for an eventual TiO2 turnaround now?
What is TiO2?
TiO2 is a white inorganic pigment used in a wide range of products for its ability to impart whiteness and opacity. It is the largest commercially used pigment because of its hiding power and resistance to interaction with other chemicals. It is used as a critical component in generic coatings, plastics and paper, as well as many specialty products such as inks, food and cosmetics. Besides industrial uses, it has been known to help whiten consumer goods such as toothpaste and Twinkie filling.
The industry's troubles
A major reason for the industry’s recent woes is that there is just too much competition. The biggest listed player in the industry is DuPont (NYSE: DD) with roughly $1.6 billion of pigment sales in the last quarter. Other producers include Kronos Worldwide (NYSE: KRO) with around $463 million in quarterly revenue, Huntsman with $330 million, Tronox (NYSE: TROX) having recent three month TiO2 sales of $288 million, and Rockwood Holdings with $271 million.
During good times, these companies are able to ramp up production which quickly oversupplies the market causing intense pricing pressure. The additional production also helps drive up raw material costs. For instance, in early 2013 selling prices in the industry dropped 30% from a year earlier due to excess inventory and Kronos reported that its cost of production per unit rose 50% in 2012 with further increases into 2013.
Industry wide profits in the latest quarter have all but disappeared thanks to these factors. Rockwood reported recent quarterly earnings before interest, taxes, and depreciation (EBITDA) of $8.6 million, 88% lower than a year earlier, and Huntsman posted EBITDA of $9 million versus $150 million previously. Even DuPont, with its enormous economies of scale, saw first quarter pigment operating profit fall 56%.
Some bright spots are emerging
In response to excess inventory and pricing pressure, companies have been curtailing production. Kronos reported manufacturing volumes were 13% lower in the last quarter compared to the previous year. Tronox noted that its pigment plants capacity utilization rate is down to the mid-70’s percent range, well below full use. That restricted production helped the company reduce inventory roughly 12% on a day’s sales basis.
Taking down supply could help accelerate a turnaround amid recent signs of improved demand. Kronos reported that sales volumes for the first quarter of 2013 increased 1% year-over-year and 29% from the previous quarter. Tronox said, compared to the fourth quarter 2012, pigment volumes increased 23% and were also up from a year ago. DuPont reported its pigment sales were essentially flat year-over-year, but increased 8% from fourth quarter 2012.
The possibility of industry consolidation is another plus. In a Bloomberg interview, DuPont CEO Ellen Kullman said that though the TiO2 business is good for the company, its large earnings volatility might make divestiture a consideration. Rockwood management has reiterated its desire to sell or spin- off the pigment unit. Huntsman said it will consider either selling the TiO2 division or adding assets to the business. “We want to be part of any consolidations in this industry,” CEO Peter Huntsman said in a recent conference call. Unlike the others, Tronox is clearly open to purchasing assets. CEO Tom Casey said the company will certainly, "evaluate strategic opportunities to expand our scale relative to the market without expanding supply in a currently over-supplied market."
When will things get better and who will benefit?
While it is impossible to know exactly when the industry will stabilize, history indicates it might take at least a couple of quarters to rebound from a trough. Kronos 2009 data shows that operations didn’t steady until late in the year after a first quarter bottoming out. But today’s steady demand, reduced production, and a possible industry consolidation seems to indicate a turnaround is likely regardless of the timing. Three major beneficiaries of such a resurgence could be Dupont, Kronos, and Tronox.
DuPont looks to prosper no matter what they do with the TiO2 division. By selling or spinning it off, the company's shares should get a market multiple boost from the divestiture of a volatile and under performing unit. If DuPont decides to retain or even expand the business, any rebound in the fundamentals will probably result in significant bottom-line benefits due to the company's dominant position and economies of scale.
Kronos would certainly benefit since it may be the most levered to an industry recovery. While its earnings volatility can be very unsettling, the company’s scope means that when times are good they can be very good. It achieved gross margins in the 30% to 50% range during the boom times compared to a break-even level currently. This characteristic also indicates Kronos could be a viable merger candidate for those looking to expand in the industry.
Tronox may have the most upside being a major integrated TiO2 player. It produces both the pigment and the raw material needed for production. Any turnaround would benefit both businesses greatly. The company might also be the most active in any industry consolidation. A significant purchase of assets on the pigment production side would help magnify the benefits of the company's integration strategy.
The TiO2 industry is currently facing tough times, but companies are taking steps to turn that circumstance around. In a business prone to severe ups and downs, investors have gained from past recoveries. By keeping an astute watch, as fundamentals eventually improve, shareholders are likely to benefit once again from any rebound.
Bob Chandler has a long position in DuPont and Kronos Worldwide. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!