TPS Trade Alert – April 26, 2016

Recommendation:

Buy Valhi Inc. (NASD: VHI) up to $2.30 per share.

 

The Opportunity:

It would be tough to imagine a company that has its hand in a more bizarre combination of businesses.

Valhi manufactures chemical compounds, locks for slot machines, and tachometers.

It’s even into waste management and real estate.

We’re typically not big fans of conglomerates.  We haven’t forgotten the expensive lessons of the late 1960s, when trendy conglomerates sputtered.  The only story with a happy ending in the conglomerate business is Warren Buffet’s Berkshire Hathaway.

We’re not suggesting Valhi is the next Berkshire Hathaway.

But when we look at this rather strange company that’s been around since 1932, we see an intriguing opportunity.

Valhi, Inc. is a subsidiary of a holding company called Contran.  Contran controls 93% of the company.

The best way to understand Valhi, and to see the opportunity, is to slice the company into four pieces… chemicals, component products, waste management, and real estate.

It’s the chemicals segment that’s bleeding.  Valhi’s core product is titanium dioxide.  Titanium dioxide is a pigment used by any manufacturer in the coatings industry that needs to make a product white.

Valhi’s chemical business shrank by 18% in 2015.  In Q4, it was down by 23%.

Along with lower market prices for titanium dioxide, the company took an overseas tax hit in Q2 on German and Belgian operations.

That’s the story on the chemical segment.

The component products business is better.  Revenue grew by $5.1 million in 2015 over 2014.  Operating income for the segment was up as well.

Waste management sales were down, off $21.5 million for the year.  The problem… the company ran into trouble securing waste shipping containers.  Business was also off because a large project performed at a nuclear power plant in 2014 was completed.

Real estate had an off year as well, breaking even in 2015 compared with operating income of $2.0 million in 2014.

Put these all together, and in 2015, Valhi lost $133.6 million, compared to a $53.8 million profit in 2014.

 

Trade Rationale:

The key to this investment is chemical prices.

With a rebound in chemical prices in general, and higher pricing for titanium dioxide in particular, Valhi can roar back.

How likely is this?  At the end of 2015, according to ICIS Research, global supply exceeded demand by 20%.

But now, we’re starting to see prices are firming up.  Just a few weeks ago, the #1 titanium dioxide producer, a Valhi competitor, raised the price by $150 a ton. This is the second price hike for the chemical in less than six months.

The price increases confuse some chemical industry analysts, who aren’t convinced the market realities of supply and demand will allow the hike to stick.

But this is good news for Valhi, and so far, the market doesn’t appear to have taken this into account.

The stock price has been decimated.  In the late summer of 2013, the stock traded at $21.08.  The fall from grace has been extreme.

Over the past few months, Valhi has made some wild shifts.  It surged up to $1.71 from $0.90 in just two weeks when the broader markets rebounded from January’s selloff.

Over the past year, Valhi’s stock price reflects similar volatility.  It has traded between $0.85 and $7.33.

Look at where the stock has been over the past two years…

What’s next?

We do not see insurmountable problems in the waste management and real estate arms of the company.  Component sales should continue to do well.

 

Investment Risks:

The #1 risk is what happens with chemical prices.  An uptick in titanium dioxide prices can easily improve Valhi’s picture, but if prices stay low, losses will continue to pile up.

There may be unpleasant surprises in the waste management business, either through operational issues or the inability of the company to secure profitable new business.

We do not foresee major problems in the real estate or components divisions.

 

Potential Return: 

At $2.17, Valhi is on sale.

We believe Valhi is the poster child of an undervalued stock, and can easily be trading in the $3.50-$5.00 range by year’s end.

 

Key Facts:

Company:                                   Valhi Inc.

Ticker:                                           VHI

Recent Price:                              $2.17

Buy up to Price:                          $2.30

Market Cap:                                $705.4 million

Avg. Daily Volume (3 month):        66,151 shares

 

Category: TPS Trade Alert