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Lithium Stocks a Bright Spot in Basic Materials

Market's decline leaves over half of the sector undervalued, trading at 4 or 5 stars.

The Morningstar US Basic Materials Index performed slightly worse than the broader market during the second quarter of 2022, by roughly 70 basis points. The materials index fell 14.9% during the quarter, while the U.S. market index fell 14.2%. On a trailing 12-month basis, the materials sector outperformed the market by 510 basis points. As a result of the market decline, we see opportunities across the sector, with more than 54% of the stocks trading in either 5- or 4-star territory.

Materials Index Versus Equity Index

- LME, Benchmark Minerals, Fastmarkets, Platts, FMC, Corteva, Morningstar.

Lithium demand will grow nearly 5 times by 2030 from 2021, largely due to increased electric vehicle adoption. As lithium demand grows, higher-cost lithium sources will need to be tapped, driving up the marginal cost of production. The lithium market is currently undersupplied, leading to prices at all-time highs. Because of demand growth outpacing new supply, we expect prices will remain above the marginal cost of production of $12,000 per metric ton through the remainder of this decade, selling at $70,000 per metric ton in 2023 and averaging in the mid-$30,000 range over the decade. This should allow low-cost producers to generate excess returns.

54% of Our Basic Materials Names Trade in 5- or 4-Star Territory

- LME, Benchmark Minerals, Fastmarkets, Platts, FMC, Corteva, Morningstar.

In agriculture, demand for biological (nonsynthetic) crop protection products will grow rapidly. The increase will be driven by growing pest resistance to traditional products, which requires farmers to turn to new products. Biologicals demand will also be aided by regulations as more synthetic crop chemicals are banned in places like the European Union and Brazil. As a result, we expect the biologicals market will double by 2025 from 2020 levels, taking market share from synthetic crop chemicals.

Lithium Prices Will Remain Above Marginal Cost Levels This Decade

- LME, Benchmark Minerals, Fastmarkets, Platts, FMC, Corteva, Morningstar.

We see long-term growth for specialty plastics producers that sell content used in electric vehicles. Electric vehicles use 3.5 times more laminated glass as a way to reduce noise, make auto cabins more energy efficient, and increase battery life. This allows specialty plastics producers to sell more content per vehicle, generating revenue growth at a mid-single-digit annual average rate.

Biologicals Sales Will Double by 2025 as They Take Market Share

- LME, Benchmark Minerals, Fastmarkets, Platts, FMC, Corteva, Morningstar.

Top Picks

Lithium Americas LAC Star Rating: ★★★★★ Economic Moat Rating: None Fair Value Estimate: $84 Fair Value Uncertainty: Very High

Lithium Americas is our top pick to play higher lithium prices. The stock trades at roughly a third of our $65 (CAD 84) per share fair value estimate. Lithium Americas does not currently produce any lithium but is developing three lithium resources that should enter production by the end of the decade, with the first resource entering production later this year. Once all projects are fully ramped, we forecast the company will become a top five producer by capacity globally. We reiterate our very high uncertainty rating because of elevated company-specific risk as a result of no projects currently operating. However, for long-term investors who can tolerate the volatility, we see massive upside in the stock.

FMC FMC Star Rating: ★★★★ Economic Moat Rating: Narrow Fair Value Estimate: $135 Fair Value Uncertainty: Medium

Our top pick to invest in growing biologicals crop protection products is FMC. The stock trades at a roughly 20% discount to our $135 fair value estimate. FMC is a crop chemicals pure-play company that is investing heavily to develop new biologicals products. As new biologicals products, which sell at premium prices, take share from traditional crop chemicals, FMC should see mid-single-digit revenue growth and mid- to high-single-digit profit growth as a result.

Eastman Chemical EMN Star Rating: ★★★★★ Economic Moat Rating: Narrow Fair Value Estimate: $140 Fair Value Uncertainty: Medium

Our top pick to play specialty plastics demand growth is narrow-moat Eastman Chemical. The stock trades at about a 35% discount to our $140 fair value estimate. Eastman is a market leader in the specialty plastics used in automotive films and window interlayers, which should allow the company to benefit from increased adoption of electric vehicles, leading to more content per vehicle. Additionally, the company is well positioned to benefit from increased demand from consumer-packaged goods for recycled packaging, as the company is a leader in converting discarded plastic to feedstock to create new products. We view the current share price as an attractive entry point.

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