The basic materials sector can be a great way to invest for a long-term horizon, especially in a volatile economic environment. These companies are sensitive to short-term moves in commodity prices. Hence, investors should try to accumulate new positions when commodity prices look set to rise. We still encourage investors to understand the company's financials, and the impact of commodity prices before investing in these companies.
To create the list below we researched basic material stocks that paid a dividend of at least 1% but not more than 5%. This allowed us to stay away from the high yield space.
Additionally, we looked for those basic material companies that appear undervalued relative to their cash flows, indicated by high ratios of levered free cash flow/enterprise value.
Levered free cash flow is the free cash flow after deducting interest payments on outstanding debt. Enterprise value is the sum of the firm's value from all ownership sources: market cap, outstanding debt, and preferred shares. When companies have ratios of levered free cash flow/enterprise value in excess of 10%, it may indicate that the company as a whole is being undervalued.
This ratio gives us the money that the business can use to grow and pay dividends to shareholders. Any possibility of a dividend payout nowadays is looked at positively.
Our final list consisted of 3 basic material stocks.
For an interactive version of this chart, click on the image below. Analyst ratings sourced from Zacks Investment Research.
A Closer Look
We looked at FutureFuel Corp. (NYSE:FF) in more detail. The stock trades around $13.18 versus its 52-week high of $14, up 30% in the past 1-year. It trades with a P/E multiple of 15 times. The company competes with Archer Daniels Midland (NYSE:ADM), which trades with a P/E multiple of 13 times, and Renewable Energy Group (NASDAQ:REGI), which trades with a P/E multiple of 44 times.
The company has a solid balance sheet with $196 million in cash and short-term investments, and zero public debt. Also, they recently announced the issuance of 3 million shares for net proceeds of $36.1 million. This additional liquidity will be used for general corporate purposes.
Future Fuel has continued to return cash to shareholders in the form of quarterly dividends and recently in a $1.20 special dividend.
The top 2 holders of the stock are MSD Capital, and Revelation Capital Management. Also note that close to 60% of the shares are held by insiders.
Would you invest in this undervalued stock with a strong balance sheet with a history of returning cash to shareholders?
Do you think these stocks look attractive? Use this list as a starting point for your own analysis.
1. Delek US Holdings Inc. (NYSE:DK): Engages in refining, wholesaling, and marketing petroleum products in the United States.
- Market cap at $2.12B, most recent closing price at $35.58.
- Levered free cash flow at $263.05M vs. enterprise value at $2.37B (implies a LFCF/EV ratio at 11.1%).
- Dividend yield at 1.1%.
2. FutureFuel Corp. : Engages in the manufacture and sale of specialty chemicals and bio-based products primarily in the United States.
- Market cap at $544.73M, most recent closing price at $13.18.
- Levered free cash flow at $45.00M vs. enterprise value at $375.55M (implies a LFCF/EV ratio at 11.98%).
- Dividend yield at 3.3%.
3. HollyFrontier Corporation (NYSE:HFC): Operates as an independent petroleum refiner and marketer in the United States.
- Market cap at $11.03B, most recent closing price at $54.30.
- Levered free cash flow at $1.59B vs. enterprise value at $10.27B (implies a LFCF/EV ratio at 15.48%).
- Dividend yield at 1.5%.
*FCF data sourced from Yahoo! Finance