Jacob Miller
Jovan Mitrovic
Matt Odem
Agenda
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Sector Overview
Business Analysis
Economic Analysis
Financial Analysis
Valuation
Recommendations
Sector Overview
• The Basic Materials Sector is comprised of companies
who are involved in the discovery, extraction,
refinement and processing of a variety of raw materials
used as inputs in production.
• These materials include chemicals, plastics, metals,
nonmetallic and construction materials; forest, wood
and paper products; and containers and packaging
products.
• Majority of the companies in the Basic Materials sector
are business to business companies that process and
supply materials to other companies in other sectors.
Sector Overview Cont’d
• Historically the Basic Materials Sector has outperformed the S&P
500 in the early-cycle and late-cycle phases.
• Main stream of growth today is through acquisition, and heavy R&D
investments
• Increased Environmental Regulation
• Large international exposure, due to nature of commodity products,
and that most companies have operations in several countries
– Stronger Dollar => Low Commodity Prices, lower profits for many
material producers
• Sensitive to Fluctuations in the Business Cycle
– Relies on Strong Economy and performance of companies who buy
from them
• Sensitive to Supply / Demand Fluctuations in commodity prices
– Prices of raw materials are largely demand driven on the commodity
markets
Catalysts and Risks
Potential Catalysts for the Sector:
• Improving Economic factors such as job growth and housing data
• Demand from emerging economies who are manufacturing based
still such as India, China, and Brazil.
• Limited supply of natural resources and arable land will drive high
demand in the long term
Potential Risks for the Sector:
• Lower earnings recently for companies who buy from material
sector companies, causing lower demand to produce
• Further government regulations involved with environment
protection
• Oversupply in the short run
Sector Life Cycle
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The sector is in the Mature Phase in the Life Cycle
Sales and Earnings are stable
Growth rate is similar to the overall economic rate now
Higher dividend yields and share repurchase programs
to compensate investors for lower growth
Lower margins due to intense competition
Consolidation within industries is common
Established sector, which creates a low risk
environment
Long term contracts are common in supplying
downstream companies
Sector Breakdown
Sector
Basic
Materials
Industry
Sub-Industry
Commodity Chemicals
Diversified Chemicals
Chemicals
Fertilizers and Agricultural Chemicals
Industrial Gases
Specialty Chemicals
Construction Materials
Construction Materials
Metal and Glass Containers
Containers and Packaging
Paper Packaging
Aluminum
Diversified Metals and Mining
Gold
Metals and Mining
Precious Metals and Minerals
Silver
Steel
Forest Products
Paper and Forest Products
Paper Products
Industry
Chemicals-Diversified
Mining & Metals-Specialty
Chemicals-Commodity
Chemicals-Agriculture/Fertilizer
Forest & Wood Products
Construction Materials
Paper Packaging
Steel
Aluminum
Precious Metals & Minerals
4/1/2016 5-Day 1-month 1-year # of Companies Market Cap
0.46%
-0.75%
0.98%
0.49%
0.82%
0.87%
0.08%
1.75%
1.69%
0.59%
-0.60%
-5.40%
-0.07%
-3.18%
1.27%
-0.40%
-0.48%
-1.95%
-4.03%
-3.47%
6.77%
13.45%
11.64%
3.51%
18.05%
14.24%
16.18%
36.21%
3.32%
10.91%
0.99%
-37.34%
2.00%
-7.11%
-2.91%
8.38%
-24.77%
-12.68%
-27.12%
-14.44%
8
181
66
33
22
32
6
64
12
174
55.7B
43.4B
21.8B
20.5B
16.9B
16.1B
11.5B
10.8B
8.9B
8.7B
Sector’s Largest Companies
Symbol
Company
Industry
DOW
Dow Chemical
Diversified Chemicals
DD
Du Pont (E.I.)
Diversified Chemicals
MON
Monsanto Co.
Fertilizers & Agricultural Chemicals
LYB
LyondellBasell
Diversified Chemicals
ECL
Ecolab Inc.
Specialty Chemicals
PX
Praxair Inc.
