XLB: Fueled By Demands For Green Hydrogen, Copper, And Clean Water

seekingalpha05-20

Materials Select Sector SPDR Fund has multiple buy signals, including increasing demands for green hydrogen, copper, and clean drinking water.XLB has a competitive expense ratio and noteworthy ...

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The fund has outperformed multiple leading competitor funds over the past year.XLB's top holdings, such as Linde, Air Products and Chemicals, and Ecolab, are well-positioned to benefit from the growth in green hydrogen, copper demand, and clean water production.Tom_Young67/E+ via Getty Images Investment Thesis The Materials Select Sector SPDR Fund (NYSEARCA:XLB) has multiple buy signals, including the growth potential for several top chemical and mining industry holdings. These signals include increasing demands for green hydrogen, copper, and clean drinking water. XLB contains companies that are uniquely postured to fulfill these in-demand resources through their current capabilities and investment. Finally, while the fund has limited diversification, XLB has a competitive expense ratio and noteworthy dividend yield. Fund Overview and Compared ETFs XLB is a passive exchange-traded fund that tracks the Materials Select Sector Index. It therefore captures holdings that provide investors with a representation of the materials sector of the S&P 500 Index. These holdings include chemical, construction, containers, metals, mining, and paper product industries. With its inception in 1998, the fund has 28 holdings and $5.72B in assets under management. XLB is heavy on chemical companies at 65.27% weight, followed by metals and mining at 18.23% weight, and various other sub-industries. For comparison purposes, other funds examined are the Vanguard Materials ETF (VAW), the Invesco S&P 500 Equal Weight Materials ETF (RSPM), and the iShares U.S. Basic Materials ETF (IYM). VAW has similar top holdings as XLB but is much more diversified with over 100 