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Here's My Top Stock to Buy in July

Image source: Braskem.

In August, Brazil will finally be in the news for the right reasons: The country is hosting the Summer Olympics. Assuming all goes smoothly (which is now in question), the Games will serve as a much-needed change from the excruciating growing pains the nation has experienced in plain view of the international community in recent years. 

The once high-octane emerging market has reeled in contracting GDP since the first quarter of 2014, which has weakened Brazil's currency and knocked down its sovereign-debt rating. Dilma Rousseff, the last elected president, is awaiting impeachment after being tied to a major scandal involving state-owned energy giant Petrobras. And as if economic and political turmoil wasn't enough, Zika virus, a mosquito-borne disease historically confined to Africa and Asia, gained its first ever foothold in the Americas in April 2015 -- with Brazil serving as ground zero. 

Given all these negatives, you would be forgiven for writing off Brazil as a source of investing ideas. But if you take the long-term view, you may instead consider the current recession and political mess as inevitable growing pains for a quickly maturing nation. This perspective may allow you to uncover several (well) above-average investing opportunities, such as Brazilian chemical manufacturing giant Braskem (NYSE: BAK). Here's why it's my top stock to buy in July.

The business

Braskem has ridden Brazil's (formerly) fast-growing economy to become the largest chemical manufacturer in Latin America and a top-10 resin producer globally. The company operates with four major segments:

  1. Basic petrochemicals -- Upgrades lower value chemicals such as naphtha, ethane, and propane into higher-value chemicals such as ethylene and propylene, which are used in the production of synthetic rubber, nylon fibers, various polymers, paints, and more.
  2. Polyolefins -- Produces various polymers that eventually become incorporated into everything from food packaging to automotive parts and household appliances.
  3. Vinyls -- PVC is the major product, but other chemicals made by the unit are used in aluminum, paper, and chlorine manufacturing.
  4. United States and Europe -- Despite being one of the largest PVC manufacturers in the United States, Braskem lists operations at its seven facilities in the United States and Germany as a separate unit.

Braskem hasn't exactly been spared by Brazil's ongoing recession nor the collapse in crude oil prices that began in late 2014, but its global presence and customer diversification has allowed it to weather the storm quite impressively. Consider how Braskem performed in the last three years reported in U.S. dollars, using the average exchange rate for each period.

 

2015

2014

2013

Average Exchange Rate (Real:USD)

R$3.33

R$2.35

R$2.16

Total Revenue

$14.2 billion

$19.6 billion

$18.9 billion

Total Operating Profit

$2.11 billion

$1.51 billion

$1.27 billion

Total Net Profit

$869 million

$308 million

$234 million

Data source: Average exchange rates from Oanda.

While the top line got decimated in 2015, Braskem managed to tighten its belt and report a record operating profit for the year. Prioritizing a strong balance sheet has quickly produced results. At the end of the first quarter 2016, Braskem had $2.1 billion in cash and a net debt-to-EBITDA ratio of 1.72, marking an increase of 37% and a decrease of 33%, respectively, compared to the year-ago period. Both Standard & Poor's and Moody's have given Braskem a better debt rating than its home country. 

Don't let an increase in its cash balance fool you into thinking the company isn't investing in the future, either. Braskem will still manage to invest over $1 billion in growth projects this year. There are multiple opportunities to extract more value from existing projects and reap rewards from projects already under way. For instance, Braskem is beginning operations at a world-class petrochemical complex in Mexico, which will take advantage of cheaper natural gas inputs from the United States market and access to global markets for selling products. Another facility in Texas is due to begin production in the second half of 2016, which benefits from even cheaper inputs from its proximity to American shale.

Meanwhile, Braskem is the world's leading producer of biopolymers and has invested in engineered biology R&D projects that could one day allow the company to manufacture rubber from yeast. Today, the bulk of the company's biopolymer production comes from a facility in Brazil that converts ethanol, instead of petrochemicals, into polyethylene. Nearly 80% of the 200,000 metric ton per output is sold to Procter & Gamble and Johnson & Johnson.

The risks

In addition to the inherent risks of being a commodity price-dependent petrochemical company, Braskem's corporate structure has dragged on the stock. That's because the two largest shareholders -- Petrobras and Odebrecht -- also happen to be the two companies at the heart of the current fraud scandal ravaging Brazil. Investors were initially worried about what that meant for Braskem's supply agreements, especially considering a majority of the company's naphtha and other feedstocks are sourced from Petrobras. The pair extended supply agreements at the end of 2015 to reassure investors (which of course inevitably led regulators to worry about fraudulence), while Braskem's management has worked to diversify sourcing agreements to the best of its ability. In 2015, the company sourced 56% of its naphtha from Brazil, compared to 72% in 2013. Investors should expect the diversification to continue.

What does it mean for investors?

The darks clouds over Brazil have overshadowed Braskem's improving balance sheet, demonstrated track record of growth, focus on future growth areas in renewable chemicals and elsewhere, and a management team keen on delivering value to investors. Using a trailing-12-month EPS of $1.38, the company boasts a P/E ratio of 8.4 -- well below peers, many of which aren't even profitable. The company pays out a once-per-year dividend that varies with results but has not yielded below 3.7% since 2010. The stock is down roughly 14% year to date.

Long-term investors may want to seriously consider this beaten-down chemical manufacturer.

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Maxx Chatsko has no position in any stocks mentioned.

 to keep up with developments in the engineered biology field.

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