Chemical stocks: 2 to buy, 2 to sell

This sector may not be on many radars, but it could be poised for some action.

By InvestorPlace Dec 18, 2012 2:12PM
Droplet Falling from Pipette into Test Tube copyright Andrew Douglas, Radius Images, Getty ImagesBy James Brumley

To say chemical stocks have kept a low profile of late would be an understatement; they've been almost entirely off the radar all year long. But that doesn't mean some of these stocks haven't been moving, nor does it mean none are poised for major moves in the foreseeable future.


And given that interest in a particular sector is cyclical, the market might put be putting some of these names back under the microscope real soon.


With that in mind, here are two chemical makers that might be worth a swing right now before the spotlight starts to shine again, and two more chemical names that are best avoided right now:


Two to buy

With a market cap of only $3.9 billion, Huntsman (HUN) certainly isn't the biggest diversified chemical name. But, priced at only 7.7 times its trailing earnings and 7.9 times its projected 2013 income, Huntsman might well be the cheapest in the category.


Simply put, Huntsman is doing what its bigger brothers haven't been able to do very well of late: grow. Though analysts still peg HUN's long-term growth outlook at single digits, that's the norm here. Huntsman's forecast growth of 7.4% is still stronger than growth forecasts for Dow (DOW) or DuPont (DD).


But the biggest reason HUN may belong in investors' portfolios is the possibility of an acquisition.


While most of the market is well versed in the ebb and flow of natural gas and oil, investors might not be aware of the growing supply strains that the titanium oxide market is under. Titanium oxide is now where rare earth metals were three years ago ... only in this case, the rising price trend is holding at more sustainable levels. The nation's three biggest producers are Kronos (KRO), DuPont and -- ta da! -- Huntsman. Between Huntsman's relatively rich supply of TiO2 and the company's trailing free cash flow of more than $500 million, a suitor might end up nabbing it before all is said and done.


Sensient Technologies (SXT) is another compelling chemical play, as shares have been sliding lower while earnings have continued to rise. And it's not just a little short-term volatility. SXT has been falling since February and is down 7% for the year, while the company has increased earnings by 6% for the year so far. One could make the argument that stocks trade on their perceived future value rather than their history (which is true), but after a year's worth of doubt, the pessimists should be right on the verge of accepting the obvious.


Sensient makes food coloring, food additives, ink and fragrances, and from that perspective, it doesn't appear to be an exceedingly remarkable company. However, it's emerging as a leading producer of natural food colors. The advent of health-savvy food consumption is forcing food producers to rethink exactly what they put in and on their packaged foods, and in turn that's putting Sensient at the front of the line for many food companies when it comes time for procurement.


Two to sell

Most investors were willing to give companies a break on fundamentals during 2008 and 2009. After all, nobody saw the depth of the economic Armageddon that was on the way, and it would have been unfair to expect any meaningful success.


It has been nearly four years since that economic bottom, though, and not only has Calgon Carbon (CCC) not started to grow its bottom line again -- its income continues to shrink with no end in sight.


Specifically, per-share income has slumped from 2010's peak of 75 cents to a projected 39 cents for this year. The pros say Calgon will earn $0.80 per share next year, though at least some of that boost stems from the company's $100 million stock repurchase program unveiled in November. Even then, however, Calgon will need to do something remarkably different business-wise than it has been since 2010. The company has talked the talk, but the market has yet to see the specifics on how it's going to walk the walk. Throw in the fact that Calgon has missed estimates in seven of the past 14 quarters, and it's not like anyone can afford to blindly trust the outlooks for the organization.


Lastly, though Ecolab (ECL) seems like a rock-solid company with just a quick glance, a closer examination of this cleaner and cleaning-accessory company waves too many red flags.

To give credit where it's due, Ecolab has been on a growth binge over the past three quarters thanks to some big acquisitions like Champion, Nalco and Ecofarm. Revenue has totaled $10.6 billion for the past 12 months, versus only $6.8 billion in all of last year. Net income has jumped from $462 million in 2011 to $561 million over the prior four quarters. All in all, not bad.


The red flag is the debt Ecolab is taking on to make it happen. Long-term debt now stands at $6 billion, where it was only $656 million as of the end of 2010. Supporters and fans will say -- and rightfully so -- that a company has to spend money to make money. Ecolab, however, seems to be tiptoeing into that dangerous "growth now at all costs later" territory, announcing last week that it was biting off another $500 million in debt via the sale of more notes.


So far, Ecolab hasn't shown any signs of trouble in servicing its debts. But net margins are getting noticeably thinner . . . enough to prompt a BBB+ rating from Standard & Poors for its latest round of debt. That's still investment-grade, but the rating agencies have been ratcheting down the company's credit quality as it continues to proceed with its buying binge. Equity investors might want to take heed of the company's changing credit quality, as there's little room for error (or economic turbulence) here no matter which accounting statement you're more interested in.


As of this writing, James Brumley did not hold a position in any of the aforementioned securities.


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