Value Investors Club / TRECORA RESOURCES (TREC)

Description

Trecora Resources has been written up on VIC twice before, by Saltaire in May 2015 and by Mitc567 in

Sept 2016. In the three years since Trecora was last written up, we believe the company has materially

increased its intrinsic value while the company’s EV is lower. We believe the business presents a

compelling entry point today because Trecora has finally completed a multi-year capex investment

phase and it has just begun to reap the benefits of those investments. Moreover, the new phase will be

led by Pat Quarles, a new CEO who was appointed last November, and we are optimistic about his

potential to strengthen the businesses and rebuild Trecora’s credibility. We currently value Trecora

Resources over 50% higher than its current valuation and we see multiple potential catalysts which may

unlock shareholder value over the next year.

The prior write-ups did a good job explaining Trecora’s business model and its competitive advantages

so we won’t go into as much detail on that front. We will be focusing on Trecora’s more recent

developments and the catalysts that we expect will unlock value.

Business Overview

Trecora operates two main business segments in addition to owning a 33% stake in a Saudi Arabian

mine. Trecora’s Specialty Petrochemical segment accounted for 87% of total sales in 2018 from their

South Hampton Resources facility and Specialty Wax accounted for the remaining 13% out of their

Trecora Chemical facility.

The Specialty Petrochemical division is located at the South Hampton Resources (SHR) facility in Silsbee,

Texas. SHR is one of the largest producers of high purity hydrocarbons which include pentane,

isopentane, hexane, and isohexane. SHR’s customers are large multi-national chemical companies who

use SHR’s products in the production process of polyethylene, polyurethane foam, polystyrene, and in

the Canadian oil sands. The Specialty Petrochemical division uses natural gasoline (distinct from natural

gas) as its feedstock which is sourced through a dedicated pipeline from Beaumont, Texas. About 2/3rds

of SHR’s sales are formula based which include a component based on the average cost of feedstock

over the prior month and the remaining 1/3 of sales are based on spot pricing. The company uses FIFO

to account for the cost of natural gasoline and the formula lags can cause profitability to bounce around

from quarter to quarter, but earnings usually normalize within a quarter. The Canadian oil sands

business is the largest end market by volume but it is much smaller by profit contribution. Our research

suggests that the polyethylene end market contributes the most profits, about as much as the

polyurethane and polystyrene end markets combined, and the Canadian Oil Sands business is smaller.

As highlighted in the prior write-ups, SHR’s products provide significant value for its customers. SHR’s

specialty solvents are mission critical in customer production processes and they account for a very low

amount of the cost of materials (less than 2% for production in polyethylene for example). It is

technically difficult or risky to try and substitute in other molecules. Additionally, many North American

polyethylene plants use Univation technology in their production and we’ve been told manufacturers

would lose their license to operate Univation if they used anything other than isopentane as a

condensation agent. One notable difference with SHR’s business today compared to SHR several years

ago is the current sales mix has a much larger exposure to stable end markets. Canadian Oil Sands is

Trecora’s most volatile end market but its exposure has declined as the price of oil has fallen since 2015.

The industry structure for SHR’s specialty petrochemicals is a duopoly and P66 is the only other company that

makes high purity pentane in North America. They compete largely on reliability since the solvents are

mission critical and the costs are relatively insignificant compared to the value they add. We’ve heard

that SHR has a reputation for being a reliable supplier despite the operational difficulties they faced in

2018. Market share has been stable and we don’t expect that SHR will take or lose a lot of share with

P66. We’ve been told it isn’t in either Trecora or P66’s interest to compete for share by driving

utilization higher because it would simply drive down prices which would hurt both. Additionally, the

market share is stable because it requires a technological change to switch from the pentane of one

producer to another. An opportunity for share shifts occur if either SHR or P66 struggles to provide

reliable service in which case the competitor may make a play for the other’s business. We’ve been told

that SHR has strong customer service, typically responding to customer requests within 24 hours

compared to weeks for P66.

Trecora’s Specialty Wax segment is located at the Trecora Chemical Inc (TC) facility in Pasadena, Texas.

