The price per barrel of oil has risen by an astonishing 13.5% during the past month, stemming from a push on both sides of the market equation. The push comes from increasing demand in the United States and China and a tightening output supply on the part of OPEC, who just announced further cuts recently.
According to the past quarter's ISM Manufacturing PMI reports, the petroleum industry stands alone in delivering a whole quarter (three consecutive months) of expansion across the board. Following this development, investors should not be surprised to see rising oil prices.
Taking the attention away from oil for a moment, specific industries are set to feel the aftermath effects of these price dynamics, especially regarding their input costs and demand.
One industry heavily dependent on where the prices of oil go is plastics and specialty chemicals, which is why investors should focus on these two stocks, which are being discounted today despite an upcoming bottoming in the industry.
Despite posting some contractions in its latest quarterly financials, Westlake Corporation (NYSE: WLK) is one stock where markets are already beginning to price in the adverse effects of higher oil prices and lower demand.
A 27% contraction in revenues is understandable once investors realize that most of Westlake's sales depend on residential real estate activity, which uses Westlake products to finish ongoing projects.
These cyclical contractions in real estate stocks, stemming from higher mortgage costs, are driving Westlake's demand side of the equation lower. On the other side of the spectrum, margins are declining due to higher input costs caused by the rise in oil prices.
Westlake's stock chart will reveal an 8.8% decline over the past month, which almost mirrors the rise in oil during the same period. As the market gets deeper into bearish sentiment for this company, investors considering a purchase are digging themselves into even higher upside potential.
Analysts are landing on a consensus price target of $127.7 a share, where the stock needs to rise by 2.2% to close this gap. However, investors can wait for the downside momentum to exhaust itself and look for this entry-level instead.
Taking Wall Street's definition of a bear market, known as a 20% retracement from recent highs, investors can mark these prices for Westlake stock as significant liquidity likely to be injected. Westlake's recent high of $138 will make a 20% retracement fall toward the $110 level.
Going from this entry target, investors can assume a more attractive 16% upside based on these analyst targets. Moreover, management has repurchased nearly one million shares during the past twelve months, using financials as of the second quarter of 2023.
This is important for those investors on the fence since they can now buy the stock at cheaper levels than insiders thought it would be cheap enough for them to buy.
Knowing that the residential real estate market is set to rebound eventually, as well as a likely event that would bring oil to more affordable levels, investors can rest assured in the eventual pivot to the upside to the tune of double-digits.
Here is another story that will likely follow Westlake, though the stock chart has taken longer to crack its pullback. LyondellBasell Industries (NYSE: LYB) is one company whose products are also affected by oil prices and real estate demand, though it has one advantage.
Sales for LyondellBasell are spread across many other countries and regions, unlike Westlake's sole focus on the North American markets. This revenue diversification may be one of the factors helping the stock remain near its all-time high prices while Westlake declines more aggressively.
However, as markets tend to treat most stocks within a sector as equals, there is still a possibility that LyondellBasell stock will decline.
Should the pullback come to this name, analyst price targets would rise from today's 1% upside to a more attractive figure; the question is, at which price will this be so?
Following the same 'bear market' strategy presented for Westlake, investors can take LyondellBasell's recent high of $101.4 a share and apply a 20% discount, bringing them to a level of $81.1 a share. While this seems like a big move, the company's financials may give markets a reason to make this happen.
A 56% contraction in earnings per share sticks out like a sore thumb in the latest quarterly results, and all else being equal, the stock should have followed a similar decline, considering that EPS typically drives stock prices. Markets are in denial, but investors can rest assured that the discount is coming.
So, why would you consider buying a couple of contracting businesses? Apart from these only being standard cyclical pivots, these are two of the industry's gems.
The sector carries an average ROIC (return on invested capital) of 9%. In comparison, Westlake and LyondellBasell deliver 10.5% and 10.8%, respectively to stand out from peers.
A famous value investor out there emphasizes his strategy of buying above-average ROIC at below-average valuations. An average P/E of 18.3x would place the industry above Westlake and LyondellBasell's 10.4x and 12.6x multiples, fulfilling the pillars for this strategy.