Investors are facing a perfect storm this year due to the impact of inflation on corporate profits, the effect of inflation on the valuation of stocks and the increasing risk of an imminent recession. During such a rough period, some materials stocks are interesting candidates thanks to the essential nature of their business.
Here, we will discuss the prospects of three materials stocks, which offer above-average dividend yields.
Dow Inc. (DOW)
Dow Inc. is a standalone company that was spun off from its former parent, DowDuPont (now DuPont (DD) ) in 2019. That company was broken into three publicly traded, stand-alone parts, with the former Materials Science business having become the new Dow.
Dow has greatly benefited from the rally of commodity prices, which has resulted primarily from the ongoing war in Ukraine and supply-chain disruptions due to the pandemic. Thanks to exceptionally high prices of chemicals, the company enjoyed blowout earnings per share of $8.98 in 2021.
However, commodity prices have incurred a significant correction lately due to fears of an upcoming recession. Most central banks are raising interest rates at a fast clip in an effort to keep inflation under control.
Higher interest rates greatly reduce the total amount of investments and thus the global economy has slowed down in recent quarters and is likely to fall into a recession in the upcoming quarters. Dow will be hurt in such a case, as the prices of chemicals will decrease materially. The company is also negatively affected by the increased cost of raw materials amid high inflation.
The business headwinds facing Dow have already begun to show up in its performance. In the second quarter, the company grew its packaging sales by 16% over the prior year’s quarter and its total revenue by 13% thanks to strong price hikes in all the segments and operating regions.
Notably, growth resulted fully from price hikes, as volumes declined 2%. Due to a steep increase in the cost of raw materials, cost of sales jumped 20% and caused the gross margin to shrink to 17.7% from 22.7%. As a result, Dow incurred a 10% decrease in its EPS. If a recession shows up, EPS are likely to remain in a downtrend.
Going forward, Dow is likely to try to enhance its bottom line via cost savings initiatives as well as share repurchases. However, given its blowout EPS in 2021 and its still high EPS this year, it is prudent not to expect meaningful growth of EPS in the upcoming years, particularly given the cyclical nature of the stock. In addition, investors should be conservative, given the short history of Dow as a stand-alone company.
Dow is currently offering an exceptionally high dividend yield of 6.0%. Given its solid payout ratio of 35% and its strong balance sheet, the company can easily maintain its dividend, even in the event of a typical recession.
On the other hand, investors should note that dividend growth is not a priority for this company. Dow has frozen its dividend for three consecutive years and prefers to repurchase shares, especially at the current low price-to-earnings ratios. A constant dividend is less attractive in the highly inflationary environment prevailing right now.
LyondellBasell Industries (LYB)
LyondellBasell is one of the largest plastics, chemicals and refining companies in the world. The company provides materials and products that help advance solutions for food safety, water purity, fuel efficiency of vehicles and functionality in electronics and appliances. LyondellBasell sells its products in more than 100 countries and is the largest producer of polymer compounds in the world. It also has a vast intellectual property portfolio, with more than 5,500 patents.
Due to the nature of its business, LyondellBasell is highly vulnerable to recessions, as global demand for the products of the company significantly decreases during rough economic periods. In the Great Recession, the company was caught off-guard, with an excessive debt load, and thus it went bankrupt. The new company, which emerged from bankruptcy in 2010, seems to have learnt its lesson well, as it has maintained a healthy balance sheet.
LyondellBasell has greatly benefited from the strong recovery of global demand for chemicals and oil products from the pandemic and the supply crunch caused by the ongoing war in Ukraine. Thanks to unprecedented margins in its chemical and refining businesses, the company more than tripled its EPS last year, to an all-time high of $18.19 from $5.61.
Unfortunately for LyondellBasell, its blowout earnings in 2021 are not sustainable in the long run. In the second quarter, LyondellBasell continued to enjoy robust demand for its products, strong pricing power and exceptionally wide margins, though the latter were somewhat lower than their record levels in the prior year’s period. As a result, the company posted a 15% decrease in its EPS, to $5.19 from $6.13.
LyondellBasell has more than tripled its EPS over the last decade. However, this growth record is somewhat misleading, as it includes an artificially low base in 2012, shortly after the emergence of the company from bankruptcy, and an extraordinary performance this year due to unprecedented profit margins.
The company will try to grow by enhancing its product offerings and by expanding into new markets but investors should expect the EPS of the company to decline significantly in the upcoming years, to more normal levels. The market seems to agree on this, as it has assigned an all-time low price-to-earnings ratio of 5.0 to the stock.
LyondellBasell is currently offering a nearly 10-year high dividend yield of 5.9%. It is also remarkable that the company offered a special dividend of $5.20 per share (6.4% yield at the current stock price) in June thanks to its excessive profits.
On the one hand, investors should not expect such high special dividends in the upcoming years. On the other hand, the 5.9% regular dividend is well covered, with a payout ratio of only 28% and a solid balance sheet.
Amcor is one of the world’s most prominent designers and manufacturers of packaging for food, pharmaceutical, medical and other consumer products. The company puts an emphasis on the production of responsible packaging, which is lightweight, recyclable and reusable.
In its current form, Amcor was formed in June 2019 with the merger between two packaging companies, U.S-based Bemis and Australia-based Amcor. This merger greatly enhanced the prospects of the company in emerging markets, which are characterized by much higher economic growth rates than the developed ones.
In its fiscal fourth quarter, which ended at the end of June, Amcor grew its sales by 13% over the prior year’s quarter, primarily thanks to strong price hikes amid favorable business conditions, and grew its EPS by 4%. In the full fiscal year, Amcor grew its sales and its adjusted EPS by 13% and 11%, respectively. The company also issued positive guidance for next year, as it expects 3%-8% growth of adjusted EPS, including a 4% negative effect of higher interest rates on interest expense.
Amcor expects its strong sales momentum to remain in place in the upcoming years thanks to its investments in high-value products and the potential for high-return acquisitions. On the other hand, it is prudent to keep somewhat conservative expectations, particularly given the short historical record of the company in its current form. Overall, Amcor can be reasonably expected to grow its EPS at a mid-single-digit rate in the upcoming years.
Amcor is currently offering an above-average dividend yield of 4.3%. As the company has a decent payout ratio of 60% and a healthy balance sheet, its dividend should be considered safe, even in the event of a typical recession.
On the other hand, Amcor has grown its dividend by only 2% per year in each of the last three years. As a result, its dividend is somewhat less attractive than it appears on the surface, especially in the current inflationary environment.
The basic materials sector offers some interesting candidates in the ongoing bear market but investors should not draw the conclusion that these stocks are immune in the current environment.
The above three stocks are currently offering above-average dividend yields and have declined much less than the S&P 500 this year. However, their outperformance has resulted primarily from their wide profit margins, as their selling prices have increased much more than their costs.
Overall, these three stocks offer above-average dividends with a wide margin of safety.
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