Plum - I found this comment attached to a Value Investors Club article...
Mitc -
Thanks for the refresh - great overview of what has gone wrong and the potential for what can go right. We've followed TREC for a better part of the decade, maybe a couple years after Simon came in, but haven't been close to it for a while.
A few thoughts. Although TREC isn't a pure commodity chemicals company, it does seem to us to be in between that and "true" specialty chemicals.
For example, we followed (and briefly owned) KMG, which (as we recall) had much higher margins and returns... their wood business was "meh" as far as growth but the semiconductor chemicals (and then Flowchem) were clearly very solid and differentiated businesses with growing end-markets. And then you have AXTA in the comp table, which is paint, which is clearly a very, very different business with different characteristics such as very strong cash flow (this was well-covered on VIC a few years ago, so we won't go into it - just pretty obvious that AXTA and TREC are not comparable).
At TREC, the most identifiably differentiated piece is the high-purity pentanes - but as you pointed out, oil sands are a big customer here, and once that buildout ended, their growth here has really stalled out, and it's not clear that there are lots of applications that will drive meaningful volume growth. Moreover, duopolies generally tend towards strong pricing and rational behavior, but our understanding from over the years is that it is such a small piece of Phillips' business that they occasionally do strange/crazy things, which keeps a lid on pricing.
Finally, TREC's results tend to be whipsawed a bit by commodity pricing (advanced reformer was supposed to help here but has been challenging so far.) And if you buy the near-term secular-decline thesis for oil (we don't, but clearly the market does), then there is sort of double exposure to commodity prices, and it is hard to think this business will garner a really high multiple?
Maybe we don't have enough insight into the waxes, but considering that this has probably been the single most disappointing part of their business (it was struggling since well before the advanced reformer headache), it's also not clear that it deserves a premium multiple until they have several years of consistent execution and strong margins under their belt. We understand wax is sold out now, but demand dipped during the initial COVID lockdowns, so downturns in certain end-markets could certainly change that pretty quickly. What are the real barriers to entry here? What are TREC's advantages?
And then there's capital. Management has cited $10-$11MM as pure maintenance capex (see Q2 2019, Q3 2020 call). This is heavy equipment subjected to heavy loads. This is a pretty significant burden on $40MM EBITDA that you forecast, especially considering how new much of their equipment is. Again as comparison, looks like KMG's capex in their last year before the buyout was $25MM on $120MM of EBITDA, or the same ratio, but this included an ERP implementation as well as expansion of their facility in Singapore, so the pure maintenance number was perhaps $15 - $20MM? So to compare KMG's multiple, you have to take into account that they were doing at most 2x the maintenance capex on 3-4x the EBITDA, not to mention the better margins, growth, end-markets, etc.
Of course, if TREC manages to fully utilize all the growth capital, then their EBITDA will rise and capex will be a proportionately smaller burden, but I think part of the problem here is that even ex growth capex, the company has not generated a lot of FCF.
It is clear that they have under-executed (and had lots of bad luck) over the past 5 years, and it does seem very likely that they can improve their results meaningfully just via basic blocking and tackling, which would hopefully result in a higher stock price. But the assumptions required for a $20 stock price in one year seem very aggressive to us - perhaps 3-5 years down the line with strong execution (which of course would be a great IRR from here). What do you see differently?
Seems like a great pick, curious if there are my ESG headwinds considering the Canadian oil sands? Not an expert by any means but know there is some general environmental concern around those.
I would argue that the Pentane business is not "whipsawed" by commodity prices. 2/3 of the business is formula and lags commodity prices by one month. Phillips 66 and TREC have been more recently acting like duopolists. TREC put through a 15 cent price increase in February, which was the third one in the last year or so. Margins in this part of the business run upper teens to low 20's, which are definitely not commodity margins. The other business has been moving to higher priced specialty waxes and you should be able to see this shift better this year. The HD unit will operate at high 90%+ margins as TREC doesn't own the chemicals that they Toll. So the second plant should also start to look a lot more profitable this year.
I think that this stock has been in the trash bin for the last few years, deservedly so, and 2021 should begin to show investors that there is value here.
In terms of multiples, hard to know what TREC is worth in the private market, but I think that it should trade closer to peers multiples as the turnaround starts to show strength in 2021 and 2022.
Thanks for the analysis. One question why would be the use of EBITDA be a good metric for judging value? Rather than profit before tax.
My understanding is that EBITDA is normally used for tech companies where a small amount of fixed capital could result in outsized returns if the product becomes the default SAAS product in the market and so on.
Pangaea Ventures/Ortelius Advisors us a recent holder. From our conversations they're not looking to sell the company.
