Chemical companies certainly aren’t the sexiest part of the stock market.
And over the past year, specialty chemicals stocks have underperformed the broad equity market, notes Dave Sekera, senior U.S. market strategist at Morningstar.
As cyclical companies, their sales and earnings are closely tied to the economy, he explains. “And the weakening economic outlook has taken a toll on the valuations of these stocks,” Sekera said.
But there’s a bright side. “While a stagnant or slowing economy will put pressure on these companies’ earnings in the short term, we think there’s long-term opportunity in higher-quality specialty chemicals stocks that are tied to several long-term themes,” he said.
These include:
- Automobile electrification,
- Increasing demand for semiconductors,
- Transition to plastics,
- Freshwater scarcity,
- Demand for healthier, more natural, and enhanced prepared foods.
“We think undervalued stocks of specialty chemical companies that are tied to these growth themes have significant appreciation potential,” Sekera said.
He listed six of them, in alphabetical order:
- Celanese (CE)
- DuPont (DD)
- Eastman Chemical (EMN)
- Ecolab (ECL)
- Ingredion (INGR)
- International Flavors & Fragrances (IFF)
DuPont: Morningstar analyst Seth Goldstein assigns the company a narrow moat (durable competitive advantage) and puts fair value for the stock at $95. It recently traded at $73.10.
“DuPont remains well positioned for long-term profit growth,” he wrote in a commentary. The electronics and industrial sectors should show higher semiconductor demand, Goldstein said.
That and rising adoption of Internet of Things technologies “should result in a high-single-digit average annual EBITDA [earnings before interest taxes, depreciation and amortization] growth rate after 2023,” he said. “We forecast a similar growth rate in water and protection.”
Eastman Chemical: Goldstein gives the company a narrow moat and puts fair value for the stock at $130. It recently traded at $84.75.
“We agree with the market's near-term skepticism for Eastman's profit growth,” he wrote in a commentary. “We forecast higher prices and lower raw materials costs will be largely offset by lower volumes.”
But on the plus side, “after an economic slowdown in 2023, we expect Eastman will be well positioned to generate strong results, driven by volume growth for its specialty chemicals,” Goldstein said.
“Much of the bad news is priced in, leaving long-term investors with a good opportunity.”
International Flavors & Fragrances: Goldstein assigns the company a wide moat and puts fair value for the stock at $140. It recently traded at $94.45.
“The market is concerned that cost inflation will continue to hurt profits and is skeptical of management's long-term growth strategy,” he wrote in a commentary.
“We see little long-term impact from cost inflation. During previous times of cost inflation, IFF’s near-term profits were hurt by inflation, but there was no long-term growth impact.”
So, “as cost inflation stabilizes in 2023, we expect IFF's profits will rebound beginning in 2024,” Goldstein said.
The author of this story owns shares of Celanese and DuPont.