TC produces specialty waxes that are used in coatings, inks, and adhesives. Historically, TC secured its

raw wax input from two companies that produced it as a waste product. With a limited amount of raw

material in North America, this business does not have a lot of competitors. Trecora even has an

exclusive relationship with one of its two suppliers. However, in 2018 they hit a bottle neck with their

feedstock supply which required them to develop the ability to make “on purpose wax”. In recent

months, Trecora has been qualifying these new on purpose streams which will allow for volume growth

in coming quarters and are expected to add mid-single-digit millions of EBITDA over time. In this same

segment, TC also provides custom processing services which is a smaller separate business located on

the same site. Custom processing provides customers with a range of offerings including the synthesis,

hydrogenation, and distillation of custom products for chemical and industrial customers. The custom

processing segment was unprofitable in 2018 because it was hindered by operating and reliability issues

related to its hydrogenation/distillation unit which came online in 2017.

Trecora owns 33% of the Al Masane Al Kobra mine (AMAK) in Saudi Arabia. The mine was shut down

several years ago but was recommissioned in 4Q17 and has since been successfully extracting cooper,

zinc and silver in addition to smaller amounts of gold and silver. For years, investors were waiting for

AMAK to IPO in Saudi Arabia but this never materialized which contributed to investor fatigue. Trecora

finally decided to pursue a sale of its stake in AMAK and has hired an investment bank. We’ve been told

the bank has relevant expertise in both mining assets and the Middle East. The most likely buyer may be

a new Saudi investor or an existing shareholder and the company may break up its stake and sell it to

multiple parties. In 2016, AMAK issued equity to one of its current shareholders, ARMICO, at a price

that would value Trecora’s stake at $130m. Since that 2016 reference price, the market value of the

mine’s copper, zinc, and gold reserves have all appreciated except for silver. But the book value of

Trecora’s stake is around $45m dollars which is where we feel comfortable valuing it. We believe that

Trecora’s ownership of AMAK has been a frustration for existing shareholders and a deterrent for

potential new investors. Divesting the AMAK stake will allow Trecora to delever their balance sheet and

we believe it will make the company more attractive to new investors.

Why Now?

Trecora’s shares have underperformed in recent years while undertaking its $100m multi-year growth

capex cycle which faced significant delays, cost overruns, and operating issues. The capex projects are

now up and running and we believe Trecora has finally reached an inflection point where it is beginning

to see returns on its investments. Trecora’s enterprise value is lower today compared to where it was in

2016 but we think Trecora’s intrinsic value is even higher now with $100m of new equipment. We

believe that the appointment of Pat Quarles is positive and we are optimistic about the ongoing process

to sell Trecora’s stake in AMAK.

We believe most of Trecora’s struggles are now behind them. Trecora built out a new D-Train in

anticipation that $100 oil would lead to increased demand from Canadian Oil Sands. That proved to be

a mistake as much of the Oil Sands business has gone away, but now expectations have been reset.

Trecora’s prior CEO initially sold investors on big growth to come from new capex projects but investors

lost confidence due to delays, cost overruns, and operational problems. The advanced reformer was the

biggest capex investment which was expected to come online mid-2017, it was delayed till the end of

the year, and then faced several reliability problems through 2018 which cost Trecora time and money.

As of January 2019, the advanced reformer has been reliably processing the byproduct stream which has

been making a noticeable impact on earnings. Several years ago, the investment story was largely a bet

on Trecora’s ability to build out these growth capex projects which involved a sequence of stumbles.

Today, the heavy lifting has been completed and these projects are finally beginning to generate

earnings, but the market still gives no more credit to Trecora’s valuation than it did three years ago.

Pent up investor frustration led the board to appoint Pat Quarles as the new CEO. He shortly purchased

$1m worth of shares on the open market which is important to us as we like to invest with CEOs who

have skin in the game. Pat came to Trecora from division leading roles at Celanese and LyondellBasell

where, based on our research, he developed a reputation for being a strong performer and for being

credible, which is important for Trecora. Based on Pat’s early traction, we believe Trecora’s main

specialty petrochemicals division is on track for substantial EBITDA and FCF growth. The segment

earned $37m of EBITDA in 2017 which fell to $23m in 2018. Pat quickly got to work in 1Q and 2Q19 and

the company showed material growth versus the prior year and outpaced the targets it set to

accomplish by the end of the year. In 2Q, the company reported EBITDA of $9.2m which beat consensus

by 50% showing how low expectations are for this company and that Pat is building credibility.

