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Company Description

Tronox (TROX) is a global titanium dioxide (TiO2) producer. TiO2 pigment is a fine white powder that is used in paints, plastics and paper to provide maximum whiteness and opacity. The refractive index (the ability to bend and scatter light) of Ti02 is what gives paint the ability to mask or hide a substrate and, as a result, Ti02 is the most important material used by the paints and plastics industry for whiteness and opacity. Ti02 has the highest refractive index of any material known to man, greater even than diamonds. However, titanium dioxide is not readily available in a form that is usable and must be mined, refined and ground to a fine, uniform particle size from mined ore that is in limited supply.

In its S-1 filing for registration on the New York Stock Exchange, Tronox describes itself as follows:

We are one of the leading producers and marketers of TiO2 the world's third-largest producer of titanium feedstock and second-largest producer of zircon. We are one of the leading integrated global producers and marketers of TiO2 and mineral sands. Our world-class, high-performance TiO2 products are critical components of everyday consumer applications such as coatings, plastics, paper and other applications. Our mineral sands business will consist primarily of two product streams-titanium feedstock and zircon. Titanium feedstock is used primarily to manufacture TiO2. Zircon, a hard, glossy mineral, is used for the manufacture of ceramics, refractories, TV glass and a range of other industrial and chemical products. In addition, we produce EMD, sodium chlorate, boron-based and other specialty chemicals.

Background

Tronox was formed on May 17, 2005 through the contribution by Kerr-McGee Corporation ("Kerr-McGee" or "KM") of its chemical / pigment business. On January 12, 2009 Tronox filed for bankruptcy protection under Chapter 11. On November 30, 2010 the Bankruptcy Court confirmed the reorganization plan and on February 14, 2011 Tronox emerged from bankruptcy and continued operations.

On September 26, 2011 Tronox announced the acquisition of Exxaro Resources mineral sands operations, essentially vertically integrating by gaining control of the ore input used to generate Ti02. In the Exxaro transaction each share of Tronox was exchanged for a share of "New" Tronox and $12.50 in cash per share. The transaction closed on June 15, 2012 and on June 18, 2012 "New" Tronox under the ticker TROX listed on the New York Stock Exchange and began trading.

Investment Thesis

As a post bankruptcy equity that has undergone a transformative transaction, TROX is a unique investment opportunity.

  • Ti02 has a supply/demand imbalance that will not be corrected anytime soon given the time it takes to open a new ore mining facility leading to strong pricing dynamics. By vertically integrating Tronox has the ability to generate significant margins and cash flow.
  • Tronox is significantly underlevered (less than 1x and will add leverage and return capital to shareholders).
  • Tronox has told investors what its capital deployment strategy will be, which involves the return of capital (see below).
  • Tronox is significantly under-owned by institutional investors and now that it is trading on the New York Stock Exchange and will put a regular dividend in place (see below) chemicals and yield investors will be taking a long hard look at the company.

Capital Deployment

In its first quarter 2012 earnings release Tronox discussed the company's capital deployment strategy post Exxaro transaction.

Tronox Limited's policy with respect to the deployment of capital cannot be determined until after the closing of the combination when the newly constituted Tronox Limited Board can consider its plans and policies. However, management currently intends to recommend the following actions to the Board of Tronox Ltd. shortly following the closing:

· Raising additional debt financing in an amount between $750 and $1.0 billion in either additional term loans and/or unsecured bonds;

· Issuing a special dividend of $25.00 per share;

· Authorizing up to $250 million of share repurchases under certain circumstances;

· Adopting a regular quarterly dividend commencing in the fourth quarter 2012; and

· A split of the shares on an approximate ratio of between 7:1 and 9:1.

Current Valuation

At its closing price on June 22 of $136.90 per share, TROX has a market capitalization of $3.5 billion and an enterprise value of $4.2 billion. Without taking into account the additional EBITDA from the Exxaro acquisition, TROX generated $502 million of EBITDA over the twelve months ended March 31, 2012.

In its June 14, 2012 investor presentation TROX presents 2011 results pro forma for the Exxaro acquisition. With $844 in pro forma EBITDA, TROX is trading at only 4.9x EBITDA. However, TROX's Q1 2012 results (pre-closing) showed EBITDA up 145% versus Q1 2011, an increase in EBITDA of $84 million. Therefore, TROX is trading at only 4.5x LTM EBITDA assuming that Exxaro's Q1 results were flat with last year. In fact, given increases in ore prices, Exxaro likely showed significant growth in Q1. Further, the company estimates at least $30 million of synergies from the deal.

Conclusion

Given the tight ore supply / demand dynamics and increasing Ti02 pricing environment, conservatively TROX could generate over $1 billion of EBITDA in 2012. Assuming $1 billion of EBITDA created at 6.0x including $100 million present value of net operating losses and the capital deployment strategy mentioned above, Tronox is worth $191.90 per share, a 40% return to the current price.

Credit Suisse in a May 4, 2012 report on Exxaro suggests that TROX could generate $1.5 billion in EBITDA in 2012. This suggests $342.57 per share of value, a 150% return.

I would suggest anyone interested in TROX review the company's investor presentation and do some research on Ti02 pricing. An investment in TROX at its current level is a compelling risk / reward proposition.

Source: Tronox: The Newly Vertically Integrated Titanium Dioxide Producer Could Be A Double