6 Cheap Stocks to Play Long-Term Growth Trends

Over the past year, specialty chemicals stocks have underperformed the broad equity market. Stocks in the chemicals industry are considered cyclical stocks, as their sales and earnings are closely tied to the economy—and the weakening economic outlook has taken a toll on the valuations of these stocks. While a stagnant or slowing economy will put pressure on these companies’ earnings in the short term, we think there’s long-term opportunity in higher-quality specialty chemicals stocks that are tied to several secular growth trends.

The long-term themes include:

• The electrification of automobiles.
• Increasing demand for semiconductors.
• The transition to plastics.
• A scarcity of freshwater.
• Demand for healthier, more natural, and enhanced prepared foods.

We think undervalued stocks of specialty chemical companies that are tied to these growth themes have significant appreciation potential.

6 Undervalued Specialty Chemicals Stocks for 2023

These stocks receive either a wide or narrow Morningstar Economic Moat Rating and are trading well below our fair value estimates.

1. Celanese CE
2. DuPont DD
3. Eastman Chemical EMN
4. Ecolab ECL
5. Ingredion INGR
6. International Flavors & Fragrances IFF

Here is a synopsis of those long-term secular themes we think each of these stocks are tied to and a few key metrics about each stock. All data is as of Feb. 22, 2023.

Celanese

• Morningstar Rating: 4 stars
• Price/Fair Value: 0.71
• Morningstar Uncertainty Rating: Medium
• Morningstar Economic Moat Rating: Narrow
• Secular growth themes: Electrification of automobiles, transition to plastics

More than half of Celanese’s sales are tied to global auto production, irrespective of whether it’s an internal combustion engine or electrified vehicle. Celanese is currently in the process of integrating its acquisition of the automotive business from DuPont, which we think will drive revenue and cost synergies as it becomes the leader in specialty plastics for the auto industry. We think Celanese stock is about 29% undervalued.

DuPont

• Morningstar Rating: 4 stars
• Price/Fair Value: 0.77
• Morningstar Uncertainty Rating: Medium
• Morningstar Economic Moat Rating: Narrow
• Secular growth themes: Increasing demand for semiconductors, scarcity of freshwater

DuPont’s electronics and industrial segments will benefit from increased semiconductor demand and the rising adoption of “Internet of Things” technologies. We forecast the company’s annual EBITDA growth will increase at a high-single-digit rate after 2023. We forecast a similar growth rate in water and protection, driven by increased water filtration demand and our outlook for U.S. housing to average nearly 1.5 million starts per year through 2030. DuPont stock trades 23% below our fair value estimate.

Eastman Chemical

• Morningstar Rating: 5 stars
• Price/Fair Value: 0.63
• Morningstar Uncertainty Rating: Medium
• Morningstar Economic Moat Rating: Narrow
• Secular growth themes: Electrification of automobiles, transition to plastics

In our view, Eastman Chemical will be the most positively leveraged specialty chemicals company to the long-term structural shift to electric vehicles. Furthermore, the company will benefit from the shift in demand to environmentally friendly plastics, as Eastman’s products are used for both recycling plastics as well as converting recycled plastics into other new plastic products. In addition to being undervalued by our measures, the stock currently pays a 3.6% dividend yield, one of the higher yields in its industry, and we don’t think the dividend is at risk of being cut. Eastman Chemical stock looks about 37% undervalued.

Ecolab

• Morningstar Rating: 4 stars
• Price/Fair Value: 0.75
• Morningstar Uncertainty Rating: Medium
• Morningstar Economic Moat Rating: Wide
• Secular growth theme: Scarcity of freshwater

As freshwater costs continue to rise globally—we expect U.S. median costs will double by 2030—Ecolab is well positioned to continue to grow its water business at a high-single-digit to low-double-digit annual rate. As an example, during its most recent quarter, Ecolab’s water business grew 14% versus the prior-year quarter as the company continued to win new customers through its value proposition to reduce water and energy expenses in excess of the cost of Ecolab’s products. While cost inflation has had a temporary impact on Ecolab’s profits, the company’s strong pricing power, which underpins our wide moat rating, should allow it to pass along cost inflation over time. Ecolab stock is 25% undervalued relative to our fair value estimate.

