Stock Alert: This One Looks Ready to Explode

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I found Rockwood Holdings(NYSE: ROC) fourth-quarter earnings call particularly interesting because it said almost everything about what’s going to keep Rockwood’s stock moving in the near future. Yes, Rockwood’s stock might have gained 17% year-to-date, but it might just be the beginning. In one line, it will be a buy and sell story. As Rockwood buys and sells, you should consider buying ... the stock, that is.

Buy One

I’ll begin with the metal that hit headlines lately, but for all the wrong reasons: after all, it grounded the Dreamliner. Though lithium is less than 15% of total sales, Rockwood considers it to be a core business. Rockwood showed how serious it is about lithium when it bid for Talison Lithium last year. Eying the world’s largest producer of lithium rock was no mean feat. The deal would have gone through, had it not been for China-based Tianqi’s (also Talison’s customer) last-minute snatch away call.

But, the game isn’t over yet: That’s what Rockwood suggested in its latest earnings call. Tianqi is yet to complete the deal, and is reportedly trying to raise finance for the takeover. Meanwhile, Rockwood plans to hold back the cash it had set aside for Talison until the latter is formally sold. When asked what to make of it, CEO Seifi Ghasemi quickly replied, “we know a lot, but I just can't comment on it.” Is something really brewing that the market’s not aware of? Because Seifi also didn’t rule out putting up a fresh bid if the opportunity arises.

Solid potential

This could indeed get very interesting. Lithium-ion batteries might have burned out inside Boeing’s 787s, but there are still takers, and believers. The Pentagon wants it for their new fighter jets, and Toyota continues to show them off in its Prius’ and eQs. Toyota has even joined hands with BMW for further research.

The world’s biggest lithium producer, Sociedad Quimica y Minera (NYSE: SQM), is trying to bag concessions to exploit lithium reserves in the leading lithium-supplying nation, Chile. Sociedad reported 25% jump in lithium sales for the first nine months of 2012 backed by higher volumes. It pegs robust demand for batteries as the driving factor, followed by increased usage of lithium in glass and lubricants industries. Rockwood confirmed this as its fourth-quarter battery sales surged 65% compared to the year-ago quarter.

In short, demand for lithium might just take off, and Rockwood is ready to taste success through acquisitions. If it’s not Talison, it will be someone else. This apart, it is also setting up new plants in North Carolina (already operative) and Chile. So if you want to play the metal in the future, Rockwood is a good choice.

Sell One

The next big thing on Rockwood’s agenda is divesting its titanium dioxide (TiO2) business by the end of this year. Yes, it’s the same pigment that DuPont (NYSE: DD) is known for, and which has also hit it hard in recent times. The TiO2 market is plagued with exorbitant input prices, dwindling demand, and threat of substitutes. DuPont expects lower sales and 7% to 9% drop in operating margins for its TiO2 business this year, suggesting the weakness is far from over.

If consulting company TZMI’s view that the TiO2 market peak of 2011 might never return is to be believed, Rockwood is doing well by exiting it. In fact, TZMI’s projection might hold water, because Rockwood isn’t the only one that lost interest in TiO2: Chemical major Huntsman (NYSE: HUN) too might tread the path. Revenue for its pigments business fell 13% last year, the highest among all business units. This is what Huntsman’s CEO said recently: “I expect that our other divisions' earnings will improve, over time, as we become less dependent on our TiO2 earnings as a percentage of our overall business.” Clearly, Huntsman has set its priorities. Why, even DuPont is gradually transitioning into an agricultural company from being a chemical major.

Sell Two

TiO2 is just one of the businesses Rockwood wants to shelve, though. It wants to drop Advanced Ceramics and Performance Additives businesses as well if offered an attractive price. Bloomberg and Reuters have both reported good interest from private-equity players in Rockwood’s Ceramics business. Deutsche Bank feels Ceramics could be worth $2 billion.

No news has come up yet for Rockwood’s additives business, but it is one of its largest, accounting for over 20% of sales and operating 28 manufacturing facilities across the globe. Housing is a key demand driver for its pigment products, which means there shouldn’t be a dearth of takers at a time when recovery is in sight. The business reported a 5% fall in sales last year and 12% dip in EBITDA.

Buy Two

So one thing’s clear – Rockwood will be sitting on a brimming war-chest as these businesses sell. That’s critical to bring its diving cash flows back to life. The situation isn’t too bad otherwise. Total debt-to-equity ratio stands at 69%, operating margins are growing consistently (currently at 15%), and interest coverage is great at 18 times.

So what will Rockwood do with all the cash? It plans to pay down $600 million debt this year. Acquisitions are high on its list; and it’s not only lithium. Rockwood already has a "target" in mind worth more than $1 billion for its other core business, Surface Treatment. This business is less capital-intensive but generates more than half of Rockwood’s cash. The bigger it gets, the more the cash expected, which in turn can be used to bolster Rockwood’s lithium business, which demands huge investments.

Get going!

So is there nothing for shareholders? Take heart. Rockwood will buy back shares worth $400 million, and aims to bump up its dividend yield to 2.8% to 3.2% in the near future. It currently yields 2.4%. Simply put, Rockwood is getting leaner, and better. And the quicker you add it to your radar, the better. Click here to add Rockwood Holdings to your stock watchlist.

Neha Chamaria has no position in any stocks mentioned. The Motley Fool recommends Sociedad Quimica y Minera (ADR). The Motley Fool owns shares of Rockwood Holdings. 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!

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