Why Are Investors Piling Into These 4 Stocks Today?

At a time when the energy markets are still on edge after OPEC’s December 4 decision to keep oil lower for longer, and with the S&P 500 barely in the green today, shares of Dow Chemical Co (NYSE:DOW), E I Du Pont De Nemours And Co (NYSE:DD), Kinder Morgan Inc (NYSE:KMI), and Freeport-McMoRan Inc (NYSE:FCX) are surging. Let’s find out why investors are piling into these four stocks this morning. In addition, let’s also examine what hedge fund sentiment has to say about each of them and their long-term prospects.

Why do we track hedge fund activity? From one point of view we can argue that hedge funds are consistently underperforming when it comes to net returns over the last three years, when compared to the S&P 500. But that doesn’t mean that we should completely neglect their activity. There are various reasons behind the low hedge fund returns. Our research indicated that hedge funds’ long positions actually beat the market. In our back-tests covering the 1999-2012 period hedge funds’ top small-cap stocks edged the S&P 500 index by double digits annually. The 15 most popular small-cap stock picks among hedge funds also bested passive index funds by around 53 percentage points over the 38-month period beginning from September 2012 (see the details here).

First on our list are two global chemical companies, Dow Chemical Co (NYSE:DOW) and E I Du Pont De Nemours And Co (NYSE:DD), whose shares are up  by 11% and 10.9% respectively, on the news that the two will announce a merger tomorrow. If regulators approve the deal, the merger of equals will create a $90 billion-a-year Goliath in the chemicals industry, with a market capitalization easily in excess of $100 billion. According to the Wall Street Journal, Dow Chemical CEO Andrew Liveris will be Chairman of the new company, while E I Du Pont De Nemours And Co (NYSE:DD) CEO Edward Breen will be the CEO. Although the terms of the deal haven’t been released, investors are buying the two stocks because there is plenty of overlap between the two companies. The overlap and additional pricing power to be gained should unlock synergies that will make the combined company substantially more profitable. Because of today’s rally, shares of Dupont are now well in the green year-to-date, while shares of Dow Chemical are up by over 20% since January 1.

Among the big winners of the deal is Dan Loeb‘s Third Point, which owned 23.5 million shares of Dow Chemical as of September 30. In 2014, Loeb wrote that Dow Chemical was under-earning its potential by $2.5 billion in EBITDA annually because the global chemicals producer was too focused on making downstream products rather than maximizing profits. Loeb called for Dow management to cut costs and divest its lower-margin divisions, which Dow management has subsequently done. If Dow merges with Dupont, the combined company will have even more cost cutting opportunities that will increase EBITDA further.

On the next page, we examine the latest news concerning Freeport-McMoRan Inc and Kinder Morgan.

Next up on our list is midstream oil and gas giant Kinder Morgan Inc (NYSE:KMI), whose shares are up by 7.5% after the company announced that it will pare its quarterly dividend distribution by 75% to $0.125 per share, from the previous $0.51 per share. Investors are buying because the dividend cut is less than expected (some thought Kinder Morgan would cut the dividend to $0.01 per share) and because management’s move will provide enough cash flow to finance the company’s growth capital expenditures without the need to raise additional money from the equity or debt market. Any equity raise at current prices would have harmfully diluted shareholders and any debt raise would likely have removed Kinder Morgan’s investment grade status. Incidentally, Kinder Morgan’s dividend cut prompted Moody’s to upgrade the company’s debt outlook to ‘stable’ from the previous ‘negative’, meaning the company will keep its investment grade status for the foreseeable future.

Perhaps following in Kinder Morgan’s footsteps, Freeport-McMoRan Inc (NYSE:FCX) suspended its quarterly dividend of $0.20 per share and announced that it will reduce its oil and gas CapEx to $3 billion over the next two years, down from the previously planned $4 billion. Because of the moves, the company estimates its consolidated operating cash flow will more than cover its capital expenditures budget for 2016 (assuming $2/lb for copper and $45 for Brent). Investors are buying because Freeport-McMoRan Inc (NYSE:FCX)’s moves give the company more liquidity to survive the commodity down-cycle. Hedge funds have been more optimistic about the stock recently, with 44 elite funds long Freeport at the end of the third quarter, up from the 41 funds long the stock at the close of the second quarter. Shares of the commodity producer are now up by 10% in morning trading.

Disclosure: None