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Attractive Upside Ahead In Misunderstood TRECORA (TREC)

|Includes: Trecora Resources (TREC)

Trecora Resources

TREC generated record fourth quarter gross margins resulting from the continuation of lower feedstock prices and higher prime product sales. The production capacity expansion projects undertaken at SHR coupled with expected increase in demand for petrochemical products from polyethylene projects and oil sands customers would drive earnings for coming quarters. We are maintaining our BUY rating with a revised $18.00 price target.

52-Week Range

$8.75 - $16.50

Total Debt (million)

82.3

Shares Outstanding

24.2 million

Total Debt/Equity

57.8%

Insider/Institutional

3.02% / 35.67%

ROE (NYSE:TTM)

14.1%

Public Float

19.3million

Book Value/Share

$5.82

Market Capitalization

$252.7 million

Daily Volume

53,405

FYE DEC

2014A

2015A

2016E

EPS($)

ACTUAL

CURRENT

PREVIOUS

CURRENT

PREVIOUS

Q1 Mar

$0.10A

$0.23A

$0.23A

$0.19E

$0.27E

Q2 Jun

0.20A

0.25A

0.25A

0.20E

0.31E

Q3 Sep

0.23A

0.21A

0.21A

0.26E

0.32E

Q4 Dec

0.09A

0.05A

0.28E

0.30E

0.32E

Year*

$0.63A

$0.74A

$0.97E

$0.95E

$1.23E

P/E Ratio

21.6x

14.2x

 

11.0x

 

Change

-20.6%

18.0%

 

28.7%

 

FYE DEC

2014A

2015A

2016E

Revenue ($ mil.)

ACTUAL

CURRENT

PREVIOUS

CURRENT

PREVIOUS

Q1 Mar

$64.1A

$55.1A

$55.1A

$54.2E

$74.9E

Q2 Jun

74.6A

59.4A

59.4A

57.2E

79.5E

Q3 Sep

76.9A

66.9A

66.9A

69.7E

84.5E

Q4 Dec

74.1A

60.5A

68.5E

69.0E

79.2E

Year

$289.6A

$241.9A

$249.9E

$250.0E

$318.1E

Change

22.6%

-16.5%

 

3.3%

 
  • Numbers may not add up due to rounding.

Q4:15 HIGHLIGHTS

  • Total revenues decreased 18.3% to $60.5 million in Q4:15 from $74.0 million in Q4:14, primarily driven by a 29.5% decline in the average sales price of petrochemical products due to a 37.4% reduction in petrochemical feedstock prices.
  • Gross profit margin improved to 19.6% in Q4:15 from 16.6% in Q4:14 as lower feedstock costs more than offset the formula driven sales price reduction.
  • Adjusted EBITDA (excluding equity and AMAK earnings/losses and share based compensation) increased 6.2% to $8.6 million in Q4:15 from $8.1 million in Q4:14.
  • TREC reported net income of $1.1 million or $0.05 diluted EPS in Q4:15, compared to $2.2 million or $0.09 diluted EPS in Q4:14. The fall in net income is due to the reported $3.0 million loss in equity in the Al Masane Al Kobra Mining Company (AMAK).
  • Cash & equivalents improved to $18.6 million at quarter end compared to $14.8 million in Q3:15. Capital expenditures in Q4:15 were $7.7 million, attributable to the expansion of D-Train construction and custom processing capacity at Trecora Chemical.
  • Book value per common share increased to $5.8 in Q4:15 from $5.0 in Q4:14.

Q4:15 Summary

Total revenues decreased 18.3% to $60.5 million in Q4:15 from $74.0 million in Q4:14, primarily driven by a 29.5% (resulted from 37.4% reduction in the average per gallon cost of petrochemical feedstock in Q4:15, which rolls over into the formula sales pricing mechanism for close to 60% of petrochemical product sales) decline in the average sales price of petrochemical products. Trecora Chemical (TC) contributed $5.4 million (including $1.6 million of custom processing fees) in revenues for the quarter. For custom processing, TREC ran three successful trails for new customers in Q4:15 and the installation of the distillation and hydrogenation capability at TC remains on track and expected to come on stream in Q3:16, thereby ramping up revenues from this segment in FY'16.

