Tronox Holdings plc (NYSE:TROX) Q3 2023 Earnings Call Transcript

Tronox Holdings plc (NYSE:TROX) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Good morning, ladies and gentlemen, and welcome to the Tronox Holdings Q3 2023 Earnings Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Thursday, October 26, 2023. I would now like to turn the conference over to Jennifer Guenther, Chief Sustainability Officer and Head of Investor Relations and Financial Planning. Please go ahead.

Jennifer Guenther: Thank you, and welcome to our third quarter 2023 conference call and webcast. Turning to Slide 2, on our call today are John Romano and Jean-Francois Turgeon, Co-Chief Executive Officers; and John Srivisal, Senior Vice President and Chief Financial Officer. We will be using slides as we move through today’s call. You can access the presentation on our website at investor.tronox.com. Moving to Slide 3. A friendly reminder that comments made on this call and the information provided in our presentation and on our website include certain statements that are forward-looking and subject to various risks and uncertainties, including, but not limited to the specific factors summarized in our SEC filings. This information represents our best judgment based on what we know today.

However, actual results may vary based on these risks and uncertainties. Company undertakes no obligation to update or revise any forward-looking statements. During the conference call, we will refer to certain non-U.S. GAAP financial terms that we use in the management of our business and believe are useful to investors in evaluating the company’s performance. Reconciliations to their nearest U.S. GAAP terms are provided in our earnings release and in the appendix of the accompanying presentation. Additionally, please note that all financial comparisons made during the call are on a year-over-year basis unless otherwise noted. Moving to Slide 4, it is now my pleasure to turn the call over to John Romano. John?

John Romano: Thanks, Jennifer, and good morning, everyone. On Slide 4, we’ve included an introductory overview of Tronox as a reference for anyone who may be newer to our story. For more information, please visit our website. We also have a video on our homepage that does a great job of outlining the value that we bring to our customers through our vertically integrated, sustainable mining and upgrading solutions. Before turning the call over for first quarter highlights, I want to briefly comment on the situation in the Middle East. While our exposure is minimal, our hearts go out to those impacted by the conflict, and we offer our support to those who are affected. Now let’s turn to Slide 5 to review a few key messages from the quarter.

We delivered third quarter performance within expectation despite softer market conditions by maintaining an unrelenting focus on managing what is within our control. Q3 saw relatively modest pricing declines across both TiO2 and zircon, as expected, despite depressed market volumes. This is a direct result of Tronox’s differentiated offering and the value customers place on Tronox as a supplier. TiO2 volumes improved sequentially in the Americas, while volumes were sequentially weaker in other regions, most prominently in the Europe, Middle East, and Africa. This contributed to an overall weaker TiO2 demand environment in Q3 than anticipated. Zircon sales volumes recovered in August and September from the low level seen in July as anticipated and communicated on our last earnings call.

While overall market demand levels remain muted, we are confident that the July represents the trough, as inventory levels are relatively normal throughout the supply chain. On the operational front, we’re continuing to prudently manage utilizing rates at our pigment mining and upgrading sites as a result of lower customer demand to reduced inventory levels and generate cash. At our Botlek TiO2 facility, we experienced a supplier outage that resulted in our plant being taken offline in September. We have been working closely with our supplier and believe the plant will be restarted by November 11. Importantly, this has not disrupted our ability to fulfill customer demand, as we had sufficient inventories on hand due to our ability to reposition product from other facilities as a benefit of our global asset footprint.

We have, however, incurred incremental charges from unexpected downtime due to unabsorbed fixed cost and idle facilities charges, and we’ll provide further details on that a little later in the call. Our finished goods inventory decreased in the quarter driven primarily by lower pigment inventory, partially offset by higher zircon inventories, as Atlas ramped up against a backdrop of softer market demand. Additionally, in the third quarter, we bolstered the balance sheet by proactively raising a $350 million incremental term loan, the proceeds of which were used to enhance available liquidity and will enable us to prepare for critical vertical integration capital expenditures in 2024. This is a demonstration of our commitment to balancing the medium and long-term strategic needs of the business to position Tronox for future success while ensuring we’re making the right decisions to manage what is within our control in the short-term against the current macroeconomic landscape.

