On June 5, DuPont (DD) received final approval for the spin-off of its performance chemical business named The Chemours Company (CC). Shareholders of DD received one share of CC common stock for every five shares of DD common stock.
Since the spin however, CC shares have lagged those of its former parent. CC stock is down roughly 25% since the official separation. Does this signal a buying opportunity?
The Business
CC operates through three segments:
Titanium Solutions: Titanium dioxide (TiO2) is a pigment used to deliver whiteness, opacity, brightness and protection from sunlight. CC is the #1 global producer of TiO2 by capacity, sales and profitability.
Fluoroproducts: Products for high performance applications across broad array of industries, including refrigerants, propellants and industrial resins. CC is the #1 global producer of both fluorochemicals and fluoropolymers.
Chemical Solutions: Chemicals used in gold production, oil refining, agriculture, industrial polymers and other industries. CC is the #1 producer in Americas of sodium cyanide, #1 in U.S. Northeast sulfuric acid regeneration, and #2 in US Gulf Coast sulfuric acid regeneration.
Competitive Advantages
46% of CC’s sales come from TiO2. Seeing that Titanium Technologies is by far the highest margin segment, it’s fair to say that TiO2 sales are the major driver of both profitability and share price fluctuations. Fortunately, CC has some major advantages in the industry.
CC is the global leader in TiO2 with production capacity of 1.4 million metric tons. On a global basis, CC has an 18% market share.
In an industry where there are significant economies of scale, CC also has one of the lowest cost positions. By operating the three largest TiO2 facilities in the world, CC is able to command significantly higher margins than most competitors.
Competitive Advantages Allow For Durability in Industry Downturns
Dealing with a largely commoditized product, CC has had a surprising ability to navigate downturns due to its strong cost advantage. In 2008, TiO2 prices were roughly 50% lower than today, causing a lot of marginal producers to exit the market due to collapsing profitability. CC meanwhile still generated solid earnings over this period although margin levels fell a bit. In a commoditized market, it’s impressive that a producer can generate profits over a complete industry cycle.
Valuation
In 2011, CC generated $1.14 billion in free cash flow. At a current market cap of $2.88 billion, clearly shares would be attractive if CC were still generating that much free cash flow. Unfortunately there are a few headwinds that have pushed FCF generation lower each year to 2014’s -$99 million level.
Falling sales have pressured margins. Although industry utilization rates have rebounded from the 2012 lows, it takes a few years for this to fully flow through to pricing action. Following the peak, TiO2 prices are down to near 5-year lows, pressuring profitability.
Capex is also temporarily bloated due to a 200,000 metric ton capacity expansion at the company’s Altamira, Mexico facility. With production scheduled to start up in mid-2016, capex spending should fall precipitously. Normalized capex levels are roughly half of the current spending rate.
Despite operating in an industry trough, with lower sales and profitability in CC’s biggest business, the company would still have generated ~$200 million in free cash flow if capex was normalized (which it will start to be in 2016). This results in a 7% free cash flow yield at the bottom of an industry cycle.
With an industry-leading cost position, CC will not only survive the current downturn, but has the financial flexibility to strengthen its position along the way. With investors focusing too much on current negative FCF generation rather than its prospects for a reversal in 2016, shares look attractively valued.
For more ideas like this one, check out GuruFocus’ Spin-Off List or the rest of R. Vanzo’s Articles.
