Description

Trecora Resources (TREC $7.77) has been written up three times (Diamond123, Saltaire. Mitch123456) previously on the VIC, including once before by me back in 2016.  The Company is finally positioned to reward investors after suffering through poor management (new team in place for approximately two years), a number of acts of god (hurricanes, cold freezes and Covid) and some bad luck (a mistake by a contractor caused major damage to a new material piece of capital equipment and a fire caused by an outside electrical issue due to a squirrel damaging a power station).  TREC now sits with a clean balance sheet (negative net debt), $100 million of previously spent growth capital expenditures ready to generate additional cash flows and a reduced cost structure from two years of new management.  I have a price target of $20.00 by March 2021, which represents upside of 157%, based on comparably traded public companies.  This price represents a significant discount to the M&A activity in specialty chemicals. 

TREC is a specialty petrochemical manufacturer based in eastern Texas.  It has two plants, one which makes high grade pentanes and hexanes and the other which makes specialty waxes.  Both plants also do “Tolling” which is another word for upgrading other companies’ petrochemical streams without taking ownership of those chemicals.  My write up from 9/13/16 and Diamond123’s from 8/29/19 have good background info on those plants if you want to read them.  TREC finished selling its non-core asset mine in 2019 for $70MM and now sits with $56MM in cash versus $46MM of debt excluding $6MM of PPP loan which we expect to be forgiven.

The Company’s customers are a who’s who of Fortune 500 companies including Exxon, Dupont, Chevron, BASF, Goodyear and many others.  Its pentanes and hexanes are mainly used in the plastics, tires and Oil Sands industries.  TREC’s main petrochemical, high grade hexane, is in a duopoly situation with Phillips 66.  TREC’s waxes are used across many industries including sealing waxes for shipping boxes. 

Prior to the troubles listed above, TREC was generating about $31MM in EBITDA on an annual basis.  The $100MM plus in growth capital expenditures increased the Company’s ability to manufacture its main petrochemical, hexane, and increased the ability to obtain more value from the by-product stream created from this process.  It also increased the amount and type of Tolling arrangements that TREC can undertake.  The three growth capital projects had the following economics according to previous management:

1.       The third petrochemical line (“D Train”) increased production capacity by approximately 45MM gallons per year.  This was supposed to generate an additional $6MM per year in EBITDA.

2.       Advanced Reformer built along side the D train was going to generate an additional $13MM per year in EBITDA from upgrading TREC’s by-product stream’s value.

3.       Hydrogenation/Distillation Units (“HD”) were going to generate an additional $6MM per year in EBITDA from an advanced form of Tolling.

In total these capital projects would have generated an additional $25MM in EBITDA a year if they were fully operational.  In retrospect, it was too many projects undertaken at one time and management brought the projects in largely on budget but had issues operating the HD unit.  Demand also slackened for pentanes by its Oil Sands customer due to operating efficiencies which hurt the D Train and Advanced Reformer sales and profitability growth.

Today, demand is returning for petrochemicals as the World wakes up from its Covid induced shutdown.  TREC is well positioned to leverage its assets to take advantage of rising petrochemical prices with its assets and reduced cost structure.  I believe that EBITDA will come in around $36MM in 2021 and can easily go to $42MM in 2022, which is well below the $56MM its previous management team was expecting to generate by that date.  I have included a table below that details the historical and my projected volumes for both plants with the resulting EBITDA.  Revenue projections are not meaningful since movement in oil and gas prices directly affects both selling and feedstock prices.  Please note, 2/3 of TREC’s pentane customers are on formula pricing and the Company takes no effective risk over the medium term on movements in oil and gas prices.

For projection purposes, it is assumed that hexane and pentane production move back to 2018 levels due to returning demand and an increase in the number of customers.  This is consistent with management discussions during conference calls.  Wax pounds demand outstrips current production volumes due to full utilization of current feedstock.  Management has publicly said that it expects to have new feedstocks that will allow for increased production.  Demand for specialty waxes is growing and there is a need for additional wax production from companies like TREC.

EBITDA should reasonably be expected to return to its historical $31mm range with volumes back to 2018 levels for 2021. The increase in EBITDA that I anticipate for 2021 and 2022 is derived as follows:

1.       higher by-product value from the Advanced Reformer adds $3mm in 2021 and an additional $2MM in 2022.

2.       HD Tolling adds $2MM in additional EBITDA in 2021 and an additional $4MM in 2022.

3.       Cost savings and optimization efforts by the new management team, should provide additional upside (or cushion) to these numbers.

4.       New Customer wins should also provide additional upside to the projections.

Publicly Traded Comparable Specialty Chemical Stocks

There are no publicly traded petrochemical companies like TREC since most of its competitors are part of much larger companies.  Specialty chemical stocks tend to have dominant niches that allow for higher margins than the wholesale chemical giants.  These stocks tend to trade at a mid-teens Enterprise Value to EBITDA (“EV/EBITDA”) multiple.  As of 3/22/21, these stocks are trading at an average of 16.9 trailing twelve months (“TTM”) EV/EBITDA.  On a forward basis they are trading at 12.8 times this year’s and 11.6 times next years average EV/EBITDA.  This is shown by the chart below:

This creates a valuation for TREC shares as shown below:

Specialty Chemical M&A Transactions

There have been 5 transactions that I could locate in the Specialty Chemical industry over the last 8 years.  The median and average multiples paid for these companies are tightly bunched between 17.8 and 17.9 times TTM EV/EBITDA.  I believe that these high multiples reflect the value that these types of companies bring to their acquirors who typically can utilize them to increase the value of their chemical streams that they already produce.  The chart is shown here:

Using the midpoint of these multiples yields a current price for TREC shares of $15.46 for TTM EBITDA and $32.61 for 2022 EBITDA.

Conclusion

I believe that investors are significantly undervaluing TREC’s shares due to the confluence of events that have caused the Company to significantly underperform expectations.  Today TREC has zero sell-side analysts, a clean balance sheet, meaningful new assets to market, strong management and trades at a wide discount to both public and private market values. The Company’s Board of Directors seems to agree with this view as it has recently announced that it intends to buy back $20MM worth of its shares.  If this does occur, then the targeted stock price will increase proportionately.   Finally, as Covid recedes from its economic impact, TREC will begin to show free cash flow growth that will attract new investors to its stock.

Catalyst

Catalysts

1.       Cash Flow growth

2.       Share Buyback (already announced)

3.       Acquisition by private equity or larger petrochemical company