Basic Materials May Be Unexciting, Except As an Investment
By Andrew Leckey
The Ups & Downs of the Stock Market
Basic materials stocks sound about as exciting as freshly laid asphalt, but they've become a steaming-hot investment in 2009.
This group was devastated last fall as hedge funds abandoned the then-dominant thesis that the world -- especially Asia -- needs to keep building, and summarily dumped the stocks.
This year it is looking like worldwide recession represented a lull in the action, as ambitious economic stimulus packages in the U.S. and abroad have revived the need for basic materials.
As the provider of the raw building blocks of construction and infrastructure, basic materials is an economically sensitive sector that includes the mining and refining of metals, chemical producers and forestry products.
Basic materials mutual funds are up 32 percent in 2009, following last year's 38 percent decline, according to Lipper Inc. That compares with the 9 percent gain of the average U.S. diversified equity fund this year.
"About $29 billion in the U.S. stimulus package is dedicated to road construction, and about half that money has specific time deadlines for bids," said Jack Kasprzak, managing director at BB&T Capital Markets in Richmond, Va., who considers exchange-traded funds the best way for people to invest in this group. "The time-sensitive nature of the stimulus plan has again focused investors on the basic materials space."
An example of a diverse ETF in this sector is the $1.3 billion Materials Select Sector SPDR (XLB), up 21 percent this year.
Top holdings in its 28-stock portfolio weighted by market capitalization are Monsanto Co., DuPont, Praxair Inc., Newmont Mining Corp. and Dow Chemical Co.
Most of its holdings are large, mature firms with reliable production and delivery systems.
"When you think about the economy over the next two years, it is pretty obvious that to generate economic activity, the infrastructure and public works segment is an area to focus on," Kasprzak said. "While it is true that state budget deficits are bad, the market looks ahead, and the infrastructure in most states is a mess."
In some cases, basic materials are numbingly basic.
Consider aggregates, the category including gravel, sand, crushed stone, recycled concrete and geosynthetic materials.
"Because of stimulus programs here and in China, we're seeing a pickup in demand, with President Obama's stimulus package and the highway bill especially creating a demand for aggregates," said Arnold Ursaner, managing director of CJS Securities in White Plains, N.Y., noting that category has rare qualities. "In that business, since it costs more to transport rocks than their actual cost, there isn't any foreign competition because it just isn't worth it."
Keep in mind the U.S. stimulus package was put in place in March and it will take some time for the money to get down to the state level, cautioned Ursaner, who expects a robust pickup in demand in the second half of the year, "particularly for shovel-ready projects."
These stocks of aggregate producers are recommended by Ursaner because of their impressive size and the fact that private contractors must buy supplies from them:
Martin Marietta Materials Inc. (MLM), with a large collection of North American quarries and a strong distribution network, is focused on the southeastern and southwestern U.S.
Vulcan Materials Co. (VMC), which has quarry assets from California to Florida, has a proven ability to increase prices and derives more than half of its volume from public infrastructure projects.
Texas Industries Inc. (TXI), a leader in cement and concrete production, has a competitive edge in Texas and Southern California.
Don't overgeneralize about basic materials as a group, since each category has its own traits.
"There are different forces at work within basic materials," Ursaner said. "For example, oil demand is driven by economic activity and miles driven, while steel is impacted by capital spending, and basic chemicals are affected by economic and industrial activity."
Because expansion at the national and local levels often takes place in fits and starts dictated by the economy, government and public sentiment, investors should never get bowled over by near-term prospects.
"Investors in basic materials should want more than the hope of a short-term pop from U.S. government spending contracts and rather focus on long-term prospects," said John Buckingham, chief investment officer of Al Frank Asset Management in Laguna Beach, Calif. "You want companies with multinational exposure that will be able to take advantage of recovering economies around the world."
Companies in basic materials and related equipment whose stocks are recommended by Buckingham include:
U.S. Steel Corp. (X), the world's fifth-largest steel producer and a direct beneficiary of infrastructure spending, has improved its balance sheet and significantly reduced its costs.
Caterpillar Inc. (CAT), multinational maker of construction and material-handling machinery and engines, has first-rate manufacturing and distribution operations and derives half of its sales from outside the U.S.
Terex Corp. (TEX), a more speculative choice, is one of the largest manufacturers of equipment used in construction and mining and has about 70 percent of total sales outside the U.S.
Finally, Buckingham recommends Chesapeake Energy Corp. (CHK), which is due to make gains as lagging natural gas prices rebound.
He also thinks oil service companies such as Transocean Ltd. (RIG) and Rowan Cos. (RDC) are worth owning, although they have rallied. He'd only buy on price weakness.
Emerging markets are like those giant slices of double-mud chocolate-brownie cake offered to you by restaurant servers at the end of your meal. You run the risk of a severe stomachache later, but they sound so good it's hard to resist.
Despite the market's roaring rally over the past three months, some stocks--including those of well-known companies--still look cheap. So how do you separate the deals from the duds? Understand why the stock is cheap.
(Andrew Leckey answers questions only through the column. Address inquiries to Andrew Leckey, 555 N. Central Ave., Suite 302, Phoenix, AZ 85004-1248, or by e-mail at email@example.com.)