Industrial Gases
APD Air Products & Chemicals Inc
Industrial Gases
PPG
PPG Industries
Diversified Chemicals
SHW
Sherwin-Williams
Specialty Chemicals
IP
International Paper
Paper Products
Market Cap
57.03B
55.55B
40.13B
37.01B
33.27B
32.83B
31.74B
30.17B
26.38B
17.06B
P/E(TTM) Annual Rev (TTM)
8.32
48.78B
29.57
25.13B
22.85
14.35B
9.06
32.74B
33.86
13.55B
21.54
10.78B
24.02
9.69B
21.99
15.33B
25.77
11.34B
18.37
22.36B
5-Day YTD Return
0.76%
0.00%
0.26%
-3.65%
1.40%
-7.54%
0.74%
-1.15%
1.89%
-1.71%
2.26% 12.30%
2.32% 11.64%
3.39% 13.24%
1.22%
9.56%
-0.15% 8.75%
1-Month
3.75%
3.25%
6.79%
6.80%
7.39%
10.43%
8.22%
12.65%
3.92%
11.47%
3-Month
0.00%
-3.65%
-7.54%
-1.15%
-1.71%
12.30%
11.64%
13.24%
9.56%
8.75%
6-Month
8.14%
32.72%
6.19%
-0.09%
0.08%
13.40%
12.36%
24.15%
22.64%
6.91%
1-Year
7.47%
-4.80%
-22.12%
-3.08%
-0.99%
-4.97%
-3.22%
-0.29%
-0.49%
-25.32%
2-Year
3.56%
-0.28%
-20.09%
-3.23%
3.46%
-12.25%
21.04%
13.81%
42.87%
-9.35%
5-Year
33.64%
21.97%
37.56%
101.74%
118.21%
12.43%
57.86%
134.74%
234.70%
39.04%
10-Year
26.77%
53.22%
118.44%
383.40%
197.41%
104.88%
111.98%
233.43%
458.36%
14.37%
SIM Portfolio VS S&P 500
Overweight by 3 bps
Stocks in SIM Portfolio
Company
Ticker Shares Unit Cost Market Value Market Value Unrealized Gain/(Loss)
Crown Holdings, Inc. CCK
LyondellBasell
LYB
2400
1800
228.54
91.45
46.85
80.21
$
$
112,440
144,378
($436,052)
($20,232)
Sector Performance
1-Month
3-Month
6-Months
1-Year
YTD
2-Year
3-Year
10-Year
5-Year
All Time
Cumulative Total Return
• Based on historical history, the Basic Materials sector is highly
cyclical, and when the S&P 500 is on an uptrend the Materials
sector is, and when it is on a downward trend the materials
sector is as well.
• The historical Beta on Total Returns is calculated to be 0.85,
showing there is less volatility in the returns.
Business Cycle Analysis
Business Cycle Analysis
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Historically the Basic Materials Sector consistently over performs during a late
economic cycle
This will help drive demand and sales for many industries throughout the Basic
Materials sector going forward, which will help alleviate some of the pressure
commodities are currently facing with oversupply.
Geographically
The United States is currently approaching a mid to late portion in the business
cycle, so the Basic Materials Sector should perform well in the U.S.
Unlike the United States, many of the foreign economies are currently in or
approaching a recession stage in their economic cycle.
Nations across the globe such as Brazil, China, and various European nations are
currently facing difficult economic and political times.
This has a particularly strong effect on the Basic Materials sector, due to the
international exposure in almost all industries within the sector.
As a result, the demand across the globe beyond the U.S. will likely be low due to
the historical underperformance of the Basic Materials sector during recessionary
cycles in economies.
Supply and Demand Analysis
• The Materials sector is highly sensitive to supply
and demand fluctuation and the prices of those
commodities within the sector.
• Prices for raw materials are largely demanddriven, and will determine the performance of
the companies operating in the Materials sector
• The demand for the raw materials is highly
dependent on the condition of the economy, and
good performance within this industry is
dependent on a strong economy
Supply and Demand Analysis
Cont’d
Factors that affect the Supply
In recent years, there has been an oversupply of raw materials in many industries of the Basic Materials
Segment with anticipation of future demand, which has caused low commodity prices as a result.
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Capital expenditure to increase capacity capabilities
Long term contracts
Increasing globalization in economies
Government Stimulus
Increased R&D investments in new technologies that improve productivity and drive costs down.
New plants, as well as facility improvements
Lower prices of inputs in production( Ex: crude oil prices have helped lower production costs)
Factors that affect Demand
Commodity prices on the Raw Material across various industries
Globalization of economies
Consolidation of companies in various industries
Economic conditions of the countries the companies operate within
Performance and customer demand for the companies who buy from Basic Material companies
Government Regulations
Technological innovation that affect rate of extraction of the natural resources
Availability of land and resources
Ease of access of land of resources
Worldwide Population growth
Porter’s Five Forces
Threat of New Entrants- Low
• Large capital investments and high fixed costs
• Almost always requires acquisition of land rich of whatever
minable resource is being used for that particular industry
within the sector.
• Mines, Forests, or Land rights in general are very expensive and
/ or already owned by someone
• High government regulations and laws involved with
environmental protection
• Limited geographical accessibility, and there is limited arable
land
Bargaining Power of Buyers- High
• Basic Materials are essentially commodities, which mean
there is little to no differentiation between products of the
companies in each industry in the sector.
• Low Switching costs often times for the various industries
within the Basic Materials Sector
• Majority of the industries are mature and have multiple
competitors, which leads to intense price competition.
