Investor Essentials Daily

The world can’t produce enough lumber to keep up with demand, and today’s company is perfectly happy about that

Tronox Holdings plc (TROX)
May 12, 2021

With the increased demand for new home builds and renovations, lumber prices have skyrocketed.

This has had a domino effect on the housing industry, including prices for inputs like paint. Today’s company has been able to charge significantly more for its paint products thanks to current lumber prices.

However, rating agencies appear to totally disregard the potential for ramped up demand with these ongoing consumer buying trends.

Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.

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With the At-Home Revolution going strong, people in the U.S. are continuing to buy new homes, conduct renovations, and inject money in home accessories.

People cannot get enough lumber to support these trends, and the price of lumber is currently going through the roof.

IOM (Isle of Man) Lumber prices, a common international reference price for investors, have not broken $0.50 per bundle over the last four years, with prices stagnant over July of 2016 to July of 2020.

Since July of 2020, prices of lumber have risen from their normal $0.25 to $0.50 range to almost $1.40 per bundle.

Lumber around the world physically cannot be created fast enough for the current demand, driving up prices.

Everyone is scrambling to build new homes and renovate existing ones due to tailwinds in the At-Home Revolution.

However, there is one area of this discussion that has seemed to go unnoticed.

No one is talking about how the demand for paint follows lumber. Specifically, this means the demand for TiO2, a key pigment component in paint, has skyrocketed.

As a result, investors might suspect the largest maker of TiO2, Tronox (TROX), will soon be printing money.

Despite this fundamental tailwind, major rating agencies do not appear to be paying attention to how the demand is being transformed in a positive light for this business.

Specifically, the major rating agencies are still skittish when rating Tronox’s debt. S&P gives Tronox a highly speculative either B or B+ rating, with the implied assumption of a 25%+ risk of default over the next five years.

Meanwhile, the company’s demand has the potential to boom in the near term.

Our Credit Cash Flow Prime (CCFP) analysis is able to get to the heart of the firm’s true credit risk.

In the below chart, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).

As depicted, Tronox should have no issues handling their obligations over the next five years. The company’s cash flows cover all obligations in each year from 2022 on, excluding 2025. Moreover, the company’s combined cash flows and cash available for use cover all obligations in each year besides 2025.

Tronox also has an ample runway before this debt matures, giving them time to refinance appropriately.

Rather than a name in distress, Tronox is actually a much safer credit. This is why S&P’s B or B+ highly speculative rating, with a 25%+ risk of default expectation over the next five years does not make sense.

Using the CCFP analysis, Valens rates Tronox as an investment grade XO rating. This rating is equivalent to a BBB- rating from the S&P.

Additionally, Valens’ rating corresponds with a default rate below 2% within the next five years, a more realistic projection once the demand potential for the company is taken into account.

By looking to take into account existing market forces, and compare them with the real fundamentals, we can understand the real credit risk of a company.

SUMMARY and Tronox Holdings plc Tearsheet

As the Uniform Accounting tearsheet for Tronox Holdings plc (TROX:USA) highlights, the Uniform P/E trades at 6.6x, which is below the global corporate average valuation levels and its historical average valuations of 10.1x.

Low P/Es require low EPS growth to sustain them. In the case of Tronox, the company has recently shown a 37% Uniform EPS decline.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Tronox’s Wall Street analyst-driven forecast is a 666% EPS growth in 2021 followed by 1% EPS decline in 2022.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Tronox’s $21.2 stock price. These are often referred to as market embedded expectations.

Tronox is being valued as if Uniform earnings were to shrink 3% per year over the next three years. What Wall Street analysts expect for Tronox’s earnings growth is above what the current stock market valuation requires for both 2021 and 2022.

Furthermore, the company’s earning power is above the long-run corporate average and cash flows and cash on hand are above its total obligations—including debt maturities, capex maintenance, and dividend. Together, this signals a moderate credit and dividend risk.

To conclude, Tronox’s Uniform earnings growth is above peer averages and the company is trading in below average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research