Our performance quarter-after-quarter is made possible by our Tronox team, to whom we extend our thanks and for their dedication and commitment. On Slide 6, we’ll review a few updates on some of our key sustainability initiatives. First, the solar project in South Africa with South African independent power producers solar group continues to progress and construction remains on track to be completed in December of 2023. Delivery of first power is expected April 1 of 2024. This is an incredibly impactful project for Tronox, and our progress toward reducing our carbon emissions. Running at full power will convert approximately 40% of our electricity to solar power in South Africa and is expected to reduce our global emissions intensity by 13% against our 2019 baseline.

Renewable power projects remain the highest return, highest impact opportunities in progressing towards our stated greenhouse gas emissions reduction targets. We are exploring green energy opportunities at all of our sites around the world. We are also progressing in other areas of sustainability as well, including reducing waste to external landfills. Our R&D teams are currently exploring alternative uses for waste in a number of opportunities, including cement, road base, bricks and water treatment chemicals. Additionally, we’re continuing to evaluate opportunities to extract valuable minerals and metals from waste, including rare earth, scandium and vanadium. We firmly believe that these initiatives and many others ongoing at Tronox will continue to be key in not only preserving our privilege to operate, but differentiating Tronox for key stakeholders.

We look forward to continue updating you on our journey. Now let’s move to Slide 7 for a review of second quarter financial performance in more detail. Revenue of $662 million declined 17% sequentially due to lower pricing and sales volume across all products. This represented a decline of 26% relative to the prior year due to continued market softness. Income from operations was $32 million in the quarter, and we reported a net loss in the quarter of $14 million. Our normalized Q3 effective tax rate was 14%, adjusting for non-benefiting items, and our adjusted diluted loss per share was $0.08. Adjusted EBITDA for the quarter was $116 million and our adjusted EBITDA margin was 17.5%. Free cash flow on the quarter was a use of $37 million.

Now let’s move to Slide 8 for a review of our commercial performance. TiO2 revenue decreased 9% versus the second quarter, driven by a 5% decrease in sales volume and a 4% decrease in average selling prices. TiO2 sales volumes declined 14% compared to a year ago quarter, while average selling prices decreased 5%, partially offset by a 2% tailwind from favorable exchange rates. The modest decline in TiO2 pricing relative to volume levels continues to prove Tronox differentiated position and the success of our commercial strategy. Zircon volumes decreased 61% compared to the second quarter, representing a 71% decline year-over-year due to significant market softness experienced in July. As a result, zircon pricing was lower by 4% compared to the prior quarter, which represented a decrease of 3% year-over-year.

Revenue from other products was $71 million, a decrease of 24% to the prior year, largely driven by lower pig iron pricing and volumes. This was partially offset by higher sales of rare earths, which improved 27% year-over-year. As a result of our unique portfolio, we are currently evaluating a range of options to leverage our expertise to further unlock the value of the rare earths generated from our mining operations in South Africa and Australia. Our differentiated integrated position sets us apart as a global leader in sustainable mining and upgrading solutions. Looking ahead to the fourth quarter, we expect pigment volumes to be relatively flat compared to the third quarter. This represents an approximate 20% increase compared to trough levels realized in the fourth quarter of 2022.

We anticipate little to no seasonality in the fourth quarter as we believe customers have largely completed destocking. We do believe that we will see some restocking in the fourth quarter as customers prepare for 2024, which is reducing some of the seasonality impact. We expect that more stable pricing trends over the last year compared to the previous years of demand decline will continue. On zircon, we expect volumes to continue to recover substantially from the third quarter of 2023 trough levels. We strongly believe in our strategy of being vertically integrated in the value that our zircon provides to our customers. I’ll now turn the call over to JF for a review of our operational performance. JF?

