Why it's time to remember America's forgotten industrials

Firstly, the value rotation has continued for far longer than some expected due to the complications of Russia’s energy war on Europe – a host of US-based oil, gas and shale producers have enjoyed record years as tankers ship ever greater amounts of LNG and petroleum to keep Europe’s economies fuelled.

That does wonders for America’s balance of payments, making the country a net exporter of energy for the first time since the early 1970s: the balance of payments gap has narrowed by more than $21bn, according to the US Bureau of Economic Analysis.

But it also means traditional value shares are now expensive by historic standards, while growth stocks have typically not yet fallen enough to qualify as value prospects themselves. It is clear then that a more nuanced approach to picking shares is needed in a year that looks set to be dominated once again by supply chain questions and uncertainty over export markets and energy prices.

There is truth in the stock market saying that investors should buy the valuation and leave the trends to sort themselves out. But sometimes where a company sources its input products, plus the size of its global market at a given point in the business cycle, means that trends do matter. It is based on this premise that a deeper look at America’s oft-forgotten soft industrials sector could yield some interesting investment angles.  

A company with the right chemistry

It could be that 2023 proves the year for makers of tangible products. With big tech reeling from overspending during the pandemic, and currently firing large numbers of employees to cut costs, America’s more traditional mid-cap manufacturing companies – which have had to manage supply chain constraints and a host of ballooning costs over the past two years – could come to the fore. By and large, this has left them looking considerably better prepared for a recovery in 2023, with share prices not yet pricing this in.

Our first deep dive is a commodity chemicals producer based in Irving, Texas: Celanese (US:CE). If you need anything to do with acetates (which, incidentally, are also a key ingredient in modern explosives) then Celanese can make it.

The company, along with similar peers, has benefited from its raw materials being available in abundance via the US's own supply of feedstock natural gas in the Permian Basin. The byproducts of this go into producing acetates for customers in the intermediate chemistry segment: polymer emulsion producers who make paint, for instance. A key point to remember is that the US industrial base has suffered far less from energy price inflation than competitors in Europe and Asia due to America’s transition to a net energy producer in 2019.

A key dynamic to consider is that while natural gas input prices initially rose during 2022, the crash back to lower levels has been swift, and in the US is effectively a return to the secular long-term trend of lower natural gas prices. That is notable for Celanese because it is occurring as the producer price index for its core output has risen to a 30-year high (see chart). If you track the trend for gas prices, it's clear that an inverse correlation with Celanese shares exists – when prices are lower, as they are currently, then Celanese’s share price rises. In essence, the company’s costs are cratering just at the point when its products are fetching premium prices, and investors have to take notice.

The company was also able to push through substantial price increases, at an average of 15 per cent, at the end of 2022, indicating perhaps a lack of serious homegrown competition in its core market, and wide moats around its core intellectual property. Currently, operating margins are running two percentage points above the five-year average of 24 per cent, suggesting that the company’s pricing power has been enhanced.

Berkshire Hathaway (US:BRK.B), Warren Buffett’s investment vehicle, added to its existing holding in Celanese during the last quarter. In fact, most of Berkshire’s recent purchases – Jefferies Financial Group (US:JEF), Paramount Global (US:PARA) and Louisiana-Pacific (US:LPX) (a building materials manufacturer) – are all varying bets on the strength of the US economy. In total, Berkshire now owns 9 per cent of Celanese's free float.

Indeed, betting on the strength of future earnings has also directed Celanese’s strategy for this year. In November, it completed the acquisition of most of the chemical giant Dupont’s (US:DD) mobility and materials business for a total of $11bn (£9.7bn). The sales price was roughly eight times cash profit, and the key point for the company is that it offers a large niche in the polymers market for cars and other vehicles. The beauty of this is that it doesn’t really matter whether the vehicle is electric or fossil-fuel driven: the demand for materials not connected with propulsion is exactly the same. In fact, the business has put a lot of effort into showcasing polymers specifically aimed at the electric vehicle market.

Celanese has had a presence in China since 2005, when it built an acetate plant to leverage China’s cost advantage in the early stages of its industrial modernisation. That is of relevance in the context of increasing geopolitical rivalry: the intervening years have evidently seen big changes. But in 2021, Celanese told the trade press that China’s cost advantage had now eroded given the rise of a wealthier middle class – who presumably find working in an acetate factory less than aspirational. This means that future investment is likely to stay close to the US home market where, despite higher labour costs, there exists a productivity advantage.

In terms of valuation, analyst upgrades have been coming through since the start of the year and Celanese’s shares are now rated at an historically cheap forward price/earnings (PE) ratio of 8.4, according to FactSet consensus, rising to 10 as the impact of the DuPont divisional acquisition feeds through the earnings statement. That represents a clear discount to a competitor such as BASF (DE:BAS), where the PE struggles to get below 12.5, despite German industry’s well-documented energy problems in recent months. In that context, Celanese is a well-priced and operationally geared play on US energy independence and home economic strength.