Tronox Holdings plc (NYSE:TROX) Q3 2022 Earnings Conference Call October 27, 2022 8:00 AM ET
Company Participants
Jennifer Guenther – Vice President, Investor Relations
John Romano – Co-Chief Executive Officer
Jean-Francois Turgeon – Co-Chief Executive Officer
Tim Carlson – Chief Financial Officer
Conference Call Participants
Duffy Fischer – Goldman Sachs
Josh Spector – UBS
David Begleiter – Deutsche Bank
Hassan Ahmed – Alembic Global
Frank Mitsch – Fermium Research
Matthew DeYoe – Bank of America
John McNulty – BMO Capital Markets
Jeff Zekauskas – JPMorgan
Will Tang – Morgan Stanley
Michael Leithead – Barclays
Operator
Hello and welcome to the Tronox Holdings Q3 2022 Earnings Call. My name is Harry and I’ll be your coordinator today. [Operator Instructions]
I would now like to hand you over to Jennifer Guenther Vice President of Investor Relations to begin. Jennifer please go ahead.
Jennifer Guenther
Thank you and welcome to our third quarter 2022 conference call and webcast. Turning to slide two, on our call today are John Romano and Jean-Francois Turgeon, Co-Chief Executive Officer; and Tim Carlson, 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 three. 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. The company undertakes no obligation to update or revise any forward-looking statements.
During the conference call, we will refer to certain non-US 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 US GAAP terms are provided in our earnings release and in the appendix of this 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 four, it is now my pleasure to turn the call over to John Romano. John?
John Romano
Thanks Jennifer and good morning everyone and thank you for joining us today. For those of you who have joined who may be a little less familiar with the Tronox story, we’re the world’s largest vertically integrated TiO2 producer with nine pigment plants, six mines, and five upgrading facilities across six continents.
2021 revenue totaled $3.6 billion which was fairly evenly distributed across the Americas, Europe, Middle East, and Africa, and Asia-Pacific. Our 1.1 million tons of pigment capacity supports our well-balanced base of approximately 1,200 customers globally. Our vertically integrated business model supplies approximately 85% of our internal feedstock needs and this ensures consistent and secure supply for our customers.
In addition to TiO2, we also generate significant value as the world’s second largest producer of zircon with approximately 300,000 tons of capacity. I invite you to listen to a replay of our Investor Day webcast from June if you haven’t already done so to learn more about our strategy, key initiatives, and mid and long-term financial targets.
Now, turning to slide five. Tronox’s strong margin performance continued in the third quarter enabled by our vertically integrated portfolio, despite difficult market conditions. We achieved adjusted EBITDA of $247 million within our updated guidance range and adjusted EBITDA margin of 27.6%. And this is now the 22nd quarter in a row that we’ve achieved adjusted EBITDA margins greater than 20% and the eighth consecutive quarter where margins were above 25%, evidence of the strength and resilience of our business through a variety of economic scenarios.
We invested $314 million in ongoing key capital projects that reinforce Tronox’s commitment to strengthening our business model. And we returned $110 million to shareholders year-to-date including share repurchases and dividend payments.
And finally, we’re now realizing increasing value from Tronox’s higher-value co-product streams which include monazite, consisting of high-value rare-earth elements. The monazite has a higher margin because it carries very little cost as historically those co-product streams were stockpiled as waste. This demand for light rare earth elements found in monazite is increasing dramatically given their use in many facets of the emerging and green economy, including permanent magnets for electric vehicle motors and wind turbines.
While revenue for these co-product streams is less than $30 million year-to-date, the rising interest has driven a 74% increase in high-value co-product revenues year-over-year, enabling Tronox to realize greater value from what it was previously viewed as waste. This provides an interesting growth opportunity for Tronox to not only generate incremental earnings but also support growth in the renewable energy space.
Turning to slide six, our third quarter revenue of $895 million represented a 3% increase, driven by higher TiO2, zircon, and pig iron prices and higher pig iron volumes. Income from operations was $163 million and net income attributable to Tronox was $121 million.
Our GAAP diluted earnings per share was $0.77 and our adjusted diluted earnings per share was $0.69 with the primary difference being due to a 10% share benefit we recorded in the quarter for an adjustment to a valuation allowance of an Australian deferred tax asset.
Adjusted EBITDA of $247 million represented a 2% decrease largely due to softer market conditions. Our margin decreased 140 basis points to 27.6% driven by higher costs and unfavorable product mix from higher pig iron volumes that rolled from Q2 to Q3.
And finally we generated $25 million in free cash flow, which was impacted by the inventory build in the quarter from both Jazan feedstock purchases and the replenishment of safety stock as a result of softer demand. And we’re taking action to address this in the fourth quarter as JF will review with you in a few minutes.
Moving to Slide 7. As we communicated in our release last month TiO2 volumes were softer in the quarter due to significant reduction in demand in Europe, Middle East and Africa and Asia Pacific. Pricing across both TiO2 and zircon was in line with our expectation, driven by our continued execution on our commercial pricing strategy. TiO2 volumes declined 13% sequentially, while average selling prices increased 3% on a local currency basis or 1% on a US dollar basis.