Petrochemical volumes rose 13.7% to 24.6 million gallons in Q4:15 from 21.6 million gallons in Q4:14, which translated to Petrochemical revenue of $55.2 million for the quarter.

Chart 1: Petrochemical Revenues Chart 2: Petrochemical Volumes

Source: Company reports

Despite decline in revenues,gross profit margin improved to 19.6% in Q4:15from 16.6% in Q4:14 as lower feedstock costs more than offset the formula driven sales price reduction.

Operating income rose 18.4% to $5.8 million in Q4:15 from $4.9 million in Q4:14, due to reduction (18.2%) in SG&A expenses in the quarter.

The company reported net income of $1.1 million or $0.05 diluted EPS in Q4:15, compared to $2.2 million or $0.09 diluted EPS in Q4:14. The fall in net income is primarily due to the reported $3.0 million loss in equity in the Al Masane Al Kobra Mining Company (AMAK).

Cash and cash equivalents stood at $18.6 millionin Q4:15 compared to $14.8 million in Q3:15. Capital expenditures in Q4:15 amounted to $7.7 million, attributable to the expansion of D-Train construction and custom processing capacity at Trecora Chemical.

Book value per common share increased to $5.8 in Q4:15 from $5.0 in Q4:14.

VALUATION

TREC reported decent results during Q4:15, despite a very turbulent commodity environment. The company generated record fourth quarter gross margins resulting from the continuation of lower feedstock prices and higher prime product sales. We note that during the earnings call, the management announced the successful completion of full test capacity of the D-Train Hydro de-Sulfurization unit (an expansion project commissioned in Sep'15 at SHR) in Jan'16, wherein the unit has demonstrated an ability to process 6,000 barrels of feedstock a day (50% greater volume than originally projected). The management also mentioned its capital budget of $30 million for FY'2016 for the construction of 4,000 barrels per day Advanced Reformer unit (expected to be completed by Q2:17) at SHR. These production capacity expansion projects undertaken at SHR are aimed to increase pentane production by 60% to support expected oil sands & new polyethylene demand. Moreover the management also mentioned that they are expanding custom processing capabilities at Trecora Chemical and expects this project to be completed by Q3:16, which will double the custom processing volume in 2017 compared with 2014.

In November 2015, the company announced the temporary shutdown of AMAK until Q4:16 as the mill is currently undergoing renovation to gain efficiencies, production and improvements in recovery such that the mine can operate profitably even at current copper and zinc prices.

Considering the above scenario and possible extension of lower feedstock costs and its impact on average sales price of petrochemical products, we are revising our price target to $17.91 (rounded to $18.00) which is an equally-weighted blended valuation of sum-of-the-parts ($16.07) and DCF ($19.74) from previously given target of $19.00. TREC currently trades at 11.5x of our 2016 pro forma petrochemicals earnings estimate of $0.91 per share, 1.8x price to book value, and 8.7x EV/LTM EBITDA.

Our sum-of-the-parts approach values TREC at $16.07 per share (Petrochemical assets at $11.07 per share + mining assets at $5.0 per share) versus the current price of $10.44 per share, while a DCF approach values the company at $19.74 per share. An average of the two approaches produces a target price of $17.91 per share, which we round to $18.00 per share.

With petrochemical earnings forecast to improve in 2016 and beyond based on better margins coupled with improved contribution from AMAK attributable to expected efficiencies driven by renovation, we continue to believe TREC's future remains bright and the valuation is attractive.

  • Value of TREC's petrochemical assets. We use a P/E multiple-based approach and back this up with an EV/EBITDA multiple-based approach.
    • PE-based valuation at $11.07 per share. TREC's petrochemical operations exhibits the potential for top line growth and profit margin improvement over the coming quarters as the company currently expanding its production capacity at SHR and expects increase in demand for petrochemical products from polyethylene projects and oil sands customers. Moreover the custom processing capabilities expansion at Trecora Chemical coupled with expectation of gaining business in 2016 from two of three successful custom processing trials the company ran in Q4:15 will enhance TC's contribution to revenues going forward. We forecast EPS of $0.91 for FY'16 from petrochemical operations alone.

