One of the most overlooked sectors in the market, basic materials stocks have become an attractive sector for investors.
Materials are a broad space that can include everything from metals, to plastics, as well as concrete and fertilizer. It can include companies that just extract raw commodities to those that refine commodities into higher-value goods like specialty chemicals.
While it's true that materials stocks may lack the fast growth of a tech stock or the perceived safety of a consumer goods company, this space has become a pocket of deep value. The massive economic contraction at the start of the year hit these stocks hard. But now, easy-money economic policies and a rebounding global economy bode well for the sector.
"We raised our recommended exposure to the S&P 500 Materials sector (.GSPM) to overweight from marketweight," writes CFRA's Sam Stovall. "We think defensive sectors will become relative underperformers in the period ahead as cyclical sectors will likely be boosted by the apparent outcome of the presidential election" as well as Pfizer's (PFE) encouraging data from its vaccine trial."
"The Materials sector is also expected to record 2021 EPS growth of 27.4%, according to S&P Capital IQ's consensus estimates, vs. the S&P 500's projected 21.2% growth rate," he adds.
Investors looking to take profits into an overlooked and unloved sector should look no farther than this short list of the five best materials stocks for 2021. Next year likely will be a great one for the sector amid expectations for rebounding profits and expanding margins.
Data is as of Nov. 9. Dividend yields are calculated by annualizing the most recent payout and dividing by the share price.
Air Products & Chemicals
Market value: $69.1 billion
Dividend yield: 1.7%
Profit margin: 21.6%
Air Products & Chemicals (APD) is a leader in the specialty chemical and gasses space, particularly concerning atmospheric gases such as oxygen, nitrogen, argon, hydrogen and helium among others.
Processed gasses are used for refining, metals and electronics manufacturing, as well as in energy production, such as the conversion of natural gas into liquid natural gas.
This is an essential aspect of so many different businesses that Air Products hasn't taken much of a hit in 2020. In fact, shares are currently up by 33% year-to-date, more than triple the S&P 500's 9.9%.
Still, there's more room to run. The specialty chemicals space is estimated to grow by over 5% annually, and Air Products is forecast to capture plenty of that growth. While Wall Street is expecting marginal revenue declines and a small bump in profit this year, they see APD growing the top line by 9% and profits by 17% in 2021.
BMO Capital analyst John McNulty, who rates the stock at Outperform with a $363 price target, says that Air Products' capital deployment and its liquefied natural gas (LNG) project should drive upside to 2021 and 2022 estimates.
Air Products also holds a space among the best materials stocks for 2021 because of its standing as a Dividend Aristocrat. ADP's 38 consecutive years of dividend increases stand out even more in a 2020 that has seen many firms cut or even suspend their dividends.
Market value: $26.5 billion
Dividend yield: 5.3%
Profit margin: 4.2%
LyondellBasell Industries (LYB) is another specialty chemical company, this one more focused on petrochemicals such as jet fuel, as well as plastic compounds and resins. It has a wide international reach, too, serving more than 100 countries.
LYB shares have recovered somewhat from their COVID lows, but they remain down 16% year-to-date. The trouble? Airline traffic has plunged by more than two-thirds from a year ago, slashing jet fuel demand. That's apparent in revenues that were off by 25% over the first nine months of 2020, and profits that had dropped by nearly 80% in the same time frame.
However, JPMorgan (JPM) sees some promise in the company's polymer business.
"We think the profitability of the industry should head higher, whether or not the September price increase passes through," writes analyst Jeffrey Zekaukas, who upgraded the stock to Overweight in September. "We think the efficient way of investing in the effects of these trends and changes in the petrochemical industry over the coming year is through Lyondell."
That should help offset what could be a slow rebound in jet fuel. While Goldman Sachs expects global oil demand to return to pre-pandemic levels by 2022, they don't believe jet fuel will do so until 2023.
Still, LyondellBasell could be one of the best materials stocks to buy for the upcoming year. While analysts don't expect earnings to rebound all the way back in 2021, they still see profits jumping by about 51% from 2020 levels. There's a strong value proposition here, too: LYB shares trade at just 10.5 next year's earnings estimates, and it yields a healthy 5.3% that's roughly triple the S&P 500's average yield.
Market value: $28.7 billion
Dividend yield: N/A
Profit margin: -0.7%
A materials stock best known for its copper mining operations, Freeport-McMoRan (FCX) also mines for gold and molybdenum, among other metals. As a result, the commodity company is susceptible to the changing prices of those metals.
