A competitive advantage instills conviction in U.S. chemicals companies

Low prices for natural gas in the U.S. − a key input in the manufacturing process for many chemicals − is a cost benefit that boosts the potential for faster earnings growth and improved profitability for U.S.-based chemicals manufacturers relative to their competitors abroad, according to Fidelity’s Ashley Fernandes.

“I believe U.S.-based commodity chemicals companies have several unique advantages,” says Fernandes, portfolio manager of Fidelity® Select Materials Portfolio (FSDPX). “First, the stocks’ valuations are attractive; in fact, I believe they remain undervalued despite strong appreciation in 2023, given the underlying strength of the businesses and barriers to competitive entry. U.S. companies also have the additional advantage of operating within a relatively strong economy and stable political environment. Most interestingly – to me, however – is that the U.S. chemicals companies enjoy a significant cost advantage, one that I believe is currently underappreciated by investors.”

The cost factor Fernandes cites is based in the U.S. chemical companies’ preferred resource for feedstock – that is, the raw material(s) used in the manufacturing process. Most U.S. chemicals companies employ a process that uses natural gas, whereas European firms generally use an oil-based byproduct in their processes. Natural gas itself is notably less expensive in the U.S. than in Europe, and U.S. natural gas is a lot less expensive than European oil.

In managing the fund since 2022, Fernandes follows a contrarian investment approach, focusing on companies with strong fundamentals that have not yet been recognized by the broader market, while also looking for reasonably valued stocks of firms with improving returns on capital and the potential for price-earnings multiple expansion.

He underscored that stocks in the materials sector tend to be cyclically driven, meaning that, as a group, they generally have risen when the global economy is growing and have fallen when the outlook is trending down.

The sector underperformed the broader market in 2023 as investors waited out the likely end of the U.S. Federal Reserve’s aggressive interest-rate-hiking campaign, Fernandes notes. But with rate cuts expected in 2024, the economy could see an uptick in growth this year – to which materials stocks could respond favorably.

In 2023, he established a sizable overweight position in commodity chemicals stocks relative to the MSCI U.S. IMI Materials 25/50 Index, the portfolio’s sector benchmark.

“I knew this was a contrarian position, and I knew the going might be a little rocky at first,” says Fernandes. “But looking ahead to the remainder of 2024, what most enthuses me about this positioning is that the stocks are appreciating even though we haven’t seen any macroeconomic improvement yet. I believe a cyclical upturn, when it arrives, could take the stocks up even higher.

By industry, the commodity chemicals group was a top contributor to the portfolio’s performance versus its sector benchmark in 2023. Notable outperformers included Westlake (WLK), Cabot (CBT) and LyondellBasell Industries (LYB) – all top holdings and sizable overweights in the fund as of February 29.

Fernandes concludes, “These U.S.-based commodity chemicals companies began heading in the right direction in the latter part of 2023, and looking ahead, I believe they remain well-positioned for further growth.”

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Ashley Fernandes
Portfolio Manager
Ashley Fernandes

Ashley Fernandes is the Natural Resources sector leader and a portfolio manager in the Equity division at Fidelity Investments.

In this role, Mr. Fernandes provides research coverage for the global integrated energy and global mining companies and he manages the Fidelity Natural Resources Fund. He is also a member of Fidelity's Stock Selector Large Cap Group and is responsible for managing the energy and materials sleeves for various diversified sector-based portfolios. Mr. Fernandes is also responsible for co-managing the Fidelity and Fidelity Advisor Balanced Funds, VIP Balanced Portfolio, Fidelity Select and VIP Materials Portfolio, and Fidelity Advisor Materials Fund. Additionally, he co-manages both the global energy and global materials sector sleeves of the FIAM sector portfolios.

Prior to assuming his current role, Mr. Fernandes worked as a global energy analyst for Fidelity International Limited (FIL) in London from 2008 to 2013. In this capacity, he was an analyst for the U.S., Canadian, European integrated, and emerging-market energy sectors, as well as small- and mid-cap international exploration and production (E&P) companies.

Before joining Fidelity in 2013, Mr. Fernandes worked as an associate in Private Equity. He has been in the financial industry since 2001.

Mr. Fernandes earned his bachelor of commerce degree, with honors, from Queen’s University, and his master of business administration degree from London Business School. He is also a CFA® charterholder.

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