Materials Industry

Most of the information is extracted from “Fisher Investments on Materials”.

Overview

Materials sector is composed largely of metals, chemicals, paper, lumber, cement, “construction aggregate” and packaging. Not all commodity falls under materials. The largest commodity falls in the Energy Sector and most agricultural products are found in the Consumer Staples Sector.

Some Key Characteristics of Materials Sector are:

  • Capital Intensive
  • Hypersensitive to Economic Growth
  • Regional Pricing may varies due to shipping costs, availability, import or export taxes. Shipping costs depend on the value-to-weight ratio. Pricing is usually set by the largest producers-“price setters” and the small producers -“price takers”.
  • Usually can be classified into Upstream and Downstream

Life Cycle of Metal

  • Finding Metal and Securing Permits
  • Building a Mine (capital intensive and sometimes must built transport system)
  • Separating Metal from Rock
  • Metal Smelting (lower profit margins)
  • Metal Recycling

Life Cycle of Chemical

  • Commodity Chemicals – fierce competition, mass produced
  • Specialty Chemicals – end market usually industrial manufacturing sector
  • Chemical Recycling – plastic

Life Cycle of Concrete

  • Making Construction Aggregate – Quarried near its end market
  • Cement – Primarily manufactured regionally
  • Concrete Recycling

Life Cycle of Paper

  • Cutting Lumber
  • Processing Paper
  • Paper Recycling

History of Materials

Much of the industry was developed with the industry revolution. As economy changes, materials also evolved. During certain events, some materials cost will go much higher (e.g. metals due to wars)

Materials Sector Drivers

  • Economic Growth
  • Commodity prices
  • Commodity production growth
  • Exploration and development costs
  • Production costs
  • Share buybacks and mergers and acquisitions (M&A) activity
  • Investor sentiment (can cause bubble)
  • Taxes, Politics, and regulations

Some questions to ask when analyzing a material include:

  • Is the material priced globally or regionally?
  • What is the material used for?
  • Who are the primary consumers?
  • Where is it produced?
  • Who are the largest producers?
  • What are Production’s Primary Costs?
  • Are there significant barriers to entry?
  • What is the expected change in supply and demand?

Materials Sector Breakdown

Metals & Mining

  • Diversified Metals & Mining
  • Steel
  • Gold
  • Aluminium
  • Precious Metals & Minerals

Chemicals

  • Commodity Chemicals
  • Speciality Chemicals
  • Diversified Chemicals
  • Fertilizers & Agricultural Chemicals
  • Industrial Gases

Construction Materials

  • Construction Materials

Paper & Forest Products

  • Paper Products
  • Forest Products

Containers & Packaging

  • Paper Packaging
  • Metal & Glass Containers

Some materials and their characteristics

  • Iron ore – priced globally on annual contracts. Infrastructure as important as mines in determining production. High barriers to entry, need for economies of scale, concentrated group of producers
  • Coal – priced regionally on annual contracts with some global export. Steam coal (for energy) and metallurgical coal (for steel production) are priced differently
  • Steel – Priced regionally with key distinctions among producers: bar vs flat steel production, and scrap-based mini-mills vs traditional iron ore-based operations. Significant trade and exports for many products exist as well.
  • Gold – priced globally and often a safe haven during uncertainties. India and China have the largest consumer demand while the rest are taken up by investors. Scarcity is its primary barrier to entry.
  • Aluminum – priced globally and most energy-intensive metal. Energy costs are the primary determinant of price and returns.
  • Commodity Chemicals – priced globally with economic growth as its primary driver, and oil and natural gas as its primary input cost.
  • Specialty chemicals – most priced regionally. Economic growth and specific end markets for each segment are the drivers.
  • Fertilizers & Agricultural Chemicals – priced regionally for most. Demand for increased crop production through greater yields is the primary driver.
  • Industrial Gases – priced regionally with natural gas as a primary input cost. Economic growth, industrial manufacturing, metal and chemical production, and oil refining are primary drivers
  • Construction materials – priced regionally and dependent on regional construction. Cement is more sensitive to residential construction while construction aggregate is more sensitive to non-residential construction.
  • Paper & Forestry – priced regionally with residential construction as primary driver for lumber, while economic growth is the primary driver for paper. Environmental legislation can play a big role.
  • Packaging – defensive sector with relatively inelastic demand due to food and beverage being its largest components.

