3 Top Picks in the Chemical Sector: The Dow Chemical Company (DOW) and More

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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.

The Dow Chemical Company (NYSE:DOW)Ashland Inc. (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.

The Dow Chemical Company (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.

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