Emerging Theme: Go Long Shares of Tronox (OTC: TROX.PK)

By: SumZero Staff | Published: May 17, 2012 | Be the First to Comment

(This is a highly-abbreviated version of a full SumZero report republished with the author's consent)

Contributor: Uncited
Source: Hedge Fund. India.

Recommendation: Long Tronox (OTC: TROX.PK)
Timeframe: 6 Months to 1 Year
Recent Price: $158.00
Target Price: $250.00

Quick Thesis
Tronox emerged from Chapter 11 on Feb 14, 2011. Tronox is merging with Exxaro to form the only completely vertically integrated TiO2 producer in the world. Current TROX shareholders will end up with 61.5% of the combined company + $12.50 in cash. This is a taxable transaction from your cost basis to October 30, which is when the merger is expected to close.

TiO2 producers operate largely in a global oligopoly. Tronox, DuPont, Cristal, Kronox & Huntsman have 60% market share between them. Collectively, the market has operated at near 95% cap util the last couple of decades. It's hard to get a new plant permitted, and even harder to arrange for a stable long-term supply of feedstock.

TiO2 prices have remained robust through the 2008 crisis (close to 0 ability to substitute) and are currently at $112 per pound, at which implies ~$800MM of FCF by my model (and could be more). Pro forma equity value at current prices is $4.66B and new Tronox should have debt of around $400MM (from Oct 2011 investor presentation). That's a FCF yield of ~14%. Comps are trading ~5-6% FCF yield, which is reasonable because of the tight market and lack of ability to add capacity in the short term.

TiO2 producers have been increasing prices consistently and, in my opinion, will continue to keep moving them higher at a measured pace. Every $100/tonne increase adds $46.5MM to EBT. Given that the major cost of production is feedstock, TROX should see significant bottom line improvement. Given that Ti02 is approx 13% of the cost of paint, I don't see a real resistance to measured price increases over time.

The pricing power above is becoming obvious in the margins. EBITDA margins have gone from 13% (2009) to 26% (LTM 9/30/2011). Exxaro EBITDA margins are already at 33%. The company's own estimate of proforma EBITDA has gone from ~400MM to ~700MM in 4 months. This does not include the 8% price increase announced in March. Adjusted for that, EBITDA should be in the ~1100MM range.

Overall, the market is not yet realizing the earnings power of the new TROX, and the changed supply/demand situation in TiO2.

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