Zircon volumes improved 8% compared to the quarter, owing to the orders that rolled from the second quarter and into the third quarter, and positive pricing momentum continued in zircon resulting in a 7% price increase versus the prior quarter. Revenue from other products was $94 million, an increase of 31% driven by higher pig iron and rare earth revenues. The strengthening US dollar in the quarter was a headwind of revenue due to the unfavorable translation impacts, primarily from the weakening of the euro.
So looking to the remainder of the year, we expect fourth quarter pigment demand to decline 25% to 30% sequentially driven by customer destocking continued weakness in Europe, Middle East and Africa and Asia Pacific and seasonal weakness in the Americas. Customer inventory levels remain low relative to previous periods of economic weakness, so we do not believe we will see similar levels of destocking as we move into 2023. Based on this and direct customer feedback, we’ve received, we are confident Q4 will be the trough for TiO2 volumes.
We continue to see the benefits of our vertical integration and margin stability initiatives in our financial results. And as we’ve communicated previously, we do not expect pricing to move as it has in previous economic transitions owing to the differentiated landscape and the commercial approach that we’ve implemented over the last several years.
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 8. Our adjusted EBITDA sequential decline was driven by higher cost to serve our customers, including increased commodity costs in addition to lower volume, partially offset by higher pricing across all products and favorable exchange rate on our operations. We saw a headwind to margin from product mix has higher sales of pig iron in the third quarter had an unfavorable impact to margin. Freight rate remained level from the prior quarter has increased abate. Costs have been a significant headwind in the year, no different to other players in our space.
Our major material increased 12% sequentially, or 58% year-over-year on a constant currency and volume basis, primarily driven by coke, chlorine, sulfur, sulfuric acid and energy costs. The 58% increase on our major material equate to a $95 million headwind versus the prior year.
In total, $29 million of the $50 million sequential headwind to EBITDA from production costs was driven by higher cost tons sold in the quarter and lower fixed cost absorption. We also incurred a $17 million lower cost or market charge due to lower pig iron pricing. The weakening Australian dollar and South African rand had a favorable impact on production costs and more than offset unfavorable FX translation impact to revenue. This results in a net positive $14 million FX impact on EBITDA compared to the prior year.
Turning to slide 9. As a result of the macroeconomic backdrop, we are taking action to navigate the current landscape and position Tronox for success. We employ a robust process as a part of our forecasting review that enable us to plan for a variety of economic scenario. Combined with our enterprise optimization model, we are able to react swiftly and optimize our portfolio.
We continue to be laser focused on cost reduction and have a number of levers to optimize performance across a variety of scenario that we are executing on. We have already begun executing on our cost reduction playbook. We have implemented a hiring freeze. We are reducing professional fee, travel and other discretionary costs. We are also optimizing our fixed costs and driving additional supply chain initiatives.
Softening demand drove increased TiO2 inventory level in the third quarter and allowed us to replenish our safety stock, which has been below seasonal norm level for the last several quarters. Additionally the contracted purchase of Jazan slag drove increased feedstock level.
As a result, we have taken action to reduce production level due to lower customer demand. As we have highlighted previously, the vertical integration investment and newTRON are key projects to support our medium and long-term profitable growth initiatives. However, we have implemented plans to significantly reduce our annual capital spend to below $275 million in 2023 to adapt to the macroeconomic environment as it is unfold [ph].
While this will delay our ability to realize benefits from these projects, we do believe this is the appropriate decision for the business at this time and it is consistent with our ability to flex our capital spend. We anticipate this action will enable Tronox to generate positive free cash flow across a variety of scenarios including our recession case.
We will continue to balance cash generation while ensuring we have the product necessary to meet our customer needs and are effectively positioning Tronox for future success.
I would now like to turn the call over to Tim for a review of our outlook. Tim?
Tim Carlson
Thank you JF. Turning to slide 10. We continue to monitor developments through a monthly bottoms-up view of market trends. Our process involves a robust discussion to thoroughly evaluate identifiable risks and opportunities to our forecast. Based upon our current review, we expect adjusted EBITDA in the range of $140 million to $170 million for Q4. This assumes TiO2 volumes declined 25% to 30% sequentially. The range also includes approximately $10 million in total one-time charges from lower production levels.
As a result, our expectation for our full year 2022 adjusted EBITDA is to be in the range of $902 million to $932 million. Our updated cash use assumptions are as follows; we expect working capital to be a use of $200 million to $230 million as a result of increased inventories across feedstock and TiO2, which we are proactively managing in Q4. Net cash interest expense of approximately $115 million, cash taxes of approximately $60 million, capital expenditures of approximately $425 million. We also anticipate completing a securitization facility and a portion of our accounts receivable that has been in the process since Q2, which will generate a one-time benefit of approximately $125 million in free cash in Q4. Based upon these assumptions we expect our free cash flow for the year to be greater than $150 million.
These continue to represent our best estimates based upon our current market outlook. We have ample levers to ensure sufficient liquidity, under any conceivable scenario. JF reviewed the actions we’re currently taking. We remain focused on executing the strategy we detailed at Investor Day, and delivering on our commitments. Given what we know today, we remain confident in achieving our recession case in 2023. That concludes our prepared remarks.