Ingredion

• Morningstar Rating: 4 stars
• Price/Fair Value: 0.83
• Morningstar Uncertainty Rating: Medium
• Morningstar Economic Moat Rating: Narrow
• Secular growth theme: Demand for healthier, more natural, and enhanced prepared foods

Technically, Ingredion is in the packaged foods industry, but we think it has many of the same attributes as a specialty chemicals company. Ingredion is undergoing a portfolio transformation away from high fructose corn syrup-based products and into specialty starches (for example, gluten-free foods) and natural sweeteners (such as stevia). The company has been slowly but surely executing on this transformation, but it has not been as fast as the market would have preferred. Over the next few years, we expect this transition to continue, which we forecast lead to higher profit growth. In the meantime, the stock yields 2.9%, and we don’t expect the dividend to be cut. Ingredion stock trades 17% below our fair value.

International Flavors & Fragrances

• Morningstar Rating: 5 stars
• Price/Fair Value: 0.67
• Morningstar Uncertainty Rating: Medium
• Morningstar Economic Moat Rating: Wide
• Secular growth theme: Demand for healthier, more natural, and enhanced prepared foods

International Flavors & Fragrances holds an enviable portfolio focused on value-added products used in food and beverages, fragrances, personal care, enzymes, probiotics, and pharmaceuticals. These products affect the desired taste, smell, or mouthfeel based on customer specifications. IFF’s products are more diversified than other specialty chemicals companies and are sold to less cyclical and more differentiated end markets. Although near-term results have been under pressure from cost inflation, we expect that IFF’s 2023 results will represent the cyclical low for the business. We forecast that revenue and margins will normalize, rising back to their long-term trend. In the meantime, IFF pays a 3.4% dividend yield, which is not at risk of being cut, in our view, and IFF stock is 33% undervalued.

Why Are Specialty Chemicals Stocks So Cheap?

Valuations for chemicals companies are closely linked to the expansion or contraction of the global economy. As the market prices in a heightened probability of a near-term global economic slowdown, these stocks have fallen out of favor and valuations have dropped.

Within the broad chemicals sector, we see a significant amount of value in those companies that focus on specialized products. Specialty chemicals companies concentrate on products that require a high degree of skill and intellectual property in order to address specific applications. Often these companies spend a significant amount of money on research and development, as opposed to chemicals companies that make commodity-oriented products that do not require specialized processes or know-how. Over time, we expect that many of these specialty chemicals companies will be able to generate excess returns over their costs of capital, and as such we have assigned them wide or narrow economic moat ratings.

5 Growth Themes for 2023

Here’s more about the themes that specialty chemicals stocks should benefit from.

1. The electrification of automobiles: We forecast that by 2030, two thirds of all new automotive production globally will be for electric vehicles (either a hybrid or battery electric vehicle). Electric vehicles are estimated to require between 2.5 times and 3.0 times more specialty chemicals in their manufacturing process than those powered by internal combustion engines.
2. Increasing demand for semiconductors: Auto manufacturers are incorporating additional features such as self-driving capabilities and entertainment systems that require more computing power. Furthermore, a greater number of electronic and consumer products incorporate features that require semiconductors.
3. The transition to plastics: Manufacturers are continuing to transition the manufacturing of parts to high strength plastics from metal. For example, auto manufacturers look to these lighter-weight parts to help extend battery range for EVs and increase gas mileage.
4. A scarcity of freshwater: We forecast that by 2030 the cost of freshwater will double. In order to offset these costs, manufacturers will look to increase the efficiency of their water usage, wastewater recovery, and filtration.
5. Demand for healthier, more natural, and enhanced prepared foods: Consumers want healthier choices of prepared foods, including those enhanced with vitamins and other healthy additives. Yet, they are not willing to give up on taste, texture, and richness.

While we expect that stocks for specialty chemicals companies that are leveraged to these long-term secular themes have significant appreciation potential over time, they can be volatile in the short term. In that light, they are best suited for long-term investors who can withstand that volatility.