Compared to the prior CEO, it seems that Pat has been careful with setting expectations to make sure he

can achieve the targets he sets.

Pat has discussed further growing profitability by improving reliability of the new equipment and

through cost reductions at SHR. The advanced reformer operated smoothly in Q1 and Q2. While we

believe Trecora’s current profit goals for the company are modest, we expect Pat will soon set larger

goals, possibility at an Investor Day during the first half of 2020. With potential for improvement at SHR

and more focus on commercial excellence which will help volumes and price. Since the advance

reformer began operating in January, TREC has produced $42m of run-rate EBITDA out of SHR and we

believe Pat’s two initiatives can generate at least $3m EBITDA each which gets us to $48m in SHR. With

a strong position in a duopoly and a diverse mix of end markets, we believe Trecora could trade at a

premium multiple. But until they show consistent execution, we are applying a discounted multiple to

our comp set of 10x EBITDA-capex. Our comp set trades at a median of 12.5x and includes Canadian and

American specialty chemicals companies with an EV between $100m and $2b.

In contrast to SHR which has been profitable, Trecora Chemical has been struggling. However, the TC

includes both the stronger specialty wax business and an unprofitable custom processing unit which is

really a separate business despite being located at the same plant. We estimate the wax subsegment

generated $5m in EBITDA in 2018 and we are underwriting an incremental $3m in EBITDA once the new

on purpose wax streams are qualified. The custom processing business has been struggling and is

lumped into the same division which masks the strength of the wax business. The whole unit is

currently unprofitable providing about a $5m EBITDA drag. Turning this business around will be difficult

but at the very least, management should be able to curb much of its operating expenses if they don’t

see a path to profitability. The wax division is more challenging so we expect Pat Quarles will begin

speaking to discuss a turnaround strategy within the next 6 months.

Lastly, Trecora shares are also face an overhang from its largest 11% shareholder slowly selling shares. Al

Athel Fahad Mohammed Saleh still owns 2.6m shares and sold over 350K shares in Q2, accounting for

more than 10% of the total trading volume. Our understanding is that he is not in touch with company

management and that he is selling to free up liquidity rather than for fundamental reasons. We’ve

heard that he is potentially interested in selling through block trades. We are optimistic that if he can

reduce his stake another significant overhang will be lifted off Trecora.

Valuation

Trecora Sum of the Parts	2020 EBITDA	Mutiple	Value
Specialty Petrochemicals	48	10x	480
Specialty Wax	8	10x	80
Custom Processing			25
AMAK Mine			45
Corporate	(9)	10x	(90)
Capex	(10)	10x	(100)
Total	42		440

Enterprise Value	440
Net Debt	94
Equity Value	346
Diluted Shares	24.7
Price Target	$14.00
Trecora Price	$9.00
Upside	56%

Trecora’s Specialty Petrochemical division generated $21m EBITDA in the first 6-months of 2019, a $42m run-rate. With additional cost cuts and improved reliability, we think Trecora could get the segment to $48m. We’re giving SHR credit for further operational improvements and some pricing but not a material increase in volume even though there will be some polyethylene plant starts in the US in 2019/2020. Specialty wax (excluding custom processing) is generating about $5m today but once the new wax streams are qualified, they will be at $8m in 2020. Custom processing is currently unprofitable so we use a $25m value which is the cost of hydrogenation distillation unit recently installed at TC. AMAK of course is valued at book value but has room to positively surprise.

If we add the parts together, we estimate the business is worth about $14 per share, representing over

50% upside, and we believe it will continue to grow in value. With numerous catalysts within the next

12 months, we believe Trecora presents a timely and attractive investment opportunity.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Monetization of Trecora's stake in AMAK Mine

Sheikh Fahad Mohammed Saleh Al-Athel (11% owner of Trecora) executes a large block trade or reduces his selling pressure

Continued execution of reliability and cost cutting plan

show sort by

			2019	2020
Price:	9.00	EPS	0	0
Shares Out. (in M):	25	P/E	0	0
Market Cap (in $M):	222	P/FCF	0	0
Net Debt (in $M):	94	EBIT	0	0
TEV (in $M):	128	TEV/EBIT	0	0