With that, I’d like to turn the call over for questions. Harry?
Question-and-Answer Session
Operator
[Operator Instructions] And our first question for today. For our first question of the day we are going to Duffy Fischer from Goldman Sachs. Duffy, your line will be open now if you would like to proceed with your question.
Duffy Fischer
Good morning, guys. First question, we’ve had a number of the coatings guys go, which is kind of three-fourth of your volume. Their volumes don’t appear to be anywhere near as bad as down 25% to 30%. So can you talk about where you’re seeing that destocking is at, is the trader level? Is that at large customer? Is that your inventory that needs to be destocked? Kind of walk through how big of a chunk that 2025 is destocking, versus what you think real demand or consumption is in the fourth quarter, please?
John Romano
Thanks, Duffy. This is John. So look it’s a combination of a variety of things. We made reference that we were building some inventory. We recovered some of our safety stock in the third quarter. So part of the destocking will be for us, to slow a bit — slow further down as a result of demand. But to your specific point, and we referenced it in the prepared comments, based on what we’re seeing from our customers, what we’re hearing from them and some of what some have reported, we believe the destocking event is going to basically be finished by the end of the quarter.
The 25% to 30% number that we referenced is based on what we’re seeing with regards to order patterns. We have a lot of customers that are obviously, using this ability to negotiate to try to get better prices. That’s absolutely, something that happens. And any time you walk into the first, I’d say real quarter of a downturn. We believe that those numbers are significantly lower and you can’t take that number, and then kind of multiply it by four to get what we think is going to happen in the coming year in 2023. So short answer is, we believe the destocking will be complete by the end of the quarter. And that’s why, we’re confident that we said that we believe it’s the trough for TiO2, volumes is the fourth quarter.
Duffy Fischer
Fair enough. Thank you. And then obviously, you’re integrated so ore costs don’t matter as much for you directly, but your competitors buy market-based or what do you see in the ore market going into next year? Will they get cost relief on that side meaningfully, and therefore maybe allow them to bring down pigment prices and compete with you more on the pigment side, or do you think, or will hang in there and is tighter structurally than pigment itself is?
Jean-Francois Turgeon
Duffy, thank you for this question. And look we continue to believe in the strength of our vertical integration. As you know, at the beginning of the year I mean, we were talking about a shortage of raw material to feed the pigment demand. Look, it’s clear that with a 25% and 30% drop in one quarter that changed the dynamic, but one quarter cannot make an adjustment for price on projects that takes five to 10 years to realize.
And the reality is the world GDP and we always said TiO2 is in line with word GDP, is not dropping by 25% to 30%. So I think the point you made we agree with your comment it’s not sustaining what is happening in Q4 in TiO2 and it’s obviously, not going to be sustaining for the feedstock part of the business, either.
Look we have seen in China, that the ilmenite price that is imported continued to grow and the price of that ilmenite continue to increase. There was absolutely no price going down for imported ilmenite to China, even with a weak demand and weak production of pigment in China. And even the local ilmenite in China, has been very stable and they have stopped and slowed their production instead of lowering price. And that’s true for all of the feedstock at the moment. So, we feel very confident with our vertical position, related to that situation.
Duffy Fischer
Great, very helpful. Thank you, guys.
Operator
Thank you. And our next question for today is from the line of Josh Spector of UBS. Josh, your line is now open.
Josh Spector
Yeah. Hey, guys. Thanks for taking my question. Just wanted to ask on the fourth quarter guide. And you talked about the one-time cost impact due to reduced production. I guess, can you separate what that cost impact would be from I guess a reduced or an absorption there versus kind of fundamentals of volumes? And kind of related to that for Tronox there tended to be kind of a lagged impact for a number of quarters, when you reduce rates of higher cost inventory flowing through. You call this one time. Is this time different or should we expect to see that into early next year as well?
Tim Carlson
Hey, Josh, it’s Tim. Great question. There are really two components that we think about. One is the increase in production costs as a result of unfavorable fixed cost absorption which does end up in inventory. And as you said, it does roll into the following quarter. However, there are certain lines that we’ll be taking down for a little bit longer period of times. And when that happens, we actually take the charge in the quarter rather than putting it into inventory. So there’s about $10 million of incremental costs in Q4 associated with costs that we flow through immediately and we don’t allocate the inventory. And there’s probably another $15 million to $20 million of cost, as a result of the lower production that will flow into the inventory costs that will flow through in the Q1.
John Romano
And Josh just maybe one more comment on that. We have nine TiO2 plants on six continents of different levels of inventory. So that flow-through that we talk about moving into the second – into the first quarter of next year, some of that’s going to hit us this year, because we don’t have the amount of inventory that we had historically. So that is going to actually impact us a little bit in the fourth quarter.
Josh Spector
Thanks. That’s helpful. And just on the mining side of it, maybe related to the prior question to an extent. I mean, I know, Tim you’re kind of load to reduce operating rates there where you don’t have to. That’s been part of the benefit of the back integration. Would you consider – are you going to build inventory there or would you consider selling any of that into the market to keep your inventories more lean and take advantage of some still semi-tight market conditions on the ore side?
