Trecora Resources ($TREC) — Initiation (4/10/21)

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Originally sourced this one from constantly seeing it pop up on a list of insider buying. Turns out the CEO, Patrick Quarles, has been relentlessly buying shares for a few years now. From nothing to ~214,000 shares in 2 years.

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Summary thesis…

  • Specialty chemicals have historically been a hunting ground for good businesses
  • Significant asset sale ($69m) cleans up balance sheet (net cash position)
  • Capex projects should lead to EBITDA growth
  • Valuation — 8.5x EBITDA based on 2020 trough numbers
  • Insider buying — already mentioned, CEO is betting big on his company

Company background…

Trecora operates 2 primary businesses

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1) Petrochemicals - South Hampton Resources (SHR)

Cliff notes version of this segment — Trecora is 1 of 2 producers (the other being Phillips 66) and the primary uses are twofold: 1) in the production of polyethylene (think: Dow Chemical or LyondellBasell); and 2) in crude oil production from Canadian oil sands.

The oil sands piece of this business is dwindling making the only true opportunity on the polyethylene side (core building block for plastics and plastic products). Making plastics is a big and growing market but Trecora is playing in a small subset of that opportunity…

Global polyethylene trends are on the upswing… and should lift this boat…

Polyethylene global market capacity

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2) Specialty Waxes - Trecora Chemical Inc (TC)

A much smaller business, TC makes chemicals used in the production of paints, inks, toner, adhesives, etc.

This segment is smaller and much less profitable on a consistent basis. This segment was acquired via acquisition in 2014 for $75m.

Segment financial performance

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Like many other commodity-driven businesses, it looks like Trecora got caught up in making large investments at the height of the energy price environment. Since then, they’ve had to cut back on capex as the business has been reeling.

Financial overview…

Trecora is a $195m market cap / $185m enterprise value company at around $8 per share.

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1) Revenue and EBITDA trends

Revenue has been falling since 2018. This has been both a volume and a price problem for Trecora with both pieces of the equation falling in 2019 and 2020. COVID certainly had an impact. Energy prices (mainly natural gasoline) had a big hit on average selling prices as most of these chemicals are priced off of natural gas liquids.

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EBITDA has been flat at $31m per year from 2016-2019 and then fell to $21.6m in 2020.

As recently as Q4 2020, the business is still declining — revenue fell 6% and EBITDA fell 25% in Q4.

Input costs (natural gasoline) and COVID dented the business the past few years but trends are starting to reverse to the point where management is calling for high-single-digit growth in prime products from the 2019 base with solid growth prospects from there.

2) Cash flow

Trecora went through a major capex cycle the past 5 years as they took on some organic growth projects.

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The business generates plenty of cash… The problem here is that it all went to organic growth projects that have not turned into higher operating cash flows…

An energy play…

It’s clear there’s some correlation between Trecora and energy prices… Maybe this is more of a commodity chemical business with a quiet play on energy prices?

From the 10-K, how Trecora prices their products:

We utilize both formula and non-formula based pricing depending upon a customer’s requirements and competitive situations. Under formula pricing, the price charged to the customer is primarily based on a formula which includes as a component the average cost of feedstock over the prior month. With this pricing mechanism, product prices move in conjunction with feedstock prices. However, the formulas use an average feedstock price from the prior month. Current formula product sales prices trail current market feedstock prices by approximately 30 days.

The stock has moved more-or-less in-line with the Energy index over the past few years. Here’s Trecora charted against 1) the energy sector; and 2) NGL pricing (feedstock cost):

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Management highlighted feedstock costs rising to 2018 levels as being a potential upside factor for company performance. There’s a lag in their formula pricing model so results may not show this trend until 2Q21… But it’s reasonable to expect earnings to climb back toward pre-2019 levels.
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Valuation…

I think it’s likely Trecora returns to 2019 EBITDA levels — $30m or better — in 2021 and beyond. The damage from oil sands customer base is mostly done and input costs (which are tied to pricing) are on the uptrend.

Major petrochemical makers — Dow and LyondellBasell — trade at ~8x EBITDA on 2021 estimates. But a good comp might be in Tredegar Corp ($TG) — a polyethylene exposed $500m chemical small cap — Tredegar is currently trading at ~10x EBITDA.

I have Trecora trading at a 6.2x multiple on $30m in EBITDA. An 8-10x multiple makes this a $10-12 stock.

My estimates take a slower build back to $30m EBITDA — mostly from the lag in pricing resets.

  • Management guided to $13m in capex — still quite high compared to peers.
  • Interest expense at 4Q20 annualized ($330k) comes to ~$1.4m.
  • D&A has been hanging around at $16m per year and capex is 80-85% of D&A so it shouldn’t decline much.
  • The Texas shutdowns from weather in 1Q21 could have an impact on the business — I pegged it at ~$1m EBITDA hit.
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Management will have some cash to deploy — roughly $50m in total by end of 2023 by my math — there is currently a $20m buyback authorization in place which would be 10% of total shares.

Past management teams have made some unlucky (bad?) capital allocation decisions in the past — heavy capex in poor price environment, bets on oil sands growth, acquiring wax business. But the new CEO has been building a large position and seems geared toward returning cash to shareholders.

I’ll be watching this one to make sure revenue / EBITDA start trending with feedstock costs. I’d get a bit more excited if they intended to divest the wax segment. And if buybacks / insider buying pick up pace, I’ll probably tag along for the ride.