Why You Shouldn’t Take Your Eyes Off This Volatile Stock

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This stock is not for the weak hearted. It has had a history of pendulum swings – there were days when it dropped double digits on a single day, and there there were some when it gained as much.

Tronox (NYSE: TROX) had the best numbers on display in the industry in its last quarter. Barron’s even considers the chemical maker a must have. So what gives? With core markets on the verge of a bounce back, is Tronox the big stock you’ve been looking for?

Doing it better

Titanium dioxide (TiO2), a white pigment that’s a key input for paints and coatings, rules Tronox’s world. If I have to sum up the present situation of the TiO2 market in one word, I’d say it’s murky.

The world’s largest TiO2 maker, DuPont (NYSE: DD), saw sales for its performance chemicals business drop 15% in its last quarter, the highest fall among its seven business divisions. Kronos Worldwide (NYSE: KRO), a pure-TiO2 player, reported 14% drop in sales and a massive 59% slump in net profit for its third quarter. It is due to report fourth quarter in a few days’ time, but preliminary release points at a disastrous 95% crack in profits. Huntsman’s (NYSE: HUN) pigments division also turned out to be the worst performer last year with 13% lower sales compared to 2011, overshadowing higher numbers from its profitable business of polyurethanes.

Expecting a story on similar lines for Tronox? Well, Tronox’s fourth-quarter revenue climbed 26% from the year-ago quarter. Yes, you read it right. How did Tronox do it? Thank its business model.

On a different path

Tronox not only makes TiO2 but also produces the input that goes into it. It made huge headway last year by acquiring the mineral sands business from one of the world’s biggest titanium ore feedstock producer, Exxaro Resources. Mineral sands business made up 55% of Tronox’s total revenue in the fourth quarter with the acquisition contributing 79% to it. If it weren’t for this, Tronox would have found itself in the same room as others – its pigments division revenue slipped 21% year on year.

It is this vertically integrated model that I believe makes Tronox one of the best plays in the TiO2 space. What you should know is this: The real advantage is yet to unfold.

Tronox isn’t sourcing entire feedstock internally yet; and 2013 will be when the major shift is made. Though 15,000 tons will still be bought from outside. But that’s a pretty small portion of the total requirement of 500,000 tonnes. So Tronox should be able to cut costs significantly.

In fact, this is what the scene will probably look like: While peers see their cost curve trending up, Tronox’s should go the other way. DuPont has already hinted at higher costs this year as its low-priced ore contracts near completion. So it’ll actually be a two-fold gain for Tronox. While at one end its pigment division costs come down, it can play with selling prices at its mineral sands business, provided it has enough feedstock in hand to sell outside after satisfying own requirement. Tronox feels that number could be as much as 200,000 tons this year. With ore costs showing no signs of easing, it’s a win-win situation for Tronox.

Round the corner

Even otherwise, each of the companies remains hopeful. According to an ICIS report, demand for TiO2 could improve 5% by spring backed largely by housing recovery. Housing construction looks primed to make the big leap, and auto sales are making the jump as well. With roughly three quarter of Tronox’s sales coming from the paints industry, this bodes well. Kronos has even announced fresh price increases effective March 1 for its TiO2 products. But one should understand that this does not mean that demand for the pigment is outstripping supply. It is only to pass on higher costs to customers.

Whether the hike will go down well with TiO2 consumers is a question mark. As an example, one of the top paint companies which also happens to be a Tronox customer, PPG Industries (NYSE: PPG) is actually looking at flat input prices this year, even ‘modest’ declines. PPG is still to pass on most of the earlier cost inflation to customers, and is even looking for TiO2 substitutes (it used just 4% lower TiO2 last year). Any further hike could give PPG and peers greater impetus to de-content TiO2.

Out to grab?

If a recovering market is a catalyst, Tronox also recently announced a quarterly dividend of $0.25 per share. It plans to stick to this pay out for the full year, which means an estimated annualized yield of roughly 4.8% at share price of around $21. The yield may not maintain, but one can at least hope for regular dividend checks from Tronox. It even returned value to shareholders through a buyback program last year.

What I would watch out for is a probable acquisition announcement by Tronox sometime this year. In its earnings call, Tronox sounded interested in RockWood Holdings’ TiO2 plants, which the latter wants to divest by the end of 2013. Rockwood’s high-quality products and good end-market presence are attracting Tronox. This could be a good opportunity for Tronox which currently holds 7% of the global TiO2 capacity.

Wait until…

As the TiO2 market rebounds, Tronox could be a good bet. But an investor should also understand that the company is yet to prove itself as it’s been just two years since it pulled itself out of bankruptcy. And, like every company, Tronox is not perfect. There are risks, some of which seem to have missed Barron’s eyes, but you should know before you make an investment decision. I’ll delve deeper into them soon. Stay tuned by adding Tronox to your stock watchlist. Click here to add it.

Neha Chamaria has no position in any stocks mentioned. 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!

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