Tim Carlson
Another great question, Josh. We look at all opportunities as it relates to our mining operations in terms of managing costs and optimizing the profit. We look at maintenance schedules in terms of how we can do maintenance schedules cheaper without overtime with outside services. We look at opportunities to sell excess feedstock. The one item that is hurting us a bit in Q3 and Q4 that we had talked about is, we are building a bit of some CP slag as a result of the production coming out of Jazan.
Jean-Francois Turgeon
Maybe Josh, I could add that, we have some time in our mind what we call satellite deposit that in time of high demand, I mean, you incur more costs to get more product out of those remote area. And obviously, in time where you see a drop of 25% to 30%, I mean, we stopped those side operation and save costs by doing that. So we’re actually doing this.
John Romano
And some of the projects that we would do historically with contract workers we’re doing those with our own workers to reduce cost as well.
Josh Spector
Okay. Thank you.
Operator
Thank you. And our next question is from the line of David Begleiter of Deutsche Bank. David, your line is now open.
David Begleiter
Thank you. Good morning. In respect to your European footprint, are you considering making any permanent changes given the higher energy environment you’re looking at going forward?
John Romano
No. This is John Romano. Sorry, David. We are not looking at making any permanent changes to our footprint in Europe. And quite frankly, we think about our biggest impact on energy actually was in the UK, we have gotten some relief. We had some more risk in our fourth quarter numbers prior to the UK coming in with a cap on what natural gas prices are going to be. So what was a significant headwind moving into the fourth quarter some of that’s been abated based on what you could call a hedge, which was put in place by the UK government putting a cap on energy.
Jean-Francois Turgeon
And David, we have strategy to reduce our dependence on natural gas in our facility. And that’s part of our five-year plan to continuously improve our cost position. So that’s why we feel confident with our footprint there.
David Begleiter
Understood. And just on project newTRON, you mentioned that there were some delays in realizing the savings, given the reduced CapEx. Can you quantify those delays and time the future benefits going forward? Thank you.
Jean-Francois Turgeon
Yes, David. It’s JF. Look, we always mentioned that newTRON was a project that gave us flexibility to adjust to the market conditions. And obviously, we want to reduce our capital expenditure in 2023. We don’t need the additional volume that newTRON was about to give us. We want the benefits of the cost reduction of newTRON and we continue to work on newTRON. We don’t stop it. We just slow it down.
And the impact of that decision will mean that the benefit will probably come more in 2024. Well, the remaining benefit, because I mean the benefit that we already have achieved with it, which is around $75 million for this year. We will still have those benefits in 2023 and we will continue to get some but at a slower pace. And we’re still very confident in the $150 to $200 per ton, but it’s going to be probably mid-2024 and 2024 instead of what we had originally anticipated.
David Begleiter
Thank you very much.
Operator
Thank you. And our next question is from the line of Hassan Ahmed of Alembic Global. Hassan, over to you.
Hassan Ahmed
Good morning, John and JF. Question on volumes. While I’m, obviously, cognizant that you can talk about competitors. But as I take a look at Q3 TiO2 volumes, Chemours sequentially down 8%, you guys sequentially down 13%, Zendor [ph] guiding to declines of 25%. So, I mean just any color around these, sort of, fairly large variances across the TiO2 majors in terms of sequential volumes?
John Romano
Thanks Hassan. This is John. So, look, you’re right. We can’t speak specific to competitors but we’ll talk generally. For us, Tronox, one of the first areas that we obviously saw the slowdown in was China. We have an operation over there. It’s not a huge one but that was one of the first plants that we actually slowed down. So, our impacts — I do believe we have a little bit more exposure in the APAC market.
So, when we think about those three competitors quarter-over-quarter is one thing. I think you also have to look at it, maybe a bit further than just one quarter. Everybody has a different customer profile. Some customers are different than others. Some are driving working capital adjustments. So, I’m not reading into that variance to be too significant between at least two of those people that you referenced.
But we’re focused on what we can control and influence. And with regards to what we’re seeing moving forward, even what we’re hearing from our customers, a lot of what’s happening is clearly demand driven but there’s a big portion of this that is destocking. We’ve referenced and the landscape is different.
The landscape is different, because we still do not believe there’s anywhere near the amount of inventory in the system that there was during the last downturn. And we’ve already got customers that were pulling back that we’re getting random last-minute orders on. So, all the signs are out there, which would indicate and support the comment that we made in the prepared comments that we believe the fourth quarter is in fact going to be the trough. And as we move into 2023, our number, our volumes are going to pick back up.
Hassan Ahmed
Fair enough. And as a follow-up just on the Q4 guide $140 million to $170 million. Obviously, I understand the fact that Q4 seasonally is a weak quarter. But on an annualized basis, that’s $560 million to $680 million in EBITDA, which obviously, is below the trough guide of $800 million to $1 billion that you guys have given. So my question really is, with the market sort of shaping out to be the way it is, and you guys reiterating that sort of trough guidance number. What gives you comfort around that?
John Romano
Tim, do you want to start?
