The Morningstar US Basic Materials Index far underperformed the US Market Index, declining by approximately 50 basis points during the quarter, compared with the broader market gain. Yet we see opportunities, with over 45% of these stocks trading in 5- or 4-star territory and the sector as a whole trading below our fair value estimate.
The Basic Materials Index Declined During Q2 On A Weakening Near-Term Outlook
We see the most opportunities in chemicals, where two-thirds of the stocks under our coverage trade in 5- or 4-star territory. We believe fears of tariffs and a potential economic slowdown will reduce demand, weighing on the profits of chemical producers.
A Little Less Than Half of Basic Materials Stocks Trade in 5-Star or 4-Star Territory
For most US chemicals producers under our coverage, we see little direct impact from tariffs. Given that chemical demand in the United States comes primarily from domestic production, the primary impact would come from counter-tariffs. While China’s proposed 10% tariff would apply to US chemical exports, it’s not high enough to disrupt the cost advantage of US chemical relative to other producers.
Volumes Tend to Move With Durable Goods, Fixed Inv., and Res. Inv. Growth Rates
The tariffs’ impact will likely be secondary, coming from an economic slowdown. We see a highly predictive relationship between chemical revenue and consumption, fixed-asset investment, and oil prices. Changes in the weighted average of consumption and fixed-asset investments are a key indicator of volumes. In contrast, oil price changes are a key indicator of changes in the prices of commodity chemicals. We forecast slower durable goods and fixed-asset growth over the next few years due to the impact of tariffs, but we see growth resume over the longer term. This should fuel higher medium- and long-term growth for chemical producers.
We Forecast Crop Chemical Sales Will Stabilize Following Two Years of Declines
In crop protection, we see industrywide sales stabilizing after two years of declines as demand returns to normal after two years of inventory destocking. For premium crop protection producers, we expect profit growth from normalized demand as production returns to typical levels. Following 2025, we expect the industry to return to growth, with premium producers seeing growth above market levels as new products drive higher revenue.
Top Basic Materials Sector Picks
Eastman Chemical
- Fair Value Estimate: $110.00
- Morningstar Rating: ★★★★
- Morningstar Economic Moat Rating: Narrow
- Morningstar Uncertainty Rating: High
Eastman EMN is one of our top picks to invest in a medium-term rebound in chemical demand. The stock trades at more than 30% below our $110 fair value estimate. Eastman’s narrow moat rating comes from its specialty chemicals, which are protected by patents and command premium pricing. This should allow the firm to perform better than its commodity chemical peers during a downturn and see a quick recovery when demand returns. Eastman should continue to generate free cash flow well above dividends even in a downturn, which should support shares.
FMC
- Fair Value Estimate: $95.00
- Morningstar Rating: ★★★★
- Morningstar Economic Moat Rating: Narrow
- Morningstar Uncertainty Rating: High
FMC FMC is our top pick to invest in stabilizing crop protection demand. The stock trades at less than 45% of our $95 fair value estimate. FMC’s narrow moat rating stems from its patent-protected, differentiated crop chemical portfolio, which generates strong pricing power, as farmers are willing to pay a premium for products that protect against pests. As a crop chemical pure play, FMC was hit harder than its peers by inventory destocking and falling sales. However, with inventory levels back to normal, we point to strong growth in the second half of the year as a catalyst for shares.
LyondellBasell Industries
- Fair Value Estimate: $100.00
- Morningstar Rating: ★★★★★
- Morningstar Economic Moat Rating: Narrow
- Morningstar Uncertainty Rating: High
Lyondell LYB is our other top pick to invest in a medium-term rebound in chemical demand. The stock trades at a little more than 40% below our $100 fair value estimate. Lyondell’s narrow-moat rating comes from a cost advantage. Most of the company’s production is in North America and benefits from low-cost natural gas prices. As a result of its cost advantage, Lyondell should be able to generate positive free cash flow even during a downturn. The company also offers a 9% dividend yield, supported by a solid balance sheet.
