|Shares Out. (in M):||58||P/E||18.6x||11.1x|
|Market Cap (in $M):||2,436||P/FCF||20x||11x|
|Net Debt (in $M):||242||EBIT||188||400|
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The TiO2 industry was overbuilt in the late 1980s, and suffered from declining prices and margins for most of the next 15+ years. The price of TiO2 declined from ~$3,700/metric ton in 1987 to $2,200 in 2007. For much of this time, the average plant ran at close to breakeven; the ROAs were terrible, but there was a disincentive to shut them down b/c of high environmental and regulatory decommissioning costs (~$100MM per plant.) The Great Recession caused a massive build up of inventory in the channel as demand, which customarily has risen and fallen with GDP, dropped 25% as customers completely de-stocked. This provided the catalyst to remove capacity from the industry, and over the ensuing 12 months, approximately 7% of global supply was permantly shut.
Pricing Power: Demand began to increase in mid-2009 and has remained strong as the channel restocks. Interestingly, pricing did not move down much during the recession, but beginning in mid-2010, the industry was running at capacity, and suppliers began putting thru price increases. Prices have risen ~15% in 2010, with most of the increase coming in H2. While pricing differs by region (Asia and South America being the strongest, North America being okay, and Europe being weakest), it is a fair approximation to say the global weighted average price for TiO2 will be $3K/ton as of the end of 2010. New capacity in the industry takes 3-5 years to come on line, and currently there are no plans for expansion. China is an interesting player; they produce a several hundred thousand tons per year (of a ~5MM ton market), but they lack chloride technology, so it is all low cost, low quality sulfate based TiO2. Much like nitrogen based fertilizer, TiO2 is essentially a closed market, a little may get imported or exported, but for the most part, they make it there to use it there. DuPont has been trying to build a 200K metric ton chloride plant in China since 2005, but has yet to break ground b/c they can not agree with the government or regulatory issue, fees, and technology sharing.
Earnings Power and Valuation: As one of only two pure plays in the TiO2 space (the other is Tronox, which is in chapter 11, exiting early next year), KRO is well positioned to enjoy margin and earnings leverage to the nascent upswing in TiO2 pricing. While 2009 and 2010 comparisons are irrelevant b/c they lost money due to massive fixed cost de-leveraging, I believe they will earn ~$400MM EBITDA and $3.75 in EPS in 2011; these levels should reach (base case) levels of $550MM and nearly $6.00 by 2012. With PF 58MM shares outstanding at $42.00 ($2.4B mkt cap) and ~$240MM PF net debt ($2.6B EV), the company is trading for ~11x 2011 earnings and ~6.5x 2011 EBITDA, both of which could rise by more than 50% in 2012.
Valuation is reasonable (if not dirt cheap), which allows us to focus on the only thing that really matters: PRICING. My research calls to date include the former head of sales and marketing at Cristal, the leading titanium ore and TiO2 consultant in Australia, and a former executive at Tronox. All independently corroborate the pricing story, with the former Cristal executive saying "if you want to be conservative you can model in 5% price increase each quarter in 2011." (My model incorporates a 3 % quarterly change, for a 12.5% compounded annual increase next year; remember, they have already increased prices 16% in H210 alone.) Channel checks with customers at major coatings manufacturers confirm that the market remains very tight, end user inventories are low, and they expect their TiO2 suppliers to raise prices next year. As a procurement professional at Valspar told me "After 20 years of us taking them for granted, the tables have finally turned, they have the power to dictate prices, and I don't expect them to stop anytime soon." Sherwin Williams pubicly called out TiO2 prices in their Q3 earnings call, and went so far as to say they expected to see 20-30% price increases in 2011. My experience with high fixed cost businesses with pricing power, from aerospace forgings to rocks, is uniform - earnings rise dramatically, and often the multiples placed on those earnings follow suit. On my bull-case $600MM in 2012 EBITDA, with an 8x multiple (25% above a "more reasonable" 6x multiple), KRO would be an $80 stock.
On the downside, I believe the current (or even a higher) valuation is supported by the replacement value of KRO's assets. My discussions with multiple industry veterans indicates greenfielding a TiO2 plant would cost ~$6K per ton, while line extensions at current facilities would likely cost $4K per ton. Building a new plant would be a very long and involved process (environmentally, the NIMBY quotient would be huge) and would take 3 to 5 years. With 532K metric tons of capacity, valuing KRO at $6K/ton yields an EV of $3.2B, or $50 per share. KRO's facilities are not brand new, and most of their European assets are sulfate-based, so I won't give them full credit for this value. But, their plants already exist and they have scale, so certainly they are worth more than their fully depreciated value.
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