Description

Tronox has a 100% upside at today’s prices. The margin of safety is its low multiple of 5.5 times trailing EBITDA, which I expect to grow at least until 2009.

The investment thesis is very simple. You are paying a low valuation for a post spin-off specialty chemicals producer and marketer that is very well-positioned competitively in an industry environment that is enjoying very good pricing outlook, where the demand for the product is very stable and predictable, where no new supply is coming in until after 2009, where management is incentivized and where continued rationalization and cost savings will increase EBITDA margins for the foreseeable future.

Tronox is one of the leading global producers and marketers of titanium dioxide pigment. They market titanium dioxide pigment under the brand name TRONOX®, and their pigment segment represented more than 90% of our net sales in 2005. They are the world’s third-largest producer and marketer of titanium dioxide based on reported industry capacity by the leading titanium dioxide producers, and they have an estimated 13% market share of the $9 billion global market in 2005 based on reported industry sales. They are the world’s second-largest producer of titanium dioxide using the proprietary chloride process which is preferred for its cost savings, efficiency and less labor intensiveness. Everyday consumer applications of titanium dioxide and pigments include coatings, plastics and paper, as well as specialty products, such as inks, foods and cosmetics. In addition to titanium dioxide, they produce electrolytic manganese dioxide, sodium chlorate, boron-based and other specialty chemicals.

Tronox has more than 2,100 employees worldwide, and 1,100 customers in over 100 countries. Their chemical operations began in 1964 and they have strategically located manufacturing facilities and direct sales and technical service organizations in the U.S., Europe and the Asia-Pacific region. Globally, they have 517,000 and 107,000 tonnes of aggregate annual
chloride and sulfate titanium dioxide production capacity, respectively.

The Industry Characteristics and its Outlook
Titanium Dioxide Pigment has no effective substitutes. It is a quality-of-life product used daily, and is differentiated and frequently customized. 20% of demand is used by Plastics, another 20% is used by Paper and Specialty Products (Inks, Catalysts), and 60% is used by Coatings. The Coatings segment is characterized by having a selective market base, relational marketing, growth in line with economy, and formulation based. The Specialty Products and Engineering Plastics segment is characterized by customized solutions, focused market base, remium priciing, value-ased marketing, and higher growth prospects. Total Market Size in 2005 is 9B.

This is a highly concentrated industry with top 5 producers accounting for 70% of global production. The industry is experiencing strong growth in Asia-Pacific, particularly China and India. The market share breakdown is: Dupont has a 23% Market Share, followed by 14% Millenium, 13% Tronox, 11% Kronos, and 11% Huntsman, and 28% Others.

Global prices are moving higher because of tight supply conditions, and continued and increased demand in China and India. Titanium Dioxide Supply/Demand is currently tight. There has been capacity rationalization of 218 Metric Tons or 11% of sulfate capacity since 2001. From 2005 to 2010, a minimum of 700 Metric Tons needed assuming 95% capacity utilization. Industry will require 3 to 4 world scale chloride plants to meet demand even after considering expected sulfate capacity growth in China. Existing capacity utilization rate is averaging over 90% in 2005 and pricing is entering the high end of the stable price region. There were announced price increases of 6 cents per pound on October 1, 2006 and another price increase of 5 cents per pound on Jan. 1, 2006. No new capacity is coming until 2009.


The competitive strengths of Tronox are:

Leading Market Positions - Tronox is the world’s third-largest producer and marketer of titanium dioxide products based on reported industry capacity by the leading titanium dioxide producers and the world’s second-largest producer and supplier of titanium dioxide manufactured via proprietary chloride technology, which is preferred for many of the largest end-use applications. They have an estimated 15% share of the $5.2 billion global market for the use of titanium dioxide in coatings, which industry sources consider the largest end-use market.

Global Presensce - In 2005, sales into the Americas accounted for approximately 48% of Tronox’s total titanium dioxide net sales, followed by approximately 31% into Europe and approximately 21% into the Asia-Pacific region. Their global presence enables them to provide customers in over 100 countries with a reliable source of multiple grades of titanium dioxide. The diversity of the geographic markets they serve also mitigates their exposure to regional economic downturns.

Well-Established Relationships with a Diverse Customer Base - They sell to a diverse portfolio of customers with whom they have well-established relationships. Their customer base consists of more than 1,100 customers in over 100 countries and includes market leaders in each of the major end-use markets for titanium dioxide. Tronox has supplied each of their top ten customers with titanium dioxide pigment for over ten years. They work closely with their customers to optimize their formulations, thereby enhancing the use of titanium dioxide in their production processes. This has enabled them to develop and maintain strong relationships with their customers, resulting in a high customer retention rate.

Innovative, High-Performance Products - They offer innovative, high-performance products for nearly every major titanium dioxide end-use application, including seven grades of titanium dioxide (“TiO2”) for specialty applications such as inks, catalysts and electro-ceramics. They are dedicated to continually developing our titanium dioxide products to better serve our customers and responding to the increasingly stringent demands of their end-use markets. Their recently introduced products, CR-826 and CR-880, offer a combination of optical properties, opacity, ease of dispersion and durability that is valued by customers for a variety of applications. Sales volume of these high-performance products increased at a compounded annual growth rate of 29% from 2001 to 2005.

Proprietary Production Technology - They are one of a limited number of producers in the titanium dioxide industry to hold the rights to a proprietary chloride process for the production of titanium dioxide. Approximately 83% of their gross production capacity uses this process technology, which is the subject of numerous patents worldwide and is utilized by their highly skilled and technologically sophisticated work force. Titanium dioxide produced using chloride process technology is preferred for many of the largest end-use applications. The chloride production process generates less waste, uses less energy and is less labor intensive than the sulfate process. The complexity of developing and operating the chloride process technology makes it difficult for others to enter and successfully compete in the chloride process titanium dioxide industry.

Costs of Inputs:

Titanium bearing ore is 25-30% COGS. Cooljarloo Mine in Western Australia. Major process chemicals make up another 60%. The 3 major process chemicals are chlorine, petroleum coke, and caustic. Energy is 10-11% COGS. Natural gas price hedging, operating efficiency gains, plant rationalizations and cost savings helped limit Tronox’s cost increases to 13% last year, which was lower than the general market’s.



Valuation (Millions)

Market Cap 684.7
Net Debt 479
Reserve for Environmental Remediation 146
Enterprise Value 1309.7
2005 EBITDA 232
Trailing EV/EBITDA 5.6
2006 Estimated EBITDA 250 Million


The closest peer is Kronos, which trades at 8.7 x EBITDA.

I estimate that replacement value is around $20 per share. Net PP&E was 839 million and Accumulated Depreciation was $1.25 billion. Their strategy for 2006 is to grow their EPS by 10 percent, focusing on cash flow generation. For 2007, their strategy is reduce debt and improve their credit rating. 2006 Capex is estimated to be 94 Million, 40% of which is discretionary, and 60% of which is maintenance and environmental. I estimate 2006 EBITDA would be 10% higher, to about 250 Million.

At today’s prices, you are paying 5.2 times 2006 estimated EBITDA which I see growing 10% a year until at least 2009. Assuming 300 million of debt is paid down over the next 2 years, and assuming the maximum of 3 million shares is used to incentivized management, and using a 7 times EBITDA multiple, the stock is worth $33. Using a 10 times EBITDA less maintenance capex, the stock is worth $40. I think this stock should trade in the mid 30's by the end of 2006 as the market looks to 2007 estimates by that time.

Catalyst

- Spin-off
- Continued EBITDA margin rationalization