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Pockets of Value Remain in Agriculture, Chemicals Industries

Decline in the demand for lithium should be short-lived.

The Morningstar US Basic Materials Index outperformed the broader market in the second quarter of 2020 by over 400 basis points. Year to date, the sector has now lagged the Morningstar US Market Index by over 800 basis points, down from a year-to-date loss of more than 760 basis points a quarter ago. Trailing one-year underperformance fell to 530 basis points, down from more than 1,000 basis points a quarter ago. As a result of the second-quarter rally, just a third of the U.S. basic materials stocks we cover now trade in 4- or 5-star territory. However, we think investors can still find attractive risk-adjusted opportunities in the sector, particularly in the agriculture and chemicals industries.

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

Just one third of materials stocks trade at attractive discounts. - source: Morningstar

In agriculture, our base case for 2020 assumes that farmers will still plant crops globally. Because of more favorable weather this spring, crop plantings for both corn and soybeans, which account for most acres planted in the U.S., are well ahead of recent historical averages. Further, South American farmer economics remain solid. Both factors bode well for agriculture input demand during the second half of the year, as farmers should continue to apply fertilizer and chemicals to maximize crop yields.

Corn and soybean plantings are ahead of schedule in 2020. - source: Morningstar

Ingredient producers saw mixed impact from the coronavirus, as sales to food-service customers declined because of lower restaurant sales, partially offset by an increase in packaged-food sales. As restaurants reopen, we expect ingredient volumes to rise during the second half of the year and see little impact to 2021.

Although the impact of the pandemic will result in reduced lithium demand in 2020, the decline should be short-lived. The largest source of lithium demand comes from electric vehicles. COVID-19 government stimulus packages in China and throughout Europe have included EV subsidies and charging infrastructure investment. We expect EV sales to rise sequentially during the second half of the year and continue to grow in 2021. This should boost lithium demand and balance the market in 2021, with larger price increases in 2022.

Lithium prices should bottom in 2020 and rebound by 2022. - source: Morningstar

Top Picks

CF Industries Holdings CF Economic Moat Rating: None Fair Value Estimate: $52 Fair Value Uncertainty: High

With our outlook for a recovery in U.S. planted acres coming to fruition, we forecast strong demand for ag inputs, including nitrogen fertilizer. In our view, the market sell-off has created an opportunity for long-term investors to pick up CF Industries, which is among the lowest-cost nitrogen fertilizer producers globally. CF trades in 5-star territory at nearly 45% below our $52 per share fair value estimate.

Ingredion INGR Economic Moat Rating: Narrow Fair Value Estimate: $125 Fair Value Uncertainty: Medium

Our top pick to play the recovery in ingredients demand is narrow-moat Ingredion, which trades in 5-star territory at roughly a 35% discount to our fair value estimate. As Ingredion increases its proportion of specialty ingredients, such as natural sweeteners or plant-based proteins, which command higher pricing, we see profit growth and margin expansion.

Albemarle ALB Economic Moat Rating: Narrow Fair Value Estimate: $125 Fair Value Uncertainty: High

Narrow-moat Albemarle is the largest lithium producer globally. The stock trades in 4-star territory at nearly a 40% discount to our $125 per share fair value estimate. As one of the lowest-cost lithium producers globally, Albemarle is well positioned to maintain decent profit margins even as lithium prices fall. Over the long term, we contend that higher lithium prices will be needed to incentivize lower-quality supply to meet demand from growing adoption of electric vehicles. We view current share prices as an attractive entry point for a quality lithium producer.

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