Plum - I found this comment attached to a Value Investors Club article...
Mitc -
Thanks for the refresh - great overview of what has gone wrong and the potential for what can go right. We've followed TREC for a better part of the decade, maybe a couple years after Simon came in, but haven't been close to it for a while.
A few thoughts. Although TREC isn't a pure commodity chemicals company, it does seem to us to be in between that and "true" specialty chemicals.
For example, we followed (and briefly owned) KMG, which (as we recall) had much higher margins and returns... their wood business was "meh" as far as growth but the semiconductor chemicals (and then Flowchem) were clearly very solid and differentiated businesses with growing end-markets. And then you have AXTA in the comp table, which is paint, which is clearly a very, very different business with different characteristics such as very strong cash flow (this was well-covered on VIC a few years ago, so we won't go into it - just pretty obvious that AXTA and TREC are not comparable).
At TREC, the most identifiably differentiated piece is the high-purity pentanes - but as you pointed out, oil sands are a big customer here, and once that buildout ended, their growth here has really stalled out, and it's not clear that there are lots of applications that will drive meaningful volume growth. Moreover, duopolies generally tend towards strong pricing and rational behavior, but our understanding from over the years is that it is such a small piece of Phillips' business that they occasionally do strange/crazy things, which keeps a lid on pricing.
Finally, TREC's results tend to be whipsawed a bit by commodity pricing (advanced reformer was supposed to help here but has been challenging so far.) And if you buy the near-term secular-decline thesis for oil (we don't, but clearly the market does), then there is sort of double exposure to commodity prices, and it is hard to think this business will garner a really high multiple?
Maybe we don't have enough insight into the waxes, but considering that this has probably been the single most disappointing part of their business (it was struggling since well before the advanced reformer headache), it's also not clear that it deserves a premium multiple until they have several years of consistent execution and strong margins under their belt. We understand wax is sold out now, but demand dipped during the initial COVID lockdowns, so downturns in certain end-markets could certainly change that pretty quickly. What are the real barriers to entry here? What are TREC's advantages?
And then there's capital. Management has cited $10-$11MM as pure maintenance capex (see Q2 2019, Q3 2020 call). This is heavy equipment subjected to heavy loads. This is a pretty significant burden on $40MM EBITDA that you forecast, especially considering how new much of their equipment is. Again as comparison, looks like KMG's capex in their last year before the buyout was $25MM on $120MM of EBITDA, or the same ratio, but this included an ERP implementation as well as expansion of their facility in Singapore, so the pure maintenance number was perhaps $15 - $20MM? So to compare KMG's multiple, you have to take into account that they were doing at most 2x the maintenance capex on 3-4x the EBITDA, not to mention the better margins, growth, end-markets, etc.
Of course, if TREC manages to fully utilize all the growth capital, then their EBITDA will rise and capex will be a proportionately smaller burden, but I think part of the problem here is that even ex growth capex, the company has not generated a lot of FCF.
It is clear that they have under-executed (and had lots of bad luck) over the past 5 years, and it does seem very likely that they can improve their results meaningfully just via basic blocking and tackling, which would hopefully result in a higher stock price. But the assumptions required for a $20 stock price in one year seem very aggressive to us - perhaps 3-5 years down the line with strong execution (which of course would be a great IRR from here). What do you see differently?
Is there still big ownership by the Saudi's? Looked at this a while ago and wrote it off because of that. What would be their incentive to sell?
Seems like a great pick, curious if there are my ESG headwinds considering the Canadian oil sands? Not an expert by any means but know there is some general environmental concern around those.
Plum - This is the author's response...
I would argue that the Pentane business is not "whipsawed" by commodity prices. 2/3 of the business is formula and lags commodity prices by one month. Phillips 66 and TREC have been more recently acting like duopolists. TREC put through a 15 cent price increase in February, which was the third one in the last year or so. Margins in this part of the business run upper teens to low 20's, which are definitely not commodity margins. The other business has been moving to higher priced specialty waxes and you should be able to see this shift better this year. The HD unit will operate at high 90%+ margins as TREC doesn't own the chemicals that they Toll. So the second plant should also start to look a lot more profitable this year.
I think that this stock has been in the trash bin for the last few years, deservedly so, and 2021 should begin to show investors that there is value here.
In terms of multiples, hard to know what TREC is worth in the private market, but I think that it should trade closer to peers multiples as the turnaround starts to show strength in 2021 and 2022.
Thanks for the analysis. One question why would be the use of EBITDA be a good metric for judging value? Rather than profit before tax.
My understanding is that EBITDA is normally used for tech companies where a small amount of fixed capital could result in outsized returns if the product becomes the default SAAS product in the market and so on.