Agriculture, Chemicals Appeal in Basic Materials

The Morningstar US Basic Materials Index outperformed the broader market during the fourth quarter of 2020 by 220 basis points. Year to date, the sector has still underperformed the Morningstar US Market Index by roughly 150 basis points, though this is an improvement from an underperformance of roughly 475 basis points through the first three quarters of the year. Trailing one-year underperformance improved to 50 basis points, down from 430 basis points a quarter ago. As a result of the 2020 rally, less than 20% of the U.S. basic materials stocks we cover now trade in 4-star territory and no stocks trade in 5-star territory. However, we think investors can still find attractive long-term opportunities in the agriculture and chemicals industries.

U.S. materials index versus the U.S. equity index - Morningstar

Less than 20% of materials stocks trade at attractive discounts - Morningstar

In agriculture, we expect potash demand will grow over the next several years. As the fertilizer helps plants grow in stressed weather conditions, including mild drought and flooding, farmers globally should continue to apply potash in greater quantities to maximize crop yields. Although demand grew in 2020, new supply has weighed on prices. However, we forecast demand growth in 2021 will sop up excess supply, leading to higher prices.

Potash market is currently oversupplied but will balance in 2021 - Morningstar

Chemicals producers saw demand continue to recover during the second half of 2020 following COVID-19-driven closures. We expect a continued sequential volume recovery in 2021. This should bode well for specialty chemicals producers, whose differentiated products command premium pricing, driving profit recovery as volumes return.

Deicing salt prices will fall for the 2020-21 winter following a mild 2019-20 winter. Deicing salt demand volume is driven by winter weather. As such, prices tend to fall following a milder winter as producers carry excess inventory, leading to oversupply conditions. While weather is volatile each year, it tends to revert to the mean over a longer period. Should normal or harsh weather occur this winter, we would expect to see tight market conditions, and prices to rebound.

Snowfall is volatile from year to year but mean-reverting over time - Morningstar

Top Picks

Nutrien NTR Star Rating: ★★★★ Economic Moat Rating: Narrow Fair Value Estimate: $61 Fair Value Uncertainty: High

For our outlook for recovering potash fertilizer prices, our top pick is narrow-moat Nutrien. The company’s cost advantage stems from its low-cost potash and nitrogen production. The stock currently trades in 4-star territory at a little over a 20% discount to our $61 per share fair value estimate. We view current prices as an attractive entry point for long-term investors.

DuPont DD Star Rating: ★★★★ Economic Moat Rating: Narrow Fair Value Estimate: $85 Fair Value Uncertainty: Medium

Our top pick to play the specialty chemicals demand recovery is narrow-moat DuPont. The stock trades in 4-star territory at more than a 15% discount to our fair value estimate. DuPont is well positioned to benefit from several underlying trends, including the growth of 5G-enabled devices, increased electric vehicle adoption, and a recovery in U.S. housing starts. We view the current share price as an attractive entry point for the quality specialty chemicals producer.

Compass Minerals International CMP Star Rating: ★★★★ Economic Moat Rating: Wide Fair Value Estimate: $80 Fair Value Uncertainty: High

Wide-moat Compass Minerals is our top pick to play a rebound in deicing salt prices. The stock trades in 4-star territory at roughly a 25% discount to our $80 per share fair value estimate. Compass’ cost-advantaged salt production stems from its low-cost Goderich mine, which also benefits from being on Lake Huron, allowing Compass to both produce and transport salt at a lower cost than its competitors. Although Compass has seen higher costs in recent years owing to temporary operational issues, we expect salt unit production costs to fall over the next couple of years as Compass’ operation is fully restored. As such, we view current share prices as an attractive entry point for the quality salt producer.