Fidelity Select Chemicals and Chemical ETFs look attractive, as potential for margins to widen and deal activity to provide abnormal returns sustain the leadership of chemical stocks.
Selected groups in the consumer discretionary and technology sectors like auto and computers led the way in 2009 as stock prices started to recover from the Great Recession.
In 2010, the leadership shifted to groups like transportation.
In recent months, stock prices in groups like auto, computers, and transportation have sputtered.
The chemicals group is different in this regard. Shares here performed well in both 2009 and 2010 and they continue to fare well in 2011.
Over the past year, the Dow Jones Chemicals Titans 30 Index ($DJACHE) is up 31.8% while the actively managed Fidelity Select Chemicals Fund (FSCHX) is up 34.7% compared to the 12.8% advance of the S&P 500 ($SPX).
With industry margins likely to widen and deal activity adding spice, chemical company stocks have a few things going for them that can help them sustain their leadership.
Chemical Industry Profits to Continue Rising
Chemical companies cut costs to the bone during the downturn. With the economy now growing, product demand in individual industry segments is increasing. The resulting operating leverage is helping chemical companies widen their margins.
Agricultural Chemicals: The secular forces of global population growth and higher per-capita income in emerging economies are lifting commodity crop prices. The United Nations reports that global food costs are at record levels.
High crop prices provide significant incentive for farmers to increase acreage and yields. The U.S. Department of Agriculture recently stated that U. S. corn acreage this year would be second highest in 67 years.
Fertilizer producers like Potash Corporation (POT) and Agrium (AGU) as well as seed developers like Monsanto (MON) and DuPont (DD) stand to benefit from the drive to increase farm output.
Petrochemicals and Plastics: Demand for petrochemicals and plastics is rising from growth in emerging markets and recovery of the auto industry.
Global capacity utilization for ethylene production, a bellwether for plastics manufacture, is forecasted to increase to 90% by 2013 from 84% in 2009.
The automotive industry accounts for 10% of U. S. chemical industry demand. Plastics manufacture should receive a boost as global auto demand approaches 76 million units.
Dow Chemical (DOW), BASF Corp. (BASFY.PK) and LyondellBasell Industries (LYB) are among the world’s top petrochemicals and plastics producers. Ample supply of shale natural gas particularly in the U. S. should help their margins.
Specialty Chemicals and Building Materials: Specialty chemical stocks typically tend to perform well in early to mid-cycle phases of economic recoveries as demand increases to drive volume growth.
Solutia (SOA), which makes various chemical and engineered materials used in consumer and industrial applications, is well-positioned to benefit from increasing global construction activity.
Building products manufacturer U.S. Gypsum (USG), roofing products manufacturer Owens Corning (OC), and paint manufacturers Sherwin Williams (SHW) & Valspar (VAL) too can fare well in varying degrees.
Mergers & Acquisitions Add to Investment Appeal
Deal activity in the chemical industry is continuing at a healthy pace as valuation metrics are attractive and companies seek to grow revenue.
Legendary investor Warren Buffett is seeing value in chemical companies. Berkshire Hathaway (BRK-B) recently announced that it is acquiring Lubrizol (LZ) for $9 billion.
Earlier, DuPont offered to buy Denmark’s Danisco (DNSOF.PK) for $6 billion to expand into biofuels and food enzymes. Air Products & Chemicals (APD) went after Airgas (ARG) in hot pursuit until the latter succeeded in staying independent by getting court approval of its poison pill provision.
Mutual Funds and ETFs to Invest in the Chemicals Group
There are several options available for investors to play the chemicals group.
Fidelity Select Chemicals – FSCHX
Among mutual funds, several index and actively managed funds invest in the materials sector. However, when it comes to the chemicals group in particular, Fidelity Select Chemicals is the only pure-play mutual fund that focuses on this group.
In the ETF space, there is no pure-pay chemical ETF. However, several basic materials and agriculture ETFs can work as suitable proxies since many of them have 40% or more of their assets invested in chemical stocks.
Market Vectors Agribusiness (MOO), Materials Select Sector SPDR (XLB), iShares DJ US Basic Materials (IYM), Vanguard Materials (VAW), and PowerShares Global Agriculture (PAGG) fit this description and have net assets of over $100 million each.