Tim Carlson
Yes. So from my perspective, Hassan, the cost saving activities that JF talked about, are in process now. So we haven’t yet realized the true benefits and the full benefits of those cost saving activities. I talked about some unfavorable absorption rolling into next year. The cost saving activities that we have in place more than offset that unfavorable absorption and also, will further support and increase our EBITDA. And on top of that the recession case that we outlined was for a 10% volume decline, we don’t expect 25% to 30% volume declines going forward because of the destocking that’s happened. So as a result with that incremental volume coming back much lower than 2019 levels that volume alone will also support our recession case.
John Romano
And I guess just to go back to the point you made the reference between the range on EBITDA, a lot of that will be dependent upon volume. What we’re seeing in the month of October was a significant reduction and we even have expectations that within that range, we might see higher numbers on volume pickup as I mentioned where customers are starting to place orders a little bit at the last minute. So there is a volume element of that that’s factored into that range for the fourth quarter.
Hassan Ahmed
Very helpful. Thank you.
Operator
And our next question is from the line of Frank Mitsch of Fermium Research. Frank, your line is now open.
Frank Mitsch
Thank you and good morning. Yes, typically I think a fourth quarter as a time to build inventories. You’re obviously it appears comfortable that you’ve rebuilt your safety stock and you’re lowering production and obviously others in the industry are lowering production. I’m curious as to what your target inventory level is at year-end? Is it where you ended the third quarter, is it lower, is it higher and how do you think about inventory levels for the TiO2 producers given that others in the industry have announced production cuts?
Jean-Francois Turgeon
So Frank it’s JF. Look we are taking action to reduce production in Q4. But as you can imagine a drop in sales of 25% to 30% is more than what we had anticipated and we’re not going to reduce capacity as fast as the sale has turned down. So, we will continue to build inventory in Q4 and look we’ll probably build a little bit above what we consider normal and that’s why some of our free cash flow is ending up in working capital.
But we are working hard on ’23 to adjust that and go back to our normal inventory level. And look we’ll be very well positioned if something happened and the demand is more than what we expect and see at the moment.
Frank Mitsch
Understood. And you were able to realize a modest increase in price sequentially. I’m curious as to what your pricing outlook is for the fourth quarter and if you could offer any comments with respect to ’23?
John Romano
Yes, Frank this is John Romano. So we don’t provide specifics on price forecasts moving forward. But generically we did recognize price improvement in the third quarter and it’s very well-known there was some movement in the Chinese pricing during the third quarter which had an impact on our pricing even in the third quarter in some regions.
So moving into the fourth quarter as I mentioned earlier our pricing at this downturn which we’re in right now will not be reflective of what we’ve seen historically and when we think about our numbers moving into the fourth quarter our pricing in the fourth quarter is not going to be significantly different than what we had in the third quarter.
Obviously, the negotiations are a little bit different, but we still have the ability to negotiate. We still have our margin stability agreements and a variety of other agreements that we have in place that are helping us manage our margin throughout economic transition.
You’ve also got the other impacts when we say the landscape’s changed. Ilmenite prices haven’t moved down, sulfur prices are starting to move back up. So there’s a lot of things along with all the other costs in the system which are going to make it very difficult for pricing to move down significantly and that’s why when we think about that recession case that we referred to during Investor Day those elements of that to get to that recession number are still in place and we’re still confident in that.
Frank Mitsch
That’s very helpful. You referenced the Asian price and there was a thought that Chinese pricing which had declined precipitously was at or near a bottom. I’m wondering if you had any comments with respect to that being the case or not?
John Romano
Yes. Look that’s a great question. When you think about the export — go ahead. Did you have another question to follow-up on it?
Frank Mitsch
No, it was just because some producers were operating at or below their variable cost of production. So I was just curious as to what your comment was there?
John Romano
Yeah. No. I mean when you think about the exports out of China in the last three to four months those have actually gone down, while pricing was moving down significantly, which would — I think it gave some visibility that pricing not dissimilar to what we saw in the second quarter of 2020 when COVID hit.
And we saw this massive drop in our TiO2 consumption. Our inventories went up. We slowed down production but pricing remained flat. And what we’ve seen as recently as in the last 48 hours, is confirmation from eight to 10 small to medium-sized Chinese TiO2 producers that have actually announced price increases.
So we do believe that where we are now there is a significant gap but costs aren’t going to allow that to continue. We’ve already seen them start to move in the other direction.
Frank Mitsch
Thank you so much.
Operator
Our next question of the day comes from Matthew DeYoe of Bank of America. Matthew, your line is now open.
Matthew DeYoe
Good morning, everyone. How sustainable are these monazite earnings that you’re going to be selling from stockpiled waste? I mean, is this — can this continue for a while? And then, given it’s transacted from waste, should we think about these revenues as nearly pure margin?
John Romano
That’s a great question. So look, it all depends on the — selling these materials, is not brand-new to us. We’ve been selling monazite for several years. But what we’ve seen is that, the margin from those sales has increased significantly over the course of the last 12 months.
So we are spending money that’s coming from that additional revenue to reinvest in development opportunities on rare earth opportunities. So it all depends on how quickly we sell that.
We produce out of Australia and South Africa if we sold it for over the 10-year period that would be somewhere in the range of 6,000 to 7,000 tons a year. That doesn’t include what we’re continuing to — we get through our tailings.
