It's used in everything from sunscreen and toothpaste to food coloring and vehicle coatings. The milk you drink has been enhanced by it and the creme of the Oreos you eat have been brightened because of it. It's applied as an undercoating on planes, trains, and automobiles and is used as a food additive and flavor enhancer in a variety of non-white foods. What it's best known for, though, is as the base pigment for paint.
Whiter than white
Titanium dioxide is the whitest substance on Earth. Global demand has surged in recent years amid greater production of automotives and home appliances in China and India. Coupled with supply disruption at the Japanese producer Sakai Chemical last year as a result of the earthquake and tsunami and no new capacity coming online, and there's a huge supply imbalance that's led to skyrocketing prices.
DuPont (NYSE: DD) is the world's largest maker of titanium dioxide with 20% of the industry's capacity, and 2011 was a year of record profits due to rising TiO2 prices. Even as sales volumes fell, DuPont was able to post earnings of $3.5 billion, with the performance chemicals division enjoying a 12% increase in sales on 29% higher prices. It was alone among major manufacturers preparing to bring new capacity online.
Yet those results should also have been a warning that pricing fatigue was setting in. Rutile, one of the main sources for TiO2, simply couldn't maintain that trajectory if demand was ebbing and prices are down 8% in 2012 with them falling back 3% this month alone. Huntsman (NYSE:HUN), tied with Kronos Worldwide (NYSE:KRO) as the third largest manufacturer with 10% of the industry's capacity, felt it was just being a realist earlier this year when it suggested it would experience margin pressure from falling prices.
Now buyers say rather than try to buy as much as they can of titanium sponge -- the first stage titanium goes through in processing -- like they did last year as prices leapfrogged ever higher, now they want to see how much they can postpone paying for.
Blood red results
DuPont's adjusted profits fell to $0.32 a share, well below the $0.47 analysts had anticipated as the performance chemicals segment saw demand fall 18%. Dow Chemical (NYSE:DOW) suffered a 32% decline in profits driven in part by significantly lower volumes for TiO2 and electronics in Europe and Asia.
Falling prices will likely benefit downstream players in the TiO2 market like paint and coatings makers Benjamin Moore, PPG Industries (NYSE: PPG), and Sherwin-Williams (NYSE:SHW). They've been able to pass along much of the rising costs to their customers, thus shielding themselves from the worst of the price hikes, but some are now trying to wring extra mileage out of the situation by changing the processes used for making TiO2.
50 shades of gray
Without getting too technical, there are two main ways of producing the pigment: a more expensive chlorine-based formulation, which is primarily used in North America to extract pigment from rutile, ilmenite, and titanium slag, and a lower cost, lower grade sulfate-based one that's common across Europe and Asia, which produces both rutile and anatase crystal forms. Some manufacturers like Valspar (NYSE: VAL) are adding the sulfate process to their production -- as much as 20% -- to lower their costs further. Sherwin-Williams says while it's not as easy for it to switch over, it's not impossible, and it just won't be leading the charge in converting.
While each method has its benefits -- anatase crystals, for example, are better in specialty applications like cosmetics -- the chloride method developed by DuPont is the most efficient process and probably helps explain why North American plants have been the most profitable.
Covering the world
When you look at Sherwin-Williams' results this past quarter, we see across all its major segments passing along input cost increases benefited the top and bottom line. Most notable was its paint store group, which caters to the professional painter, commercial businesses, and government, enjoyed 10% higher revenues in the quarter along with gross margins that widened 350 basis points. Its consumer segment was weak, as were global finishes and Latin America, though they would all have been worse had price hikes not made up the difference.
Now with the key ingredient for its finishes coming down, and likely no concurrent reduction in the price of a gallon of paint, investors should see margins widen further, though the process takes time to filter down through the channel. At 25 times earnings and 18 times estimates, the paint maker offers a premium to rivals PPG and Valspar, but sporting an enterprise value that trades at 23 times its free cash flow makes me think it's not a bargain stock.
Yet investors may want to instead focus on the paint makers as a sector to profit from rather than those making the ingredients that go into the formulations. Sherwin-Williams likely has a better prospect for profitable growth right now than does DuPont, Dow, Kronos, or even Tronox (NYSE: TROX). It could be a very white Christmas for the coatings specialist as it continues to paint profits black.
Color my world
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