It’s just another example on how our newfound energy abundance is changing the American economy. After years of struggling, former retail icon Sears Holdings (NASDAQ:SHLD) no longer will be included in the benchmark S&P 500 Index — and will be replaced by petrochemical company LyondellBasell Industries (NYSE:LYB).
Formed back in 2005 via a merger of Kmart and Sears, Roebuck & Co., SHLD has continually underperformed as it faced falling sales and tough competition from other broad-line and discount retailers. During the past five years, Sears’ shares are down by 60%.
Aside from that loss of capital, investors now have to deal with the fact that the former retailing giant will no longer be considered as part of the “Bedrock of America.”
Last Wednesday, Standard & Poor’s made the decision that Sears is no longer considered representative of the index, as its public float has been well below the 50% threshold for inclusion for a long time. According to FactSet, Edward Lampert and his ESL Investments hedge fund own a total of 65.7 million, or 62%, of Sears’ outstanding shares. While Sears’ representatives stressed that the action was a result of the public float level and not a valuation of the company’s performance, being booted from the S&P 500 is just another heartache for SHLD investors.
However, sometimes heartache can bring about other opportunities.
The company replacing Sears Holdings after Tuesday’s market close — LyondellBasell Industries — is a petrochemical powerhouse. As the hydraulic fracking revolution has unearthed an ocean of cheap natural gas and oil, those who use them as a feedstock are thriving. That includes our newest S&P 500 entrant.
For long-term investors, Sears’ exit and Lyondell’s entrance could be seen as a great plus — and an opportunity to profit.
Chemicals, Polymers & Refined Crude Oil, Oh My!
Featuring 58 manufacturing sites across 18 countries, Netherlands-based LyondellBasell is one of the largest chemicals, plastics and refining companies in the world. That puts itself in a good position as margins at U.S. chemical operations are at their highest in years thanks to the glut of natural gas and shale oil.
The reason why comes down to feedstocks. Produced alongside natural gas, ethane is a vital ingredient for the petrochemicals sector. The natural gas liquid (NGL) is sent through a refining process and “cracked” similarly to crude oil, producing one of most basic of commodity chemicals: ethylene. Ethylene is a key component in a variety of products, and as the emerging world continues to modernize, utilization rates for the commodity chemical are forecast to grow to 90% by 2013. Yet prices for ethane continue to plunge as the glut of natural gas persists.
That creates some pretty juicy spreads for firms that are able to use the cheaper NGL to make their ethylene. This includes LyondellBasell, whose vertically integrated operations allow it convert crude hydrocarbons to materials for advanced applications. During the last quarter, Lyondell saw its operating income grow 38% at its North American olefins unit, which uses shale natural gas to make ethylene. In contrast, operating income was flat at the firm’s European olefins unit, which primarily uses Brent crude oil-derived naphtha to make ethylene.
While LyondellBasell refines crude oil and produces chemicals around the world, the company expects cheap natural gas to continue to boost results across its operating platform. This echoes various other materials analysts’ positions, who maintain that the glut of ethane will persist until 2017. That said, the chemicals firm stated it would continue to invest heavily in its North American operations that use the natural gas, despite global economic volatility. That will put Lyondell in a very good position to profit from current and future emerging-market ethylene demand.
Lyondell’s refining operations also are benefiting from growing emerging-market demand. The firm’s Houston facility is one of North America’s largest full-conversion refineries and can take advantage of cheaper heavy and high-sulfur crude oil produced onshore — i.e. WTI and Bakken shale oil. Located on the U.S. Gulf Coast and near the Port of Houston, Lyondell facilities are strategically ready to take advantage of the fact that refiners are exporting record amounts of gasoline.
Running the Numbers
In the immediate short run, we have seen a pop in shares as various S&P 500 Index funds — such as the SPDR S&P 500 ETF (NYSE:SPY) and Vanguard 500 Index Fund (MUTF:VFINX) — add LYB to their holdings, and amid excitement over the move. Still, the stock could see a bit more upward pressure in the next couple days. Consequently, Sears’ shares should sink further as it’s sold.
Over the longer run, the petrochemical giant seems poised to continue its growth, and that’ll benefit both indexed investors as well as individual shareholders. Since 2010 — when the chemical firm emerged from bankruptcy — Lyondell shares have more than doubled, and they are up roughly 44% year-to-date.
Yet, LYB still is pretty cheap. LyondellBasell stock currently can be had for a P/E of 13.45. That’s right around the chemical’s sector long-term average of 13.69, and less than rivals Dow Chemical (NYSE:DOW) and Westlake (NYSE:WLK). For that cheap price, investors get access not only to a 4.1% dividend yield, continued operating improvements, attractive free cash flow and good reinvestment opportunities, but the potential to profit from some of the juiciest margins in the global chemical industry.
Overall, Sears’ exit and LyondellBasell’s entrance to the S&P 500 could be seen as a win-win for petrochemical/energy and index investors.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.