Summary
- Tronox holds great long-term prosperity.
- The company is experiencing a cyclical downturn that will impact profitability.
- I believe that Tronox will be able to offset volume declines using their navigation strategy.
- Analysts are divided upon Tronox's performance.
- Tronox is undervalued according to my assumptions presenting a possible future buy.
With Tronox Holdings ( TROX ) providing a well-diversified and vertically integrated business model during a cyclical downturn, the business seems to be in a fair position amid economic headwinds. With a leading brand in the Ti02 segment , an undervalued cyclical company at a P/E GAAP TTM of 4.97, and an industry growth rate of 6% CAGR until 2028, I rate TROX stock as hold as I believe the company will be able to partially offset this cyclical downturn and outperform its peers due to its new risk navigation plan.
Business Overview
Tronox Holdings mines and processes titanium ore, and zircon and produces TiONA and TiKON titanium dioxide pigment, specialty-grade CristalACTiV products made of titanium dioxide, and high-purity titanium compounds. The company's products are designed to improve paint, plastic, and paper quality. Tronox Holdings has had solid growth over the past few years, with a market capitalization of $2.32 billion, ROIC of 16.56% , a 52-week high of $21.65, and a low of $11.09, a price of $15.76 presenting a great discount. Tronox also pays a stable dividend of $0.50/share which is 3.18% with a healthy payout ratio of 25.51% giving room and protection for a cyclical decline. The company has also been actively repurchasing shares which is very beneficial, especially during cyclical lows when the stock is very cheap.
Tronox Holdings 1Y Performance (Seeking Alpha)
Tronox Holdings Previous Growth (Trading View)
With disappointing Q4 2022 earnings amid a cyclical downturn as Ti02 volumes dropped, Tronox had implemented a solid strategy to offset this volume decrease. The company reported an adjusted diluted loss was $-0.17 per share, revenues down from $884 million in Q4 2021 to $649 million in Q4 2022 marking a YOY decline of 27%, product sales declining, and a net income decline of 116%. Some positive results from the report include the projections for EBITDA to recover in the upcoming 2023 quarters, and the escape of operational challenges such as building a new road to their flooded Atlas Campaspe project to begin transporting heavy metal concentrate.
Q4 2022 Results (Tronox Investor Relations)
Tronox's Adaptation to Market Headwinds will Offset Volume Declines
Due to the tough market conditions, and the weak Q4 2022 earnings outlined above, Tronox has created a plan to make a turnaround and combat the cyclical downturn effects. This initiative displayed below includes lowering costs, managing working capital, and reducing their CapEx as displayed below. I believe that this plan will be able to better defend the company's valuation as it stands and will protect Tronox's market share in the long term. The company also displays solid available liquidity totaling $608 million with $164 million in cash or cash equivalents and a fair debt level that will assist Tronox in navigating tough conditions such as now.
Plan to Navigate Economic Headwinds (Investor Presentation)
With Tronox mentioning that the trough has been reached for Ti02 volumes which accounts for 78% of their revenues, a return to recent profitability could be very possible in the near future. Tronox's current strategy compliments this trend because although their actions to navigate the cyclical downturn are more defensive, they can easily shift back into their growth strategy and have ample free cash flow to embark on new avenues.
Tronox's Navigation Strategy can Further Fund Energy Independence Projects and will generate Future Margin Expansion
Tronox has been investing heavily into energy independence with companies such as SOLA group in South Africa to provide 200 MW of solar power to Tronox’s mines and smelters. With energy sources such as oil having high costs recently, impacting all businesses' profitability due to transportation and operational costs, Tronox will be able to stabilize these factors by being independent on a decentralized source of energy which will yield a positive return on investment in the long-term as it is expected to be implemented by Q1 2024. With cost-cutting actions being implemented, short-term results may not be evident but, cutting discretionary costs and managing working capital will enhance operating efficiencies leaving more room in the future for CapEx.
Tronox Sustainability Recap (Investor Presentation)
Analyst Consensus
With eight analysts rating Tronox a buy, or strong buy, and three rating the stock hold or lower, I believe that the company holds a possibility of significant upsides and downsides depending upon Ti02 future volumes. With an upside of 14.79% and a price target of 18.09, analysts recognize Tronox's large room for expansion in the near future.
Tronox Analyst Consensus (Trading View)
Valuation
Before calculating my DCF model, I calculated Tronox's Cost of Equity which is 9.2% using the Capital Asset Pricing Model factoring in a risk-free rate of 3.95% as shown below.
Tronox Cost of Equity (Created by Author Using Alpha Spread)
Assuming the Cost of Equity of 9.2% from above, I calculated Tronox's WACC to be 6.75% which is under the industry average of 12.27% as displayed below.
Tronox WACC Calculation (Created by Author Using Alpha Spread)
After completing a Firm DCF model via FCFF, I have determined that Tronox is currently undervalued by 17% based upon a fair value of ~$19.29. To arrive at this value, I used a discount rate of 8% over a 5-year period. In terms of revenue assumptions, I estimated high-single-digit growth after 2023, with growth plateauing to mid-single digits in later years as the company becomes larger and more challenging to scale. The reason why I used a discount rate of 8% rather than 6.75% (their WACC)
Tronox DCF (Created by Author Using Alpha Spread)
Tronox Capital Structure (Created by Author Using Alpha Spread)
Risks
Company Employees During Inflationary and Cost-Cutting Times
The labor union representing Tronox's employees holds a dominant position in the chemicals and petrochemicals industry. During the annual collective bargaining negotiations, pay increases, including those for minimum wages, are typically based on the inflation rate. As personnel expenses, which include payroll taxes and social insurance charges, constitute a significant portion of the company's costs, any wage increase exceeding the inflation rate could potentially harm the business, especially during a time when cost savings are critical to success. Therefore, it is crucial for Tronox to consider the impact of such pay increases on its financial performance.
Currency Exchange Rates Changes
Changes in currency exchange rates, particularly the devaluation of the Brazilian Real, can lead to increased costs of raw materials quoted in US dollars. This can also affect the expenses associated with road transport and port logistics, thereby impeding Tronox's ability to compete with exports from other countries, such as China. In addition to these challenges, the high tax burden in Brazil, coupled with the bureaucratic approach of the tax authority, rising transaction costs, and the expenses related to complying with official environmental standards required to obtain environmental licenses, all contribute to the production costs and ultimately have a negative impact on Tronox's earnings.
Cyclical Shifts
Cyclical shifts in the price of titanium dioxide as mentioned in my thesis would result in stock underperformance and a decline in profits due to a decrease in pricing, profits and pricing power. This risk is also accompanied by the low free cash flow Tronox has due to their high CapEx to achieve further vertical integration and sustainability which pose a short-term risk due to a decreased safety net in recessionary times.
Conclusion
In conclusion, I view Tronox Holdings as a Hold as it is a leading company that has a strong plan to combat cyclical downturns, and is undervalued presenting large upsides. With the stock yielding a strong dividend and frequent buybacks and great sales, Tronox is a long-term hold that may pose a buy case in the near future.
For further details see:
Tronox Holdings: Undervalued Amid Cyclical Downturn