Is Tronox Still a Great Investment?


As the world's largest fully integrated titanium dioxide producer, Tronox can't whitewash the fact that its real fortunes these days lie in a major lawsuit against petroleum producer Anadarko Petroleum . If it wins, the materials maker can paint the future black with profits; a loss just might send it back into bankruptcy.

A short history in pain
Spun off from the former chemicals and petroleum specialist Kerr-McGee in 2006, Tronox was saddled with all of the environmental liabilities of its former troubled parent, while Anadarko purchased the remaining petroleum business cleanly. When the economy subsequently crashed, Tronox went bankrupt and sued Anadarko, claiming Kerr-McGee knowingly didn't set aside enough money for its environmental liabilities because it knew the TiO2 business wouldn't survive long enough to pay them.

Tronox emerged from bankruptcy in 2011 and established a trust to pay the environmental claims pressed against it by more than 2,700 polluted sites, with the EPA eventually joining in and looking to recover $25 billion.

Like white on rice
The Tronox that emerged from bankruptcy was a stronger company than the one that fell, and having acquired the mineral sands division of South African listed Exxaro Resources, the world's third-largest producer of titanium ore feedstock and the second-largest producer of zircon, it had added a layer of diversity.

Titanium dioxide, which is Tronox's bread and butter, is the whitest substance on Earth. As the economies in China and India soared, global demand for the pigment surged along with greater production of autos and home appliances. When the Great Recession forced producers to shut off capacity, a huge supply imbalance was in the making, and TiO2 supplies were further disrupted by Japan's devastating earthquake and tsunami. With an industry operating at almost full capacity, prices skyrocketed.

DuPont controls 20% of the industry's capacity, making it the largest producer of the pigment base followed by Dow Chemical, Huntsman, and Kronos Worldwide. Tronox is in fifth place. But pricing fatigue finally set in in 2012, causing paint makers like PPG and Valspar to look for alternatives (although there aren't many).

Heads I win, tails you lose
There are two main ways of producing the pigment: extracting pigment from rutile, ilmenite, and titanium slag -- the process primarily used in North America even though it's more expensive -- and a lower cost, lower grade, sulfate-based one that's common across Europe and Asia, which produces both rutile and anatase crystals. The chloride method developed by DuPont is the most efficient process (and its North American plants are the most profitable as a result), but anatase crystals are better in specialty applications like cosmetics.

Valspar is adding the sulfate process to its production -- by as much as 20% -- to lower its costs. PPG reduced TiO2 consumption by about 4% last year and believes that it can hit lower-single-digit targets again in 2013. Sherwin-Williams says it's not as easy for it to switch over, though not impossible, but it won't be in the forefront of any conversion. With TiO2 pricing still trending down after peaking in the second quarter last year, there may no longer be the impetus to find an alternative.

A dark tint
Which presents some risk for Tronox as it grapples with the effect of its lawsuit against Anadarko. Although observers seem doubtful of it losing, some analysts expect Tronox will win no more than a tenth of what the government is seeking.

In the TiO2 market, the company should benefit from having a stable supply of raw materials, but any further economic slowdown in China would have a negative impact on performance, as it would with other TiO2 producers. The industry is cyclical so investors should expect margin contraction to prevail, particularly if DuPont goes through with its capacity expansion plans.

Further, Tronox's South African assets are subject to political risk from potential nationalization, labor unrest, and power grid outages, all problems similar to those plaguing precious metals miners in recent years.

Still, it is well-positioned to take advantage of any new demand that materializes (lower prices help spur greater volumes), and it should have the financial wherewithal to service the debt it took on to acquire Exxaro. Overall, with its valuation just a fraction of its rivals, Tronox seems like a good bet to color its world with profits.

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