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Mat-Chem Notes

Heavy lithium. Halfway through the year, the S&P 500 has appreciated 15.4% YTD, driven by the strong performance of the Magnificent Seven, even as the remaining 490+ companies saw their stock prices move more in line with the Russell 2000, which itself posted an 7.8% gain YTD. Over the same timeframe, the WTR-CMI Index delivered a disappointing 4.4% gain under the weight of lithium and graphite companies losing 36-62% of their value due to collapsing lithium and synthetic graphite prices, driven by slower growth of EVs and steel production and liquidation of excess inventories by customers, built over the course of 2022-23. Sticky costs remain as pricing power wanes. Over the course of 2022-23, many companies experiencing a rapid rise in raw material costs, driven by higher petrochemical prices and rising costs of transportation and logistics aggressively raised prices in an attempt to preserve profits, if not profit margins. As a result, 2023 was a period of modest volume growth but improving price-raw material spreads that drove margin expansion, even as demand stumbled, and preserved or even improved valuation multiples for specialty chemicals and materials technology stocks, a trend that was maintained into 1H24. However, with Y/Y price increases anniversarying as we go through 2H24 and raw material, energy, transportation, labor, and other costs beginning to ramp up again, weakening volume performance as global economies continue to cool may preclude meaningful selling price increases, resulting in slow, if not negative, organic top-line growth and weakening of margins, a recipe for multiple compression based on past valuation cycles. Organic growth woes may drive M&A activity. With volume growth potentially turning negative and limited pricing power, not to mention a possible negative mix component as customers, both retail and industrial, opt for less expensive product offerings, lack of organic growth and lead to higher M&A activity as industry participants look to take advantage of lower multiples to help drive growth over the next six to 12 months and position their enterprises for better performance in the future. Not just acquisitions, but divestitures, should play a role in reshaping company portfolios over the balance of 2024 and into 2025, as evidenced by DuPont’s decision to split into three companies and RYAM’s announced intent to explore the sale of its Paperboard and Pulp divisions. Tough times ahead. With costs rising again, demand weakening, and pricing power almost non-existent after two years of being the main driver of performance, WTR-CMI companies may struggle to improve their performance versus the broader market represented by Russell 2000, let alone the star-studded S&P 500 index. Looking toward 2H24, companies with the biggest exposure to the construction and automotive/transportation industries may fare poorly, while those with a bigger exposure to consumer-facing markets, those at the more commodity end of the supply chain, and those with specific internal drivers doing relatively better, perhaps even keeping pace with the broader indexes when it comes to stock performance.