Jean-Francois Turgeon: Thank you, John, and good morning. Turning to Slide 9, our adjusted EBITDA of $116 million represented a 53% decline year-on-year, driven by lower sales volume, lower product pricing and unfavorable fixed cost absorption due to lower production rate. This was partially offset by favorable exchange rate tailwind, lower freight costs and lower corporate costs. Sequentially, adjusted EBITDA decreased 31% due to lower product sales volume, lower average selling price and unfavorable fixed cost absorption due to lower production rate. This was partially offset by lower freight costs, favorable exchange rate tailwind and lower corporate costs. As John mentioned, we are continuing to run our operating site at reduced rate as a result of lower demand leveled in order to manage inventory and cash.

As a result, year-over-year production cost increase of $43 million, include $30 million of higher costs associated with lower absorption and higher input costs, and $13 million of lower of cost or market and idle facility charge due to lower production rate. Looking to the fourth quarter, as a result of the market dynamic John previously outlined, we anticipate adjusted EBITDA to be $105 million to $125 million. Turning to Slide 10. We will continue to balance the medium and long-term strategic need of the business to position Tronox for future success, while ensuring we are taking the right decision to manage what is within our control in the short-term against the current macroeconomic landscape. This includes disciplined action to reduce costs, optimizing our fixed costs, and driving additional supply chain initiatives.

We are prudently managing working capital. This quarter, we reduce pigment inventory, though we built feedstock and zircon inventory. As a reminder, our mining and upgrading asset have higher fixed cost than our pigment site. So while we have reduced production level as a result of current market demand, we are balancing running at optimal rate and we will as a result build some inventory. While our long-term strategic target is to be approximately 85% vertically integrated on feedstock as a result of the current lower TiO2 production level driven by customer demand, which was down 30% year-on-year in Q1, 21% year-on-year in Q2 and 14% year-on-year in Q3, we are continuing to run our pigment asset at lower rate. This has result in higher costs this year, which will continue in the fourth quarter.

On capital expenditure, as we have highlighted previously, we will invest approximately $270 million this year to adapt to the macroeconomic environment as it unfold by delaying investment primarily associated with volume grow not required in the short-term. While this will delay our ability to realize the benefits from our key capital project, we do believe this is the appropriate decision for the business at this time and it’s consistent with our ability to flex our capital spend. We will continue to balance cash generation, while ensuring we have the product necessary to meet our customer need and are effectively positioning Tronox for future success. I want to briefly provide our latest comment on Jazan. As we have disclosed in our filing, the original Jazan Option Agreement expired on May 10, 2023.

We extended our agreement with TASNEE such that until November 1, 2023, all chloride slag produced by the Slagger will be delivered to Tronox as repayment in kind of the $125 million Tronox loan to the project. We received shipment of the chloride slag, which reduced the loan balance and the related accrued interest by $27 million in the third quarter. Full repayment of the Tronox loan is required by January 2025 in either cash or in kind through chloride slag delivery. Tronox and TASNEE additionally agree to extend the term of the Technical Service Agreement to November 1 to enable Tronox’s continued support to the Jazan’s smelter complex, while negotiations are going on. We will keep the market update on the statues. Before I turn the call over, I would like to provide a few word on yesterday announcement of my upcoming retirement.

I’m extremely honored to have played a part in Tronox transformation over the last ten year. I strongly believe the company has never been better positioned to continue navigating the current environment and generate meaningful value for shareholder. I look forward to the future ahead for Tronox and I wish John the best as he take over, having absolute confidence he is the right choice to continue to lead the company. I would like to thank the Board, John and my colleagues for an incredible journey at Tronox. It is the effort of all of our employee that make Tronox what it is today. And with John’s vision and leadership, this will continue to evolve for the better. I will now turn the call over to John Srivisal for a review of our financial position.

John?

