3 Top Picks in the Chemical Sector

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It is true that the chemical space saw a boost in their earnings due to the savings from the shale gas as well as consolidation in the same industry. However, this in no way means that these stocks may have reached their peaks and will not appreciate in 2013. I have selected three stocks; two of them have already seen capital appreciation in double digits while one of them went down by 5%. However, I have briefly explained below how these three stocks can still be a productive investment for investors.

Ashland (NYSE: ASH)

Ashland was one of the better performing stocks in the group in 2012, and it is expected that it will be one of the best performers in the space again in 2013 with multiple expansion and earnings that come in better than consensus. The fundamentals of their business are likely to show improvement throughout the year, and management will work to fix Water Tech. As such, Ashland offers a compelling risk/reward profile for investors with the stock likely reaching the low to mid $90’s over the next 12-months. However, for the stock to reach its full potential ($115-$120 over the next 18 months), management needs to successfully execute on:

1) Drive high-single digit organic growth in Spec Ingredients,

2) Fix (or divest) Water Tech,

3) Manage Street expectations more effectively over the next few quarters (constant blow outs/ups are hurting the multiple).

All of these requirements seem attainable.

Dow Chemical (NYSE: DOW)

Looking to 2013, DOW should have one of the best performances in the chemical space. While the stock struggled in 2012 relative to the group, DOW should benefit from a solid improvement in earnings driven by:

1) A recovery/strength in a number of its end-markets (agriculture and electronics most notably),

2) The shale gas/ethane advantage creating a wider spread in ethylene,

3) Execution on its 2013 cost cutting/restructuring—which will be essential to the earnings growth and management credibility.

DOW should also benefit from the cash inflow from the $2.5 billion K-DOW award and their own free cash generation that will enhance their financial flexibility and go towards creating shareholder value (through debt/preferred reduction as well as returning it to shareholders). Moreover, the stock is trading at a cheap multiple of 6x for 2014 EBITDA. This along with a 3.9% dividend yield should all help to drive the stock 20% higher through 2013, and potentially higher with any improvement in the macro-environment.

Rockwood (NYSE: ROC)

Looking to 2013, despite the macro uncertainty, Rockwood is expected to outperform the space as:

1) The management remains committed to separating Rockwood from the TiO2 business in 2013, thereby helping the valuation multiple recover;

2) The management has provided clarity on the uses of its $1.4 billion cash hoard (post the collapse of the Talison acquisition), which includes a $400 million (~10%) share repurchase program;

3) Investors focus on the potential for upside to Rockwood’s numbers helped by solid lithium demand/pricing, steady growth in ceramics and the potential start to a recovery in the Performance Additives segment.

Foolish Bottom Line

Stocks in the chemical space witnessed a solid 2012 as far as the capital appreciation is concerned. However, this is just the beginning of a huge rally that can be achieved given that the management of the respective companies takes adequate actions to help shareholders make large gains. Let’s see if the management is able to deliver in 2013 as well. 

AnalystX has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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