Rivalry among Existing Competition- Very High
• Mature industries with low growth rates and established
companies fighting for market share
• Heavy price competition
• Low differentiation in products offered between the
competitors in various industries
Threat of Substitutes- Low
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Very few to no substitutes for raw materials
The basic materials sectors consist of raw materials
which are hard to replicate.
Many products offered in various industries are
specialized for a specific purpose, chemicals in
particular, and there are few substitutes as a result
Supplier Power- Low
• Existence of suppliers to these industries is limited, because
many of the companies in the various industries vertically
integrate backwards to the source of the raw material (own
mines and land to extract material).
Economic Indicators
• Real GDP:
– About 1% in Europe
– 2% in the USA
– 6.8% in China (maybe even
less)
We are not seeing the
growth expected 3 years ago
Economic Indicators
• Unemployment rate positive, especially in the
USA
Global Economy Growth
Forecast: Low to Moderate
• Industrial production In the USA is forecasted
to stay flat
World Commodity Prices
• In the last year: almost every commodity is
negative, but there are also positive signs of
recovery
Month % Change in CDS
Spread
• CDS Spreads are beginning to be lower in the
Energy Market
• But they are rising in the Materials
• Europe is constant
Materials Sector-Sales
Outlook
Materials SectorOperating Margin
Operating Margin
11.97%
10.32%
10.07%
12.40%
14.05%
11.46%
11.20%
11.03%
7.98%
7.59%
Materials Sector Operating Margin
Operating Margin
Year
CY 2007
CY 2008
CY 2009
CY 2010
CY 2011
CY 2012
CY 2013
CY 2014
CY 2015
Current
CY 2016 Est
CY 2017 Est
15.00%
14.00%
13.00%
12.00%
11.00%
10.00%
9.00%
8.00%
7.00%
6.00%
5.00%
Year
Materials Sector – Earnings
Outlook
Earnings
$15.15
$13.03
$7.42
$12.45
$16.18
$14.55
$15.42
$16.59
$15.84
$15.78
$15.67
$18.51
Earnings
$21.00
$19.00
$17.00
Earnings
Year
CY 2007
CY 2008
CY 2009
CY 2010
CY 2011
CY 2012
CY 2013
CY 2014
CY 2015
Current
CY 2016 Est
CY 2017 Est
$15.00
$13.00
$11.00
$9.00
$7.00
$5.00
Year
Sector Valuation – Absolute
Basis
• The Materials Sector is currently trading just
above the sector’s more recent historical
medians
Price / Earnings
Price / Book
Price / Sales
Price / EBITDA
High
20.37
3.76
1.61
10.95
Low
15.31
2.55
1.20
7.42
Median
18.13
3.12
1.46
9.16
Current
17.98
3.42
1.49
10.95
Figures based on 3 year, monthly data
Sector Valuation – Absolute
Basis
• The Materials Sector is currently trading
higher than the sector’s longer-term medians
Price / Earnings
Price / Book
Price / Sales
Price / EBITDA
High
36.81
3.76
1.61
10.95
Low
8.54
1.51
0.57
3.51
Median
16.85
2.74
1.27
7.52
Current
17.98
3.42
1.49
10.95
Figures based on 10 year, monthly data
Valuation Relative to S&P
500
• Relative to the market, the Materials Sector is
currently trading below the market.
• The Materials Sector is cyclical, in which it
outperforms the market when times are good
and underperforms the market when times
are bad
P/E
P/B
P/S
P/EBITDA
High
1.08
1.31
0.87
1.01
Low
0.97
1.09
0.82
0.89
Median
1.03
1.17
0.84
0.99
Current
0.96
1.22
0.81
1.01
Valuation Relative to S&P
500 – P/E
• The Materials Sector’s
Price-to-Equity value
has historically been
greater than that of the
S&P 500.
• Significant drops in past
year
• Since the middle of
2015, it has been
below that of the S&P
500
Valuation Relative to S&P
500 – P/B
• The Material’s Sector’s
Price-to-Book ratio has
consistently been greater
than that of the S&P 500
• Significant dip,
rebounding
• More recently, the
Materials Sector’s P/B has
seen a substantial jump in
relative valuation to the
S&P 500’s P/B ratio
Valuation Relative to S&P
500 – P/S
• The Materials Sector’s
Price-to-Sales value has
consistently been higher
than that of the S&P 500
• Trending upwards this
year after significant drop
in 2015
• More recently, there has
been a larger difference in
the two values
Valuation Relative to S&P
500 – P/EBITDA
• Historically, the Materials
Sector and S&P 500’s
Price-to-EBITDA values
have fluctuated above
and below each other.
• Continuing to rise after
dip in 2015
• Currently, the Materials
Sector’s P/EBITDA is very
similar to that of the
market
Recommendation
Considering:
-Uncertain economic growth
-Possible economic slowdown
-High cyclicality of the Materials sector
We recommend the portfolio to be UNDERWEIGHT
in the Materials Sector