Small Cap Strategist is published by Crystal Equity Research an independent research resource on small capitalization stocks. Follow along as we discuss the most recent trends in the small-cap sector, investigate interesting companies and pan a few not-so-promising stocks.
Part I: Changes Afoot in Titanium Pigment Industry
A Canadian company
has developed a new low-cost, environmentally friendly process to create titanium
pigment.The process has already got the
attention of one major buyer in the paint and coatings industry, and that could
present a big challenge for incumbent titanium pigment producers.This is the first in a two part series
offering investors two ways to play the innovation.
Cost of Paint
summer, with its not too cold and not too hot temperatures, is high season for
home improvement.A bit of grass seed
here and some paint there, leaves the ol’ homestead looking like new.During the entire year 2014 over 1.2 billion
gallons of paint will get applied to U.S. structures.Globally, home and business owners coat dwellings and buildings with three billion
gallons of paint a year.That
is big business for the likes of Sherwin-Williams (SHW:NYSE), PPG Industries (PPG:NYSE) and Valspar (VAL:NYSE).
Industry analysts at Timetric expect
the global market size of paints and coatings to increase at a compound annual
rate of 7.1%, reaching US$69.4 billion by 2016.
year some of us may have fallen victim to ‘sticker shock’ when buying
paint.Many of the major paint suppliers
implemented single-digit price increases in 2014, to cover increases in raw
materials costs.Raw materials,
principally titanium dioxide, represent between 70% and 80% of the cost of
paint.Titanium dioxide is an opaque
substance that gives paint its high gloss and rich depth of color.Indeed, it is the whitest substance known to
man. TiO2 for short, titanium dioxide
replaced lead in paint after lead’s toxicity was fully understood.
rising cost of TiO2 is due in part to the growing popularity of this metal for
a wide array of uses.Many of us
probably think first of golf clubs and space vehicle coatings.However, TiO2 is also used in coloring for
food, cosmetics and crayons as well as ultra-violet protection in
sunscreens.Innovators in Japan are
using TiO2 for its disinfecting qualities and European manufacturers are
coating ceramic tile with TiO2.The food
industry is eyeing the photocatalytic properties of TiO2 to remove ethylene gas
from the air around fruits and vegetables so as to stave off ripening and
prevent spoilage.Global TiO2
consumption is estimated at around 5.2 million tons per year, representing a
value of US$16 billion per year according to the industry research firm TZ
Minerals International Pty.
proliferation of uses has put pressure on demand and selling price.Suppliers and their customers are meeting
both challenges head-on.For example, after
a public spinoff failed to gain traction, Dupont Chemicals is now considering a private
spinoff of its TiO2 operation to current Dupont shareholders followed by a
merger with Tronox Ltd. (TROX: Nasdaq), another smaller TiO2 producer.Dow
received recognition from the Department of Environmental Protection for its
Evoque branded paint ingredient, which is formulated to reduce the carbon
footprint of latex paints.More
importantly, it is expected to reduce the required amount of expensive TiO2 materials by
Supplier Enters Market
latex paints represent only a portion of total paint demand, so Dow’s Evoque is
not likely to make much of a dent in the overall demand or price situation for
TiO2.That is why an investment by
another paint industry competitor is so interesting.Keeping with its corporate motto ‘bringing
innovation to the surface,” PPG Industries has entered into a development
relationship with an enterprising Canadian company that could upset the
proverbial cart in the supply of TiO2.
Argex Titanium, Inc.
(RGX:Toronto, ARGEF:OTC) has a history in
the mining industry and management knows its rocks.Argex plans to produce high purity TiO2 pigment
from ilmenite ore using a highly proprietary process the company has been
developing with PPG’s support.A
demonstration plant in Salaberry-de-Valleyfield, Quebec has proven highly
successful.Apparently PPG has been
sufficiently impressed with Argex’s progress that last year PPG entered into a new technology
sharing and supply agreement with Argex.
one off-take agreement under its belt, Argex management has hit the road to line up
more customers.In October 2013, the
company signed an agreement with a yet-unnamed distributor that has pledged to
take at least 25,000 tons of Argex TiO2
each year.Roy Bonnell, Argex’s chief
executive officer, has more distribution discussions underway.
still needs to build its first commercial production facility.The company has located a suitable building
at an industrial park near its headquarters in Quebec, Canada and has completed
an engineering study of its process.Next step is to secure an environmental certificate and get construction
permits.The design of Argex’s
production facility calls for standard equipment, some of which has already
been put on order.It will take at least
one full year after construction is completed to reach full production.
the meantime, Argex is working hard on sourcing ilmenite for its Canada plant. The ore can be found
in abundance in a number of other continents, including North America and South
Asia.Currently Australia is the largest
ilmenite source, with South Africa running a close second.While Canada is fourth in terms of total
ilmenite production, Rio Tinto’s (RIO:NYSE) Lac Tio mine in Quebec is the largest with three million tons per
year in annual production capacity.
Argex expects to open additional production plants in other locations.It might seem logical to locate production
near ilmenite sources in order to minimize the cost of transporting heavy feedstock
ores.However, Argex’s chief financial
officer Glen Kayll has put a sharp pencil to all production costs.The availability of low-cost natural gas
supplies might ultimately sway the location decision.
Balance Sheets and Capital Needs
price tag for Argex’s first TiO2 production plant in Canada is near CDN$300
million. However, at the end of December 2013,
Argex held CDN$5.1 million in cash and short term investments, just enough for working capital.Argex management expects to raise all the
required capital yet in 2014 and begin construction of its first plant next
year.Most likely the financing will
take the form of both debt and equity as the anticipated profit margins would
certainly support servicing some debt.I
would not look for a public offering, but qualified investors might have a
chance to take part in a private placement.
private placement of CDN$7.5 million of 8% convertible debentures is already
underway.The proceeds will be used as
working capital while the company prepares for the construction phase.The debentures will present an element of
potential dilution as the debentures convert into 6.6 million new shares of
Argex common stock at the rate of CDN$1.14 per share.The company already has 113.2 million shares
outstanding and another 19.9 million in options and 1.1 million warrants have
been issued.With all derivatives exercised
and debentures converted, the company would have 140.8 million shares
outstanding-an increase of 24%.
some investors the shortage of capital and the potential for double digit
dilution are less than appealing.Thus
the play on Argex’s innovative TiO2 production process might be better made through
its first customer, PPG Industries.
the paint supplier has no trouble meeting its capital investment
requirements.PPG’s operations are
strong cash generators, turning an average of 12% of sales into operating cash
flow over the past three years.PPG’s
capital spending budget averages approximately US$400 million annually.As of March 2014, the company had built up a
fairly impressive nest egg on its balance sheet composed of US$1.7 billion in
cash and short term investments.There
was another $393 million on long-term financial investments.
PPG Industries might be the better vehicle for some
investors to take advantage of changes in the titanium pigement market.However, we have added Argex to the Materials Group of our Mothers of Invention Index
of innovators in alternative energy.The
company has more to offer than just new TiO2 production.The Argex TiO2 process presents real change
in TiO2 production in terms of cost and environmental profile.In the next post we will look more closely at
how Argex’s technology has the potential to turn the TiO2 pigment industry on
Neither the author
of the Small
Cap Strategist web log, Crystal Equity
Research nor its affiliates have a beneficial interest in the companies mentioned