Table 1: Peer Comparison Valuation

In comparing TREC to a small group of chemical companies (Table 1) we believe that TREC should sell at a 15% discount to the respective 2016 peer median P/E multiple of 14.3x. This produces a value of $11.07 per share as shown below in Table 2.

Table 1: Peer Comparison Valuation

Source: Singular Research estimates

  • EV/EBITDA-based valuation at $6.94. Again, focusing on forecasted FY'16 EBITDA and applying a 15% discount to the peer median multiples, we arrive at a valuation of $6.94 per share.
    • Value of AMAK mining interest remains estimated at $5.0 per share. Due to our inability to obtain updated and reliable detailed mining revenue and operating cost per ton figures, we are temporarily abandoning using a discounted present value of cash flow approach to assist in the valuation of TREC's interest in AMAK and instead are taking an average of the two approaches below.

(1)The most recent May 2013 sale of five million shares (a 10% increase in outstanding shares) at $8.00 per share which were purchased by AMAK's existing shareholders including TREC;

(2) AMAK's current carrying value on the balance sheet of $47.7 million, which is equivalent to a value of ~$2.0 per share.

Admittedly, neither approach is particularly timely or accurate, until we have the necessary updated data to complete a more refined valuation or the IPO is completed in late 2016, we believe the number is a good enough approximation for now.

  • A sum-of-the-parts approach defines a value for TREC of $16.07 per share. By combining our valuations of TREC's petrochemical assets based on a P/E multiple valuation of $11.07 per share and the mining assets of $5.0 per share we calculate a total value for TREC of $16.07 per share.

As a further validation of our sum-of-the-parts valuation, we perform a DCF analysis based on TREC's combined petrochemical and mining operations. For our DCF model, our forecast describes an ROC of 10.2% in FY'16. We use a 15.0% ROC after FY'16 and growth in after tax EBIT of 6.75%. With an after-tax weighted average cost of capital of 6.7%, our DCF model describes a price target of $19.74. Our equally weighted, blended sum-of-the-parts / DCF price target is $17.91 which we round up to $18.00.

As the table below shows, using P/E as a supporting valuation metric the majority of ratios yield valuations that are in excess of the current share price when applied to our FY'16 pro forma EPS estimates of $0.91 from petrochemical operations alone.

Table 3: Forward PE Ratio Vs. Forward EPS

Source: Singular Research estimates

IMPORTANT DISCLOSURES

The following disclosures relate to relationships between Singular Research and Millennium Asset Management, LLC ("Millennium") and companies covered by Singular Research and referred to in research reports.

This report has been prepared by Singular Research, a wholly owned subsidiary of Millennium which is an investment advisor registered in the State of California. Singular Research receives fees from Millennium for the right to use and distribute research reports prepared by Singular Research.

Millennium does and seeks to do business with companies covered in Singular Research's research reports. Millennium may receive fees from issuers that are the subject of research reports prepared by Singular Research for investor and public relations and other marketing-related services provided to such issuers by Millennium. As a result, investors should be aware that Singular Research and Millennium may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

There are no company-specific disclosures.

General Disclosures

This research report is for our clients' informational purposes only. This research is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. Any opinion expressed in this report is subject to change without notice and may differ or be contrary to opinions expressed by other professionals or business areas of Singular Research or Millennium. We are under no responsibility to update our research.

The views expressed in this research report accurately reflect the responsible analyst's personal views about the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that analyst in the research report.

Millennium and its affiliates, officers, directors, and employees, excluding analysts, will from time to time have long or short positions in, and buy or sell, the securities or derivatives thereof of covered companies referred to in our research reports. Our affiliates, officers, and directors won't execute on any new recommendation or recommendation change until 48 hours after the dissemination of the report.

This research is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Clients should consider whether any advice or recommendation in this research is suitable for their particular circumstances and, if appropriate, seek professional advice, including tax advice. The price and value of the investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors.

Rating Definitions

BUY, 30% or greater increase in the next 12 months.

BUY- Long-Term, near term EPS horizon is challenging, attractive long-term appreciation potential.

HOLD, perform in line with the market.

SELL, 30% or more declines in the next 12 months.

© Copyright 2016 Singular Research

No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of Singular Research.

Disclosure: I am/we are long TREC.