Jim Jubak

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Posted 5/18/2005

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Jubak's Journal
Recent articles:
• Get ready for a nice growth surprise, 5/17/2005
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 Jubak's Journal
5 stocks aided by rising prices

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Some specialty chemical makers are able to boost prices faster than their raw materials prices are climbing, boosting their earnings. Here are five with solid prospects for the next six months.

By Jim Jubak

Rising prices are terrible if you're a steel maker paying more for iron ore and scrap metal. Unless, of course, you're a steel maker raising prices for your products faster than your materials costs are climbing.

Rising prices are great, if you're an iron ore producer collecting top dollar from steel makers for your output. Unless, of course, you're an iron ore producer and the costs of fuel to run your mining machinery are climbing even faster.

For investors, it's the spread that counts. The goal when prices are rising here and there --but not everywhere -- is to find a company that's seeing the price of the product that it sells rise faster than the cost of its raw materials.

And nowhere does spread separate the winners from the losers more clearly than among the specialty chemical makers. Here tight supply and strong demand has pushed up prices as soaring prices for natural gas, the major raw material for many chemicals, has pushed up costs.
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With demand expected to outstrip scheduled capacity increases, companies that can keep their costs under control will see earnings soar, and investors who pick the right stocks in the sector should reap solid profits over the next six months.

Here are my three picks in the specialty chemicals sector that I made during my regular weekly appearance on CNBC's "Morning Call" at 11:45 a.m. ET on Wednesday.

The poster child
  • Celanese (CE, news, msgs) is my poster child for this trend. The company is a leading global producer of acetyl products and the low-cost producer in that sector. It's also a leading global producer of vinyl acetate monomer. In these two areas, the company is operating above 90% of capacity, traditionally a level that signals an ability to raise prices. It looks like Celanese will be able to raise prices faster than its costs increase.

    Cost controls also get a huge boost from the company's decision to exit the production of methanol at its plants and instead buy it from Southern Chemical, a low-cost producer in Trinidad. That'll reduce the company's exposure to rising and volatile natural gas prices by better than 70%.

    The stock trades at 9.1 times projected 2005 earnings per share and is even cheaper if you believe that the company can deliver earnings surprises anything like the first quarter's 28% surprise. The stock isn't rated by our StockScouter.

    Just what I like to see
  • FMC (FMC, news, msgs) is showing exactly the kind of profit margin expansion that I want to see in the current economy. Despite higher fuel and raw materials costs, the company was able to grow its net profit margin to 5.9% in 2004 from 3.5% in 2003. More important for investors who want to buy the stock now, it looks like FMC will be able to keep margins growing: Value Line projects its net profit margins will reach 6.5% this year. Wall Street analysts apparently agree with that projection since they expect the company will grow earnings by 33% this year.

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    Even though the stock was up 41% in 2004 and is up another 14% this year, FMC shares are still undervalued in comparison to its industry peers. For example, the stock trades at a price-to-book value ratio of 2.15 while the average for diversified chemical companies is 2.34. The price-to-cash-flow ratio is now 5.11, again below the industry average of 7.79. I especially like the combination of undervaluation with higher-than-average profitability: FMC's return on equity is 28%; the industry average is 18%.

    The stock trades at 12.2 times projected 2005 earnings. Our StockScouter rated the stock a 6 out of a possible 10 on May 18.

    Riding the growth
  • Albemarle (ALB, news, msgs) should ride strong growth in two of its core businesses this year. Strong demand from the electronics industry for tetrabrom and from the oil and chemical industries for catalysts plus solid price increases for the company's flame retardants are projected to push earnings up by 24% this year.

    At the same time, costs should drop as the company further integrates recent acquisitions, such as last year's deal for Akzo-Noble's refinery catalyst unit. But the company clearly has pricing power in several of its business segments if it needs to use it: In 2004, Albemarle increased prices for some of its catalysts and additives by 9%.

    The stock trades at 16.7 times projected 2005 earnings. Our StockScouter rated the stock a 6 on May 18.

    Exclusive picks
    And, as always, I have two exclusive picks for CNBC.com on MSN readers.

  • Agrium (AGU, news, msgs) rode the fertilizer price wave in 2004 with nitrogen prices up 44%, potash up 35% and phosphate up 15%. Wall Street thinks Agrium has one more good year ahead of it -- with earnings projected to climb 20% this year -- before the bottom falls out in 2006 and earnings drop 29%. I think the 2006 numbers radically underestimate the strength of global food demand and the length of the current strong farm cycle. But you can find that same pessimism on the agricultural sector pretty much anywhere you look. Deere (DE, news, msgs), for example, will see earnings growth drop to just 8% this year, despite good profits down on the farm that should fuel tractor sales, from 30% over the last 12 months.

    I think Wall Street's pessimism gives this stock substantial upside. Agrium trades at 10 times projected 2005 earnings. Our StockScouter rated the stock an 8 on May 18.

  • Potash (POT, news, msgs) is the low-cost producer in most segments of its core fertilizer business. So if you like Agrium, you should love Potash, except for one thing: the stock trades at a 20.6 times projected 2005 earnings. This means it's about twice as expensive as Agrium. But investors do get substantial value for those extra dollars.

    First, Potash is the global swing producer in many of its markets. Since the company controls the bulk of excess capacity in those segments, it has the ability to control, to a great extent, prices for its chemical products. Second, the company is the low-cost producer in many of those segments, with substantial cost advantages over its competitors. That results in a return on invested capital of 10.2% at Potash versus 8.6% for its industry. Our StockScouter rated the stock an 8 on May 18.


    Editor's Note: A new Jubak's Journal is posted every Tuesday and Friday.

    E-mail Jim Jubak at jjmail@microsoft.com.

    At the time of publication, Jim Jubak didn't own or control shares in any of the equities mentioned in this column. He doesn't own short positions in any stock mentioned in this column.

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