That's an advantage right now, amid a weak U.S. dollar that's only expected to get flimsier in 2021. (Remember: Most commodities are priced in U.S. dollars, so when the value of the greenback declines, the price of those commodities rises.)
"We believe that the main driver of dollar weakness in 2020 has been a revaluation of the euro, reflected in a lower U.S. Dollar Index (.DXY), writes the Wells Fargo Investment Institute. "We expect these dynamics to continue into 2021."
UBS analysts, who rate FCX at Buy, also believe that Freeport is pricing in lower copper prices than its forecasts for the next two years. "This is at the core of our Buy rating on FCX coupled with 1) further production growth as Grasberg and Lone Star ramp up; 2) renewed talk of dividends and share buybacks; and 3) Grasberg smelter capex possibly being pushed back."
An interesting note: Freeport-McMoRan is considering the radical idea of selling its corporate headquarters to go almost fully remote. That likely won't have a huge impact on profitability, but it shows management is keen on keeping expenses down. In a commodity-driven business that simply can't control prices, every little bit helps.
Market value: $76.8 billion
Dividend yield: 6.3%
Profit margin: 17.2%
Rio Tinto (RIO) is another mining stock, this one with a focus on aluminum and iron ore. This global producer also generates "unusual" earnings from the sale of gemstones such as rare yellow diamonds.
Rio Tinto's strength is its efficient operations; it's one of the lowest-cost producers in the world, which allows them to survive during downcycles and profit significantly in higher-price environments, evidenced by a strong 17% margin.
"Rio Tinto has strengthened its operating performance and balance sheet by cutting costs and selling noncore assets," write Argus Research's David Coleman (Buy). "It also continues to return cash to shareholders through dividend increases and stock buybacks. The company has traditionally performed well during difficult economic times, and, in our view, has strong long-term growth opportunities."
JPMorgan Cazenove analysts also see some reasons for bullishness over the next few months despite headwinds for iron ore.
"We share the consensus view of lower iron ore prices, but remind investors that in nine of the last 11 years prices rose (from end of October to the start of March) in part due to global supply-demand seasonality, which should mitigate downside risk over the next five months," JPMC's analysts write.
But Rio's strengths don't appear to be reflected in its share price. Its forward-looking P/E of 9 is less than half the sector median of 21.7, and also well below the S&P 500's average forward P/E of 25. Better still, RIO shares yield more than 6% on its semiannual dividend.
For investors seeking high total returns (price plus dividends), Rio Tinto looks well-positioned as one of the best materials stocks for 2021.
Market value: $21.0 billion
Dividend yield: 2.4%
Profit margin: 7.0%
Lastly, let's look at a lesser-discussed material: timber.
Timber is its own specialty asset class, with returns that are unique relative to stocks. And Weyerhaeuser (WY) straddles the line. It owns or controls roughly 11 million acres of U.S. timberlands, as well as additional timberlands licensed in Canada. But it also is one of North America's top producers of wood products.
Timberland tends to be less volatile than other assets over time. However, WY has had a roller-coaster year, losing almost half its value at the depths of the bear market before rebounding to a modest 7% year-to-date loss. It also suspended its dividend this summer to conserve cash.
That's a particularly tough blow for shareholders given that while Weyerhaeuser is a clear play on materials, it's technically organized as a real estate investment trust (REIT). REITs are required to distribute at least 90% of its taxable earnings as dividends to shareholders, and dividends are typically the main draw.
But there are reasons to believe Weyerhaeuser could be one of the best materials plays for 2021.
WY has been steadily recovering thanks to lumber prices, which have been rising because of both soaring housing demand and wildfire damage. And residential housing is expected to remain hot heading into 2021, which could keep this tailwind blowing.
Weyerhaeuser also is showing signs of recovery. In its recently released third-quarter results, the company reported its highest wood products adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) on record. Overall earnings shot 192% higher year-over-year to $283 million.
And best of all, Weyerhaeuser reinstated its dividend with a more sustainable framework. WY will pay out a "base" quarterly dividend starting at 17 cents per share, which is reflected in the 2.4% yield listed above. However, WY will also supplement that dividend with additional returns of cash, aiming for a total return of 75% to 80% of annual "adjusted funds available for distribution." That supplemental dividend is expected to be paid annually, in the first quarter of each year starting in 2022.
Just remember: You're buying more than just a purely timber REIT here. Consider this an appreciating land-based asset with a cash-flow business on top of it.
|For more news you can use to help guide your financial life, visit our Insights page.|