When Huntsman Corporation needed to get serious in its pursuit of Clariant, the chemical giant decided to spin off its market leading titanium dioxide business and a sizable amount of related debt. The move cleaned up the company's balance sheet and created a new pure-play stock for the pigment in Venator Materials (VNTR 0.96%). Besides, the sagging titanium dioxide market was weighing on its financial performance.
Too bad hindsight is 20/20. The planned merger fell through late last year. Worse, titanium dioxide selling prices exploded higher at the end of 2016 and steadily climbed through 2017. When coupled with industry consolidation that resulted in six companies controlling 62% of the global market, the bump in selling prices meant titanium dioxide stocks were some of the best performers in 2017.
Unfortunately, newcomer Venator Materials didn't join in the fun. A ho-hum IPO in August of last year followed months of preparation to begin operating as a stand-alone company, which was accompanied by separation costs and efforts to improve efficiency. A fire at an important facility in Finland also sapped production volumes of high-margin specialty products.
Investors would be forgiven for overlooking the company to date, but given promising third-quarter 2017 results and management's expectations for a big 2018, is now the time to buy the newest titanium dioxide stock?
Poised for a big 2018?
Investors waiting for the company to capture the benefits of strong upward momentum in titanium dioxide selling prices that were blowing up the share prices of peers must have been satisfied with third-quarter 2017 results. Venator Materials handily beat its performance from the year-ago and prior-quarter periods.
Metric |
Third-Quarter 2017 |
Third-Quarter 2016 |
% Change |
---|---|---|---|
Revenue |
$582 million |
$532 million |
9.4% |
Adjusted EBITDA |
$134 million |
$21 million |
N/A |
Net income |
$51 million |
($5 million) |
N/A |
Diluted EPS |
$0.48 |
($0.05) |
N/A |
The titanium dioxide segment, which comprises roughly 75% of total sales, drove the quarterly performance as expected. Segment revenue and adjusted EBITDA turned in year-over-year growth of 10% and 477%, respectively. While the fourth quarter is usually accompanied by lower volumes in the cyclical market, prices are expected to be higher, which should offset most of any expected seasonal decline.
Venator Materials' performance additives segment reported tamer results, although year-over-year revenue grew 8%. Nonetheless, management's strategy (called the "business improvement program") includes shuttering lower-margin businesses and production facilities, two of which are in the segment, to boost cash flow in the near and long term.
The company embarked on the strategy in 2017, but it's expected to deliver the bulk of its overall gains in 2018. Management expects facilities closures, fixed costs improvements, and volume increases to drive an annual $90 million improvement in EBITDA by the first quarter of 2019 -- with each category delivering one-third of the benefits. Over half of the incremental gains will be realized in 2018.
A significant contributor to volume gains in the year ahead will come from the production facility in Finland that suffered significant fire damage in January 2017. It was still being repaired as of last November and was only operating at 20% of its full capacity. But Venator Materials expects to reach 40% operating capacity by the second quarter of this year and 60% operating capacity by the end of the year. All of the initially restarted capacity will be dedicated to high-margin specialty products that typically generate over 75% of the facility's total EBITDA.
The bad news is that while the facility is insured for losses up to $500 million, Venator Materials expects to exceed that by as much as $150 million. That's out of management's control, so simply getting the facility up and running again is the best investors can hope for right now. The good news is continued momentum in titanium dioxide selling prices will make the production restarts -- and the rest of the company's manufacturing footprint -- increasingly valuable.
In fact, excluding the reconstruction costs at the Finland facility, management expects to generate over $200 million in free cash flow in 2018. That will be used to aggressively reduce debt, which stood at $751 million at the end of last September. The long-term target is to achieve a net debt position of $350 million, compared to $565 million at the end of the third quarter of 2017.
Management has hinted that strong cash flow in future periods could be deployed to repurchase shares or even initiate a dividend, although there are much better uses for cash in the near term. Reducing debt and building a sizable cash position would insulate Venator Materials from the volatility inherent to the cyclical industry. Therefore, I wouldn't expect for shareholder value creation activities to be enacted until 2019 at the earliest -- and even then it may not be the right long-term move.
Is Venator Materials stock a buy?
Venator Materials stock certainly has the potential to break out in 2018. The business exited 2017 with significant momentum and has several catalysts on the horizon in the year ahead. However, the timing and costs related to rebuilding the Finland facility remain sources of risk for shareholders.
If the company delays restarts for any reason or spends more than the expected $150 million, then the stock could be punished by Mr. Market. On the other hand, if reconstruction costs come in at the lower end of the expected range, then the company would be significantly further along in its plans for strengthening the balance sheet.
That said, given the rising selling prices for titanium dioxide -- which remain well below historical peaks -- and the potential for consistently higher earnings throughout 2018, I think Venator Materials stock could be due for a good year. Investors looking to piggyback on the prevailing trends in the industry should feel relatively comfortable buying the stock right now -- just be sure to watch important indicators (selling prices and the Finland restart) that may prove otherwise.