So that is one stream that we believe will continue to look at also looking possibly downstream in future. As we move into a longer-term strategy we will also be looking at opportunities to move downstream.
Matthew DeYoe
Okay. And I guess on the inventory, right. We’re talking about this replenish and you’re going to build more days sales and inventory are like 150 now. I mean, I know there’s inflation feeding through that, but theoretically that should be feeding through the sales number as well. So, why did days sales inventories have to be as high?
John Romano
Well, — great point. I’m not sure when you get the 150 days…
Tim Carlson
Until, our feedstock.
John Romano
So are you talking about total inventory? Okay. So go ahead, Tim.
Tim Carlson
No. So that day sales inventory as you mentioned includes all of our feedstock throughout our vertical integration channel. As you look at our — at each of those different components which we manage as part of our global enterprise optimization, we’re a bit high on feedstocks right now as I mentioned earlier.
And as JF mentioned, from a days sales on finished goods we’re pretty much where we’d like to be from a seasonal norm standpoint. But by the end of the year, as JF mentioned we’re going to build a little bit of inventory.
We’ll continue to manage that with our production in Q1 and Q2, to make sure that our production is consistent with demand. And while it’s been a burn we do not anticipate inventory to be a burn next year.
Matthew DeYoe
I guess then if I can slide in then to, what do we think for working capital unlock next year? I guess, that you can comment on that?
Tim Carlson
Yes. So we’ll be providing specific guidance and thoughts on 2023 as part of our call in February. At this point in time we’re not going to be providing any specifics on 2023.
Matthew DeYoe
Understood.
Operator
Thank you. And our next question of the day comes from John McNulty of BMO Capital Markets. Hi John, your line is now open.
John McNulty
Yeah. Thanks for taking my question. So I guess, one thing that seems a little bit confusing is the zircon markets tend to feed into the construction markets just like TiO2 they’re obviously different products, but are tied into the same end markets to some degree.
And yet the pricing in zircon seems to be hanging in really well. Can you help us to understand why that is and if that’s a sustainable level or if there may be some potential weakness going forward?
Tim Carlson
Hey, John, I start and JF and let John add if he wants to. But it’s really a supply-demand situation in the case of zircon. And you have to remember that last year, the supply came — and it was very strong demand, and the supply came from inventory. But this year this inventory has completely disappeared.
And the demand — even if the demand is much lower this year than it was last year, the supply is still short of that demand. And as I mentioned earlier in this call, building new mine takes five to 10 years. And in the case of zircon, there is no new mines that were added and that’s why we haven’t seen such an impact on zircon as we have on TiO2.
John Romano
Just one more maybe to add on that John. We had an event that happened in South Africa here recently where the port went on strike. And we ship a lot of material out of that port in containers to our customers. So you get a real good idea of what inventories are when something like that happens, when we start delaying orders. So, I think, that’s one I think good indicator of where inventories are in the system.
And the other one, as we mentioned in the last call, our percentage of sales in China is not reflective of what the market is. We spent a fair amount of time during that period where we destock significantly, optimizing our supply chain and our customer base to deemphasize China and focus more on other regions of the world.
So, although, China has moved down when we see a volume impact where we’re maybe losing some sales in the China market, we had plenty of opportunities to displace those in other regions and other markets.
Tim Carlson
The only thing I would add John is, the inventory build that I’ve spoken about does not include zircon. We’ve actually depleted zircon inventory every quarter for the last four or five quarters. And in fact, our zircon inventory levels are at the lowest levels that I’ve seen in the six years I’ve been here.
John McNulty
Okay, okay. No, that’s helpful. And then, I guess, the other question is just — and I guess, a lot of the questions have kind of gotten to this. But when we look back earlier this year, the story was inventories in TiO2 are tied across the board at the consumer level, the producer level, you name it. And then, fast forward a quarter to 1.5 and we have two of the biggest producers saying we have to cut production by 25% to 30% in the quarter.
I guess, where — like, where was the inventory essentially hidden, if you will? Like, was it on the TiO2 front? Was it on the end product, whether it’s paint or plastics front? I guess, where would you say the surprise is coming from for all of you? Because it seems like, this was something that kind of snuck up on and the magnitude is pretty big?
John Romano
So, just maybe a quick comment on that from the standpoint of — I don’t think it’s snuck up on us, but there was a lot of that caught up in the supply chain, right? So you had — we’ve been talking about supply chain issues for the last 12 months with regards to shipments being delayed. So there could have been some buildup from inventory moving across the water.
I know we had that issue specifically. But more specific to our customers, it’s our opinion that a lot of what is happening, costs have gone up so people are seeing demand drop. But the reason we’re confident that this downturn is a short-lived event is because, there isn’t as much inventory in the system as there was before.
So, what, I think, caught up with us a bit sooner was the speed with which the demand would slow down. It did drop significantly, that’s been significantly exacerbated by destocking, which we don’t think will last beyond the end of the year in any significant amount.
Jean-Francois Turgeon
Yes, John, to us, it’s absolutely unsustainable what’s happening in Q4 at the moment.
