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 companies that appear undervalued relative to their cash flows, indicated by high ratios of levered free cash flow/enterprise value. Levered free cash flow plays an important role in paying for dividends and further expansion of the business.
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.
Do you think these stocks look attractive? Use this list as a starting point for your own analysis.
1. Delek US Holdings Inc. (DK): Engages in refining, wholesaling, and marketing petroleum products in the United States.
- Market cap at $2.19B, most recent closing price at $36.92.
- Levered free cash flow at $321.66M vs. enterprise value at $2.16B (implies a LFCF/EV ratio at 14.89%). Compare this to Marathon Petroleum Corporation (P/FCF ratio at 10.15) and Phillips 66 (P/FCF ratio at 16.32).
- Dividend yield at 1.1%.
- Since 3/8/13 DK has returned -7.54%. Marathon Oil Corporation and Phillips 66 returned -3.07% and -5.63% during the same time period.
2. FutureFuel Corp. (FF): Engages in the manufacture and sale of specialty chemicals and bio-based products primarily in the United States.
- Market cap at $517.79M, most recent closing price at $11.97.
- Levered free cash flow at $59.90M vs. enterprise value at $388.24M (implies a LFCF/EV ratio at 15.43%).
- Dividend yield at 3.7%.
- Hedge funds signal that there is upside for this stock: Net institutional purchases in the current quarter at 1.8M shares, which represents about 9.42% of the company's float of 19.11M shares.
3. HollyFrontier Corporation (HFC): Operates as an independent petroleum refiner and marketer in the United States.
- Market cap at $9.82B, most recent closing price at $47.72.
- Levered free cash flow at $1.50B vs. enterprise value at $9.38B (implies a LFCF/EV ratio at 15.99%).
- Dividend yield at 2.5%.
- HFC has a lower than average projected earnings growth rate over the next 5 years (1.50%). This is significantly below the analyst projections for Marathon Petroleum Corporation (projected EPS growth over next 5 years at 11.26%) and Phillips 66 (projected EPS growth over next 5 years at 10.78%).
*FCF data sourced from Yahoo! Finance