We believe that the promised pro-growth policies of the Trump government, especially the proposed $1-trillion spending on infrastructure improvement have boosted prospects of a number of industries in the United States. Basic Materials is one of 16 broad Zacks sectors that have performed impressively, riding on the government’s policies.
Year to date, the sector has yielded 14% return, outperforming 11.9% gain recorded by the S&P 500 and 9.2% of the NYSE Composite index. Also, the sector’s earnings grew 7% in the second quarter of 2017 while revenues expanded 3.8%.
Basic Materials can be further sub-divided into four industries including Chemicals & Fertilizers, Metals-Non Ferrous, Steel and Paper. Chemicals industry has yielded 16.1% return year to date while Metals-Non Ferrous, Steel and Paper recorded returns of 16%, 16.8% and 8.4% respectively.
What Does the Basic Materials Sector Have in Store?
Per the Earnings Trends dated Sep 14, the sector (accounting for 2.1% of the S&P 500 index’s total market capitalization) is likely to record 10.2% growth in revenues while margins will likely fall 1.7%, earnings will decline 11.2%.
We believe strengthening U.S. economy, as evident from 1.4% growth in the Gross Domestic Product in the first quarter and 3% in the second quarter, as well as steady growth in job additions, with roughly 156,000 added in August, will work in favor of the sector. Moreover, the government’s proposed infrastructure investment, if implemented, will boost the needs of basic materials. Other tailwinds are the strengthening housing, automotive and commercial construction markets.
Also, rise of 2.5 percentage points in Purchasing Managers’ Index (PMI) or manufacturing index in August and growth of 4.7% in industrial production in the second quarter of 2017 are positive indicators for the Basic Materials sector.
However, there are certain factors that can jeopardize the prospects of the basic materials stocks. Sharp rise in oil prices can dampen global economic growth and hamper growth opportunities of a number of industries, including transportation, farm machinery, airline, chemicals and many more. This will indirectly lower demand for basic raw materials used in the manufacturing process of these industries.
Moreover, a high interest rate will make funds more expensive for financing capital-intensive exploration projects and setting of processing plants by the mining and chemical industries. Economic uncertainties in developing nations might hamper export demand for basic materials. Moreover, unfavourable movements in foreign currencies might make other markets over cost-competitive than the United States.
Best Way to Gain Exposure in the Sector
Despite the near-term hurdles faced by the Basic Materials sector, we believe that the industries within it will gain from healthy growth in global manufacturing economy, better trade relations and effective government policies.
We recommend Growth Investing strategy as favorable method for picking suitable investment option in the sector as majority of the sub-industries are capital-intensive and have a large gestation period for yielding returns in any projects.
Per the Zacks Style Score system, growth investment strategy chooses its most favorable investment choice after analysing the company’s income statement, cash flow statement and balance sheet. Instead of paying shareholders regularly, these stocks reward shareholders with solid capital gains. Majority of the annual earnings are reinvested in the business for funding growth programs. In regard to their price/earnings multiple, these companies might seem overvalued at present, but promise healthy long-term growth.
Growth Style Score of A is considered better than a B while a B is better than a C. Companies with favorable growth score of A or B when combined with Zacks Rank #1 (Strong Buy) or 2 (Buy) are anticipated to yield solid returns, clearly outperforming the market.
Favorable Investment Choices
Below we discuss four Basic Material stocks that are worth investing in by growth investors. These stocks have solid growth potential in the next five years, favorable Zacks Rank and Growth Style Score and offers attractive returns on equity.
Sociedad Quimica y Minera de Chile (NYSE:SQM) – This $15.3-billion company primarily produces fertilizers, industrial chemicals, iodine and iodine derivative products. It anticipates benefiting from its expansionary initiatives in lithium and iodine markets as well as demand growth in potassium chloride business.
The company currently sports a Zacks Rank #1 and has a Growth Score of B.
It promises returns of 14.8% on equity and 10% on capital, higher than 4.7% and 3.1% offered by the industry it belongs to. Its earnings are anticipated to grow 32.5% in the next five years.
Versum Materials Inc (NYSE:VSM) – The company provides specialty process gas, cleaners and etchants, slurries, organosilanes and organometallics deposition films and equipment. We believe that the company is poised to gain from the strengthening semiconductor industry, its inorganic growth initiatives and efforts to provide new and improved products to customers.
It currently has $4.1 billion market capitalization and carries a Zacks Rank #2. Its Growth Score is B.
The company’s earnings are anticipated to grow 11% in the next five years. At present, it yields 24.2% return on capital versus 7.3% provided by the industry.
American Vanguard Corp. (NYSE:AVD) – The company, with a $618 million market capitalization, engages in manufacturing chemicals for crops, human and animal health protection.
It currently carries a Zacks Rank #2 and has a Growth Score of A.
It promises returns of 5.1% on equity and 4.5% on capital. The company’s earnings are anticipated to grow 15% in the next five years versus 10.6% predicted for the industry it belongs to.
Koppers Holdings Inc. (NYSE:KOP) – The company provides wood treatment chemicals, treated wood products and carbon compounds to customers globally. It currently has $844 million market capitalization.
The company currently carries a Zacks Rank #2 and has a Growth Score of B.
It promises returns of 153.5% on equity, higher than 21.1% offered by the industry it belongs to. Its earnings are anticipated to grow 18% in the next five years.
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