Tim Carlson
Again, we’re seeing the impacts of that based on order patterns already. And that’s why when we mentioned, I think, Hassan made the reference to the $140 million to the $170 million range in EBITDA, it depends if we see a pickup between now and then.
John McNulty
Got it. Okay. Fair enough. Appreciate the color.
Operator
Our next question is from the line of Jeff Zekauskas of JPMorgan. Jeff, your line is now open.
Jeff Zekauskas
Thanks very much. If your volumes are down sequentially 20% to 25%, I think, year-over-year maybe they in the fourth quarter would be down 30% or 35%. So when you look at that kind of volume decrease by geography, how does it look? How is Europe different from Asia, different from North America on that basis?
John Romano
Jeff, that a good — thanks for the question. This is John. So as we mentioned we’ll start with North America. North America, we’ve seen some slowdown. We think that’s more — obviously there is some destocking there. We do believe that there’s some seasonal adjustments. But you have to remember in that particular market a lot of what we sell goes in the form of pre-dispersed TiO2 or slurry. So we have a bit more visibility on what those inventories are. So we don’t think it’s been that significant in the US.
As I mentioned earlier, the APAC market was where we saw it first. Then you saw a lot of the exports moving out of Asia Pacific into the European market. So I’d say Europe Middle East are the — and Asia Pacific is where we saw the most significant downturn. You had Korea as a really good market for us. We had some months where exports our sales into Korea almost went to nothing. So there’s a variety of things that I think are impacting that, but it’s Asia Pacific, Europe, Middle East and Africa is where we saw it most significantly. I’d say next would be Latin America and North America still remains I’d say reasonably firm.
Jeff Zekauskas
So just to take a step back I mean my recollection is that Chinese TiO2 exports this year are up I don’t know 160,000 or 170,000 tons. So is it the case that you guys are getting displaced by the excess Chinese shipments in a soft market?
John Romano
Well, they are definitely up year-to-date if you compare a 12 trailing months. As I mentioned previously, they’re down the last three to four quarters. And look there is – we compete with the Chinese and the Chinese have a model around raising prices extremely high when the market is tight and they come in and lower pricing when the volumes go the other direction. So there is an element of — and we talk about margin stability agreements.
Not every one of our customers has those. Not every one of our customers some of them like volatility. So is there some customers out there right now that are displacing higher-priced TiO2 with lower-priced Chinese TiO2? The answer to that is yes we don’t think that’s a significant amount of our volume.
We have good relationships and understand our contracts that aren’t only margin stability, but they’re volume based. And as we mentioned previously loyalty rebate based. So there’s some of that going on, but we also believe it’s sustainable. I mean at the end of the day this is — that what you just described is a normal process when you get into some sort of economic transition.
Jeff Zekauskas
I guess for my last question what you said was the fourth quarter would be some kind of a trough. I get that. But what about the first quarter of 2023 like instead of being down 35% are we going to be down 20% or like what’s your read on the volatility of demand? I understand that the fourth quarter is a trough, but do we go back to flat volumes year-over-year in the first quarter or down 10% or down 20%? Like I’m not asking you for a forecast I just want to know like what’s your general feel for where demand is going to be?
Tim Carlson
Yes. And Jeff this is a great question. And what we’re doing at the moment is we’re using our playbook for recession case. And we feel confident that it’s not going to be — well would like it to be a great year from a volume point of view, but that’s not what we’re anticipating at the moment. And we’re adjusting our production globally from our mine to our pigment plant for a recession case scenario. And, I guess, that what we have shared at Investor Day with the different scenario that we had is probably our best view of 2023 at the moment.
John Romano
When we think about that specific to your question on what do we expect in the first quarter we do expect the first quarter numbers to be up because it was — as we defined a significant destocking event. We’ve got a variety of different models when we were going through the COVID process. We had a V-shape, a U shape. There was all kinds of different scenarios that we’re factoring into what we would see as demand recovers. When we look into where we are today, this was a very – fourth quarter is a very significant move on the downside. And we gave you a number of 25% to 30%. We don’t expect it to be down that same range moving into the first quarter. And I’d say it’s just – everything is moving relatively quickly. So it’s a bit hard for us to actually give you a firm estimate on what we think the first quarter is going to be at this particular stage. But we definitely think it’s going to start moving up.
And it won’t move up I think at the rate of COVID, because COVID was kind of a start and stop, but we do think it will factor its way up. And I don’t think we’re going to get back to the early COVID days either because there was a tremendous amount of stimulus money that went into the economy and people weren’t traveling, they weren’t going out to eat. They were staying home, reinvesting in their home. So we believe we’ll return to more of a normalized basis but it’s hard to give you a specific on what we think first quarter is going to be at this particular time.
Tim Carlson
And Jeff, when we talked at Investor Day, we talked about our recession case with demand down, approximately 10%. So that’s what we would anticipate. And the 25% to 30% is not going to repeat that’s a Q4 item. So by definition Q1’s got to be better.
Jeff Zekauskas
Okay. Great. Thanks very much.
Operator
Our next question comes from Vincent Andrews of Morgan Stanley. Vincent, please go ahead.