3 Items to track

  1. Supply
  2. Demand
  3. Sentiment

Fundamentals to watch

  • GDP growth
    • Residential and non-residential construction
    • Durable goods orders
    • Industrial production
  • Global materials production growth
  • Inventories
  • Global materials trade (imports and exports)
  • Capacity utilization
  • Raw material costs
  • Marginal cost of production
  • Tariffs, royalties, subsidies, and price caps
  • Freight rates

Bullish Drivers

Bearish Drivers

Rising GDP growth Falling GDP growth
Rising construction Falling construction
Rising durable goods orders Falling durable goods orders
Rising industrial production Falling industrial production
Falling global materials production Rising global materials production
Falling inventories Rising inventories
Rising global imports Falling global imports
Rising capacity utilization Falling capacity utilization
Rising raw materials costs Falling raw materials costs
Rising marginal cost of production Falling marginal cost of production
Increased commodity regulation (tariffs, royalties, subsidies, etc) Decreased commodity regulation
Increased freight rates Decreased freight rates

Important Area to look in assessing companies

  • Supply/Demand Environment
  • Revenues and Earnings Breakdown
  • Production Growth
  • Reserve Replacement (e.g. mines)
  • Hedging
  • Geographic Breakdown & Geopolitical risks
  • Production Costs
  • Vertical Integration
  • Transportation
  • Government Control
  • Legislative Risks
  • Competition and Barriers to Entry
  • Technology and Innovation
  • Brand Name
  • Regulation
  • Market Share
  • Margins
  • Cash Flow Use
  • Balance Sheet
  • Interest Rates

Strategies on Materials Investments

  1. Overweighting and underweighting materials industries or sub-industries based on your market outlook and analysis.
  2. Adding value at the security level based on specific pricing outlook. Can also employed long-short, pairing style.
  3. Adding value in a materials sector downturn. Can also short or purchase inverse ETFs if bearish on materials.
  4. Investing in commodities such as futures, ETFs.

Industry Cheat Sheet

  • Metals & Mining
    • high beta and cyclical
    • Often outperforms when raw material prices are rising due to strong economic growth
    • Sensitive to EM economic growth recently
  • Diversified Metals & Mining
    • Holds large weight in most major materials index
    • extensively capital intensive, dominated by large producers and highly cyclical
    • Benefits from strong economic growth and when GDP per capita is rising
  • Gold
    • Safe haven and outperforms in times of uncertainty
  • Aluminium
    • Similar to Diversified Metals
    • Most energy intensive metal to produce. Outperforms in strong economic growth and falling energy prices
    • Performance between producers may vary due to access to lower or higher cost energy resources
  • Steel
    • Similar to Diversified Metals but less capital intensive and reduced barriers for entry
    • Evaluated regionally. Important comparison factors: iron-ore vs scrap-based producers, bar vs flat steel producers, and vertically integrated vs non-vertically integrated
    • often underperforms miners in periods of rising raw material costs
    • Vertically integrated producers with upstream raw material operations often outperform non-vertically integrated in periods of rising raw material prices
    • fragmented sub-industry of small producers and generally small cap outperforms large cap
  • Precious Metals & Minerals
    • Similar to Gold
  • Chemicals
    • most are intermediary and broad economic growth is one key factor
    • often outperforms in periods of strong economic growth and stable or falling energy prices
    • higher variable costs and lower operating leverage than mining industry. Less cyclical
  • Commodity Chemicals
    • often outperforms in periods of strong economic growth and stable or falling energy prices
    • characterized by large, highly cyclical firms competing primarily on efficiencies and production costs. Very little pricing power
  • Speciality Chemicals
    • Evaluated regionally
    • Sensitive to economic growth
    • most resistant in economic downturns
  • Diversified Chemicals
    • Analyzed depending on conglomerates product mix
  • Fertilizers & Agricultural Chemicals
    • heavily influenced by government intervention
    • Mostly evaluated as Speciality
  • Industrial Gases
    • Evaluated regionally, benefits from economic growth, oil exploration and oil processing
  • Construction Materials
    • Sensitive to construction expenditures
    • Evaluated Regionally
    • Construction aggregate producers more sensitive to non-residential construction. Cement producers more sensitive to residential construction
    • Global production is concentrated to a small group of dominant conglomerates producing cement and construction aggregate
  • Paper & Forest products
    • Small industry dominated by paper dominants
  • Paper Products
    • End markets are primarily in developed world. Often outperforms during periods when the economic growth rate in developed world is increasing relative to the economic growth rate in emerging markets
  • Forest Products
    • Primarily driven by regional residential construction
  • Containers & Packaging
    • Defensive
    • Rising raw materials are a negative
    • Compete on operating costs and distribution networks
    • Focused on food and beverage and least cyclical
  • Metal & Glass Containers
    • defensive and similar to above packaging
  • Paper Packaging
    • defensive and similar to above packaging

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