John Srivisal: Thank you, JF, and congratulations. We are all grateful for the invaluable contributions you’ve made to Tronox. Turning to Slide 11. We ended the quarter with total debt of $2.8 billion and net debt of $2.6 billion. Our net leverage at the end of September was 4.8 times on a trailing 12-month basis. The incremental term loan of $350 million raise in the third quarter reinforced the strength of our balance sheet and bolstered available liquidity ahead of anticipated critical vertical integration related capital expenditures in 2024. This transaction increased total available liquidity by approximately $350 million while net leverage remained net neutral as we use the proceeds to pay down outstanding borrowings on our revolving credit facilities with the remaining going to cash.

Our nearest term significant maturities remain 2028 and we have no financial covenants on our term loans or bonds. We maintain interest rate swaps such that approximately 73% of our interest rates are fixed through 2024 and approximately 64% are fixed from 2024 through 2028, aligning with the maturity of our term loans. Total available liquidity as of September 30 was $726 million, including $246 million in cash and cash equivalents, which is well distributed across our global operations. Capital expenditures totaled $54 million in the quarter, approximately 55% of this was for maintenance and safety, and 45% was for strategic growth projects. Depreciation, depletion and amortization expense was $67 million for the quarter. As John mentioned earlier, our free cash flow was a use of $37 million.

We reduced our pigment inventory levels in the quarter. Offsetting this benefit was increased feedstock levels due to lower pigment plant production as well as higher zircon inventories, as Atlas ramped up against a backdrop of softer market demand. We returned $19 million to shareholders in the form of dividends. Moving to Slide 12. Based on our current view that John and JF outlined, we anticipate fourth quarter adjusted EBITDA to be $105 million to $125 million. Pivoting to our expectations for our 2023 cash uses, our working capital assumption increased to a use of approximately $185 million. While we are continuing to actively manage working capital, including continuing to reduce pigment inventories through year end, the increase is a result of the softer market conditions driving higher than expected zircon inventory levels.

Our net cash interest expense is expected to be $125 million, our cash taxes are expected to be approximately $40 million, and our capital expenditures are expected to be approximately $270 million for the year. We remain focused on delivering on our commitments. I will now turn the call back over to John Romano for a few closing comments before we get to questions. John?

John Romano: Thanks, John. I wanted to also congratulate JF on his upcoming retirement and thank him for being an extremely valuable partner and a force of positive change in our company over many years. It’s been an honor to serve in this role as Co-CEO together with him and especially with someone for whom I hold an immense amount of respect. I’m excited about the future for Tronox, and I’m confident it will be a smooth transition over the next six months. And with that, we’d like to turn the call over to questions. Operator?

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Duffy Fischer at Goldman Sachs. Please go ahead. Your line is open.

Duffy Fischer: Yes. Good morning, guys. Just a question on your expectations going into the fourth quarter, it seems like you guys are more bullish on volumes for both TiO2 and zircon. I think most others have kind of commented they see things continuing to be down. Can you just walk through what underscores your belief that volumes will be flat? What are you seeing in the market for both zircon and TiO2, please?

John Romano: Yes. Thanks, Duffy. So on TiO2, we said relatively flat. And part of that has to do with – the market has already – has been significantly down for the last eight quarters, we’ve seen volumes down. And we called the bottom in the fourth quarter of 2022 and we’ve continually seen that uptick. We do believe that all the destocking has run its course. And when we look at our order book for the fourth quarter, that reference to – little to no seasonal demand, we’re seeing some areas in areas like Asia Pacific where our volumes are actually up in the fourth quarter. So is that because the market has recovered significantly? No. Part of it is just because customers are starting to order again. So we feel pretty confident in where we are at this stage.

We’re a third of the way through the quarter. We’ve got good visibility in where our order book is at this particular stage. I mean, there is a range that we provided, but at this particular stage, on the volume side of the equation, we are continuing to see things move in the right direction as we move into first quarter next year. And we’ll provide more guidance on 2024. But we’re cautiously optimistic that we’re moving in the right direction for a recovery on TiO2. On zircon, the third quarter was the lowest quarter we’ve had in many, many years. And when we think about where we are, we called the bottom in July, we saw volumes pick up significantly in August and September. So when we look at the fourth quarter, based on our forward order book, our volumes are expected to be up over the third quarter by more than 50%.

