The materials sector is a supplier to all industries. From agribusiness to aerospace, there is no industry that does not demand technology from some of the companies I have chosen for this post or some of their peers. If you want to have some exposure to materials, I would recommend the following three-stock portfolio. The three companies named below offer a fair valuation with top-line future growth and good market positioning. Let’s take a look at them!
Three companies for one portfolio
I would give Agrium Inc. (USA) (NYSE:AGU), a global producer and marketer of agricultural products, a 45% portfolio weight. The reason is simple; the company looks relatively cheap and it operates in the most resilient sub-sector within the materials industry.
Even though 1Q 2013 results were below expectations (EPS of $1.03 versus consensus of $1.07), the miss was driven by lower revenue in the retail segment. This was in light of the farming community’s inability to conduct preliminary field work, let alone plant, due to inclement weather throughout the corn belt. Hence, it would not be fair to blame management for such a miss.
Farmer demand for Agrium Inc. (USA) (NYSE:AGU)’s products is tough to predict since it’s highly dependent on weather conditions. Nevertheless, when weather conditions are not good enough, demand remains latent and shifts from one month to the next. That explains why, since April remained weak for similar reasons, May should show a dramatic pick up once the results are in.
For the reasons explained above, I wouldn’t blame management for the EPS miss; I only saw good news when Agrium Inc. (USA) (NYSE:AGU) presented results. For instance, there was one great surprise: one big share buyback authorization. Agrium announced a new authorization to purchase up to 5% of its common shares. Subject to regulatory approval, the buyback will start as soon as this month. Trading at 2013 6.4x EV/EBITDA and paying a 2.2% dividend yield, I believe Agrium is a great buy at the current price if you want international exposure to soft commodities.
Shareholder value
Cytec Industries Inc (NYSE:CYT), a global specialty chemicals and materials company, develops, manufactures and sells its products to a diverse range of markets. The company, which is much more diversified than Agrium Inc. (USA) (NYSE:AGU) across sectors, shares one thing with the producer of agricultural products: It will be buying back a significant amount of shares.
One month ago, Cytec Industries Inc (NYSE:CYT) announced that the company purchased 1.2 million shares from its US pension plan for $88 million (coupled with a $65 million contribution to the plan at the beginning of May, the US pension will finally be 100% funded). This repurchase, coupled with open-market transactions held before, resulted in Cytec buying back 3.1 million shares for $228 million year-to-date. I estimate the remaining buyback authorization for the second quarter, $322 million, should continue to drive the stock higher.
With the stock trading at 9x 2014 EV/EBITDA (versus its closest competitor, Hexcel Corporation (NYSE:HXL) at 10x), and taking into account Cytec Industries Inc (NYSE:CYT)’s strong outlook for growth over the next few years, the company looks like a compelling option within the materials sector. Cytec pays a low 0.6% cash dividend yield, but the company is committed to growing the distribution after the share buyback is over.
Given its higher relative valuation, I would assign Cytec Industries Inc (NYSE:CYT) a 15% portfolio weight.
Upside potential
Rockwood Holdings, Inc. (NYSE:ROC) has had a nice run since the year started–the stock is up by 36% year-to-date. That said, I believe there is still solid upside for investors looking out both through the short term (driven by spin-offs or sell-offs of businesses) and the long term, as Rockwood becomes a high-growth, high-margins company.
The short-term potential catalysts for the stock are related to spin-offs of non-core and lower margin businesses. The company has committed to exit the titanium dioxide (TiO2) business and might be selling the ceramics business soon (at a price no lower than $1.8 billion).
In regard to the TiO2 business, having combined the asset with the performance-additives segment, management appears to be using a dual-track approach with the possible exit being a sale or a spin-off, depending on what would drive maximum shareholder value.
In the longer term, after having sold all non-core assets, Rockwood Holdings, Inc. (NYSE:ROC) will be a leaner operation. The remaining entity should have its EBITDA margin at around 25% with top-line growth in the 6% to 8% range, and solid free-cash-flow generation.
Trading at 2013 9.5x EV/EBITDA and paying a 2.4% dividend yield, I think Rockwood Holdings, Inc. (NYSE:ROC) is a good bet within the space with significant upside potential coming from its corporate reorganization.
