VHI - Valhi: A Substantially Undervalued Stock

Summary

• Despite holding over 75% of Kronos and over 30% of CompX, Valhi has been trading for just $700 million.
• If we calculate the current market value of these subsidiary businesses separately, it turns out to be over a billion dollars.
• I believe that Valhi stock has become undervalued despite considerable cash reserves and a strong balance sheet.

Company Overview

Valhi, Inc. ( VHI ) is a holding company that operates through subsidiaries such as NL Industries (NL), Kronos Worldwide, Inc. (KRO), The LandWell Company, and CompX International Inc. (CIX). Upon merger with a subsidiary of Contran, Lisa K. Simmons and the family trust became significant stake owners in the company.

The company manages its operations through three main segments, which are as follows.

Chemical segment

The company owns a majority stake in Kronos (about 75%). Kronos Worldwide is one of the top five TiO2 producers in the world and has a considerably strong business model. As a significant portion of revenue comes from Kronos, business performance has fluctuated significantly over the period as per the TiO2 industry dynamics. But due to considerably increasing demand along with limited capacity, the business is expected to perform reasonably well in the upcoming years.

Also, to understand the business model of Kronos, the investor can read my recent article . Note that I have assigned sell ratings on Kronos due to its fair valuation, but in the case of Valhi the investors are getting a chance to hold the same company at a substantially discounted price.

Component products

The company operates through its majority stake in CompX International. As the segment has started focusing on manufacturing equipment for the recreational marine industry, business performance is expected to improve significantly over time.

Although the company also operates in real estate management segments, its operations don't contribute significantly to the revenue.

The current valuation of the company's holding interest in Kronos and CompX is substantially greater than the company's current market capitalization. Therefore, I believe Valhi, Inc. stock has become undervalued despite considerable cash reserves and a strong balance sheet. From this price point, the stock offers significant upside potential.

Historical Performance

Over the last ten-year period, revenue has been volatile, fluctuating from $1.5 Billion in 2015 to about $2.3 billion by 2021. Also, over the same period, net profit has seen substantial ups & downs; during the industry downturn of 2015, the company incurred a significant loss of $149 million. Such a wide fluctuation in the business performance is primarily attributed to the cynical nature of the industry, where the company faces significant pricing pressure upon demand drop. Therefore, investors must consider that the business performance in the upcoming year will largely depend on industry dynamics.

Furthermore, for the last few years, the company has been focusing on debt reduction; as a result, long-term debt has come down from over a billion dollars in 2017 to about $538 million in the recent quarter, Also due to consistent profitability from the last few years along with strong free cash flow, the company could reserve substantial cash; currently, Valhi has over $578 million in cash reserves & over $1.6 billion in current assets which provides significant financial stability to the business models.

Also, note that, for the last five years, Valhi has seen a substantial improvement in its cash flow, which shows that the business conditions are improving, but such an improvement might result from strong industry-wide demand. Therefore, investors must consider all the aspects before reaching the final conclusion.

It should be appreciated that Valhi's management is consistent in dividend payments, which further attracts divided-seeking investors. The company has been paying considerable dividends even during the current adverse condition. Over the last nine months, it has paid over $47.5 million, which gives a yield of nearly 6.7% as per the current valuation, which seems attractive.

Strength in the Business Model

Even during adverse economic conditions, the company has been producing considerable profits, which gives the business substantial strength. Also, having strong liquid assets can help the company if the conditions turn unfavorable.

Also, TiO2 markets are expected to grow as the economy grows. There has been no capacity addition in the last ten years except debottlenecking, and there seems to be no major capacity expansion about to occur in the near future. Therefore, I believe Kronos can sustain its profit margins in the upcoming years.

As CompX has been focusing on components manufacturing, revenue and profitability are expected to increase substantially; its lock business has been improving with new technological developments, which can help the company to expand its reach.

Furthermore, management's initiatives to reduce debts could strengthen the financial position, which can drive investors toward the company.

Risk Factors

The TiO2 market has been significantly volatile over the last ten years. Therefore, such fluctuations are expected to affect business performance over time; buying the stock at its cyclical downturn has produced considerable returns, but buying at the top of the industry cycle has turned out to be a value-destroying decision. Ensuring the right price becomes substantially essential. The current Valhi, Inc. valuation of $700 million seems considerably attractive and may protect the investor from permanent capital loss.

Furthermore, strong performance in the Kronos segment might be attributed to a reduction in Chinese capacity, but any increase in capacity by others can hurt the business performance significantly; therefore, investors must keep an eye on capacity addition by peers.

Recent Developments

In the recent quarter, revenue has reduced from $578 million in the same quarter last year to about $556 million. In contrast, net profits have dropped to $40 million. Also, in the previous nine months, revenue and profitability have seen considerable improvement, where net profits touched $146 million; such attractive growth is attributed to strong TiO2 market performance along with significant demand from marine component segments. These businesses are performing considerably strong even in recessionary environments. Therefore, as inflation starts normalizing and the economy starts booming, these businesses can produce ultra-high returns.

Conclusion

Currently, Valhi, Inc. has been trading for $700 million, whereas it has produced over $146 million in the last nine months, showing that it has been trading for just 5 times its previous nine months' earnings. Also, it has over $578 million in cash reserves and over $3 billion of balance sheet.

Kronos and CompX are publicly traded companies. The current valuation of Kronos and CompX is about $1.3 billion and $227 million, respectively. Despite holding over 72% of Kronos and over 30% of CompX, Valhi, Inc. has been trading for just $700 million. In contrast, if we calculate the current market value of these two subsidiary holdings separately, their value turns out to be over a billion dollars.

It seems that Valhi's stock has become substantially undervalued and can provide considerable returns to the investors. I assign a buy rating to Valhi, Inc. stock.

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