Will Tang
Hey, guys. This is Will Tang on for Vincent. Thanks for taking my question. So you guys are taking off 25% to 30% of your capacity in the fourth quarter and you’ve talked about being 85% vertically integrated on the feedstock side. So I’m wondering, how much wiggle room do you have left before you might look at reducing some of those or utilization rates? If things recover even 5% to 10% in the first quarter, it sounds like you might still be long feedstock at that point?
Jean-Francois Turgeon
So, Will it’s JF. When we talk about the 25% to 30% in sales, it’s not production. Look, we did mention that we will continue to build inventory in Q4. So we have and we will continue to reduce our production. But we haven’t reduced it at the 25% to 30% level. And we don’t plan to do it either because we don’t believe that that 25% and 30% will stay. As Tim and John mentioned, we expect Q1 to move up in volume. And obviously, we’re going to adjust 2023 not to build inventory and even probably reduce inventory in Q3, but I hope that clarify the situation.
John Romano
Yes. Just maybe a little bit more color on that. When you think wind back the clock 60 days ago we mentioned we had different levels of inventory at the nine different facilities we have globally. We were still having issues getting orders placed and filled 60 days ago. So what’s happening is happening very quickly. To JF’s point, we’re reacting to that but we also want to be prepared for what we believe to be as we’ve talked about extensively on this call a rebound as we move into the beginning of the year. Are we going to be back to 2021, 2022 peak volumes quickly? No but we’re going to migrate up moving into the first quarter. So we want to be ready to make sure we have the ability to continue to service our customer needs.
Will Tang
Got you. Okay. And then you mentioned sulfur and ilmenite kind of priced directories earlier. Could you remind us of some of the cost assumptions in the recessioncase scenario that you gave back in June? And then how do you see all the different inputs tracking as we exit 2022 versus kind of what you had factored into your model?
Tim Carlson
Well, what we assumed in our recession case was a 2.5% drop in the ore and a 10% drop in energy. We’ve not yet seen either one of those in our overall assumptions, which is one of the reasons from our perspective prices in the industry continue to be firm. But we’ll see how that goes as next year unfolds.
Will Tang
Got it. Thank you.
Operator
[Operator Instructions] And our next question is from the line of Michael Leithead of Barclays. Michael, your line is now open.
Michael Leithead
Great. Thanks. Good morning, guys. First, I just wanted to get back to an earlier question and I fully appreciate, it’s too early to talk 2023. But usually working capital is I don’t know plus or minus $100 million give or take. And this year, it’s over a $200 million use which is like 10% of your current market cap today. So is it fair to roughly assume you get at least half of that back next year or no?
Tim Carlson
Working capital should be a source of cash for us next year, the absolute amount will be more specific about as part of our year-end call.
Michael Leithead
Okay. And then just two on the rare earth side. First is where primarily is your monazite supply geographically? Is that in South Africa? And then two, as you mentioned kind of increased commercial value or interest in these products, can you supply your customers from your existing byproduct streams as it is or do you need to invest in some sort of upgrading or separation process to kind of ramp that up from here?
John Romano
So Mike, two things. First, it comes from South Africa and Australia. That’s where our mines are. So we have two sources. And we’re not doing a significant amount of upgrading at this particular stage. So what we’re doing is selling, what was historically a tailing. What we’re doing now though is looking at how we can actually move downstream to look at opportunities to even significantly improve the revenue and the margin that we’re getting through that. And I mentioned earlier in the call that we had some development opportunities that we were looking at to move downstream.
We’re using the revenue and the margin that we’re getting from those streams to invest in those opportunities. And right now they’re development opportunities. So we’re early, I would say in the development of what we think can be a long-term solid business for Tronox. And the value of those streams to answer your question specifically, we don’t have to really do much to them right now other than determine how we might change or step up in the value chain.
Tim Carlson
And just Mike to be a bit specific. For example, the tailing that John’s talked about is sand that is a waste from cleaning the ilmenite and the zircon and the rutile. So that’s how we sell it today as a tailing. But separating that tailing to extract the monazite is exactly the same type of process that what we’re doing to separate the zircon from the sand at the moment. So it’s an expertise that we have and we’re not doing it at the moment, but it would be very easy for us to move, to clean that and obviously increase significantly the revenue from a very small step for us. And as John said, we’ll continue to explore and see if there’s more that we can do and ramp-up with the demand of the electrification of the world.
John Romano
And it’s not just our mining expertise. It’s also our expertise in chemical producing. So the separation is one thing, but there’s other steps that we could take as we continue to expand and develop the strategy on rares which quite frankly could be a real upside for us.
Michael Leithead
Great. Super helpful. Thanks guys.
End of Q&A
Operator
And we have no further questions registered today. So it would be my pleasure to hand back to Mr. Turgeon for any closing remarks.
Jean-Francois Turgeon
Thank you, Harry, and thank you for joining the call today. In summary, we remain focused on the lever within our control, prudently managing cash, executing against our strategy, driving operational excellence and delivering on our key capital projects to enhance our vertical integrated portfolio. Tronox remains well positioned to continue delivering on our commitment. That concludes the call. Have a great day. Thank you.
Operator
Thank you for joining everyone. This concludes the Tronox Holdings Q3 2022 earnings call and you may now disconnect your lines.
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