So we’re coming from a very low base, but those volumes are up and we feel confident in what those numbers are looking like in the fourth quarter at this stage. So I hope that answered your question.

Duffy Fischer: That is helpful. Thank you. And then on the comment, did I hear that right, working capital is going to eat $185 million in cash this year? And if that’s right, what do we need to see next year for that to be released?

John Srivisal: Yes. And Duffy, that’s correct. We are guiding $185 million use for the full year. Obviously, we do expect Q4 to be a generator of cash. If you count through LTM, the first nine months of the year, we’re roughly at the $218 million use. So we will have a benefit for the fourth quarter. We do see – we have managed our inventory down pretty well, so we’ve brought down production levels. But frankly, the driver here on inventory, as we mentioned, is the zircon market. So continue to produce, obviously, we’re running our minds. Zircon is a product that comes out of it. So we’re building inventory, roughly $50 million build in the second half of the year, that’s driving that. So as we look towards 2024, we do expect to be working capital to be a use.

Obviously – sorry, expect working capital to be a source of cash for 2024. As we do expect, as John mentioned, we do expect the market to recover. So we do expect to sell the inventory, draw that down, and generate significant amount of cash.

Jean-Francois Turgeon: And Duffy, I would add, we obviously – it’s zircon, but it’s also high grade feedstock, because we have slow down our mine, but we have not slowed them down as much as our pigment plant. And because of that, we have built some feedstock.

John Srivisal: That’s right. Yes. Obviously, we brought down pigment production, but we’re not using the feedstock. So that’s building this year as well.

Duffy Fischer: Great. Thank you, guys.

Operator: Thank you. Our next question comes from the line of David Begleiter of Deutsche Bank. Please go ahead. Your line is open.

David Begleiter: Thank you. Good morning. Just going back to the Q4 volume expectations and TiO2, how good is your visibility? And you mentioned some potential restocking. How confident are you on that occurring either in Q4 or Q1?

John Romano: Well, we’ve provided guidance for Q4. And again, based on our forward order book at this particular stage and what we’re seeing in the month of October, which is largely past, we’re seeing some of that rebuild happening. And again, it’s not happening in every region. So that rebuild is having an impact or dampening effect on what we would normally see as seasonal demand downturn. So in a normal year, and again, you got to go back a while to find a normal year, but you’d say high-single digits kind of decrease in demand in the fourth quarter for seasonal adjustments, we’re seeing nothing in that range. So a lot of it has to do with customers having destocked significantly and having to start rebuild some of the inventory. So I’d say, in some areas, it’s going back to normal buying patterns, which they have not been on for more than three quarters.

Jean-Francois Turgeon: And John, we can add that obviously Q3 was a very low volume quarter. So that’s why being flattish for Q4 is not a great quarter.

David Begleiter: Understood. That’s helpful. And just on the CapEx for next year, can you talk to the increase? And is there any potential for further delays, if the macro remains or even gets more challenging from here? Thank you.

Jean-Francois Turgeon: Look, maybe I can cover that. Look, we obviously wanted to be in a good position to continue to invest in our vertical integration. And we have a couple of projects in our mine in South Africa that will create a lot of value. And when we talk investing in mine, you’re talking of project that will take couple of years to realize, but then they had ten-year of benefit to the company. And we will obviously adjust that capital requirement based on what we will see the economy of the world do. We always said we have some flexibility with our capital, but there is some good project that will add value to the business that we consider doing at the moment, based on what we’re seeing. I mean, we expect 2024 to be better than 2023.

I mean, we called the downturn for TiO2 in Q4 2022, and we still commit that that was the case. And the downturn for zircon was in Q3 this year, and we’re seeing things improving, and we expect 2024 that will continue to improve for zircon as well.

John Romano: I mean, if there was some sort of unforeseen event, a war escalated somewhere, we needed to make adjustment, we do have flexibility on that 350 and we would adjust accordingly.