After a long streak of weeks without potential superstock, we are finally back with a potential superstock candidate, and the company is NL ...

Weekly Superstock Scan 21 May 2018 - 25 May 2018: NL Industries, Inc.

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After a long streak of weeks without potential superstock, we are finally back with a potential superstock candidate, and the company is NL Industries Inc (NL).




NL is primarily a holding company with a majority stake in CompX International Inc and also a non-controlling stake in Kronos Worldwide, Inc. Both CompX and Kronos are listed companies on the NYSE.

The structure of NL is complex. Valhi, Inc held approximately 83% of NL's outstanding common stock. NL in turn owns the following:
  • 87% of CompX - CompX manufactures mechanical and electrical cabinet locks and other locking mechanisms used in the recreational transportation, postal, office and institutional furniture, cabinetry, tool storage and healthcare applications, and also stainless steel exhaust systems, gauges, throttle controls and trim tabs for the recreational marine and other industries.
  • 30% of Kronos - Kronos is a leading global producer and marketer of value-added titanium dioxide pigments, or TiO2, a base industrial product used in a wide range of applications
  • 14.4 million shares of Valhi - This is confusing since Valhi owns 83% of NL and yet NL still owns shares of its parent company.

Technical



NL was trading in the $14 region from end 2017 to the beginning to this year. In February, price fell steeply to trade in the $8 region. Last week, price broke above the range to close at $9.60. The volume of the week was only slightly above its weekly trading volume.

The catalyst for the spike was a settlement that NL agreed to pay to fund remediation of lead paint in California. The settlement of $60 million ended 18 years of litigation. The market viewed the amount as a favorable amount and NL is happy to put the litigation behind it without acknowledging any wrongdoing as part of the deal.

Fundamentals




Including the most recent quarter, NL recorded 7 consecutive quarters of year-on-year EPS growth. 

Recovering Titanium Dioxide Prices

Since NL is primarily a holding company, I will need to analyse the subsidiaries separately. Between Kronos and CompX, Kronos is more likely to provide the catalyst for future growth. Titanium prices have been spiralling downwards for years due to oversupply brought by cheap Chinese competition. But the trend reversed as Chinese competitors failed to compete and exited the industry. 

Titanium Dioxide price recovered in 2017 and is expected to continue through 2018. In 1Q2018, Krono's average selling price was 28% higher year on year.

On the demand side, demand for Titanium Dioxide is expected to increase due to increasing prevalence in modern coating, plastic, glass, paper and other food and beauty products. New found use in solar panels will also increase the demand for Titanium Dioxide.

Stakes Exceed Market Capitalization

As at the end of the most recent quarter, NL held the following shares:
  • 35.2 million shares of Kronos - worth $873 million
  • 10.8 million shares of CompX - worth $158 million
  • 14.4 million shares of Valhi - worth $105 million
Along with $100 million of cash, these liquid assets are worth more than $1200 million. The market capitalisation of NL, however, is just $467 million based on the current price. NL has minimal debt, so the differences between the assets and the market capitalisation is the potential liability on environmental remediation and related costs. 

NL formerly manufactured lead pigments for use in paint. NL and other manufacturer have been named as defendants in various legal proceedings seeking damages for personal injury, property damage and governmental expenditures allegedly caused by the use of lead-based paints. 

NL does not believe that they have incurred any liability except for County of Santa Clara v. Atlantic Richfield Company, et al, which was the case described earlier. This case caused the value of NL to be heavily discounted as the likelihood of loss is high and yet the amount of loss cannot be estimated easily. Hence, the $60 million settlement reached last week is indeed great news for the company putting a close to 18 years of litigation and the amount is probably way less than what the market discounted NL for.

Matrices
o Small float of 8.25 million shares with a average daily trading volume of 50000 shares. The float is thus 165 times its average trading volume.
+ NLis trading at just 6 times its trailing twelve months EPS.

Risk Factors/ Things I do not like:

  • Litigation - While the case of Santa Clara is finally resolved, other CA counties or even counties in other states may file new cases against NL. While the probability of losing the case is small for NL, any loo can have a material adverse impact on NL. Certain properties and facilities used in their previous former operations are the subject of civil litigation, administrative proceedings or investigations arising under federal and state environmental laws and common laws. They have accrued more than $100 million for the environmental remediation and related costs. NL has estimated the upper limit to be $154 million, excluding certain cites that they cannot reasonably estimate the range of costs. 
  • Cyclical Titanium Dioxide Price - The Titanium Dioxide market is a cyclical market. Having seen big gains in 2016 and 2017, it can possibly have a downturn in 2018 like what happened in 2014. Also, the cost of the raw material used to produce Titanium Dioxide is increasing. Despite Kronos owning some mines for the raw material which can offset some of the impact of increasing raw material cost, there will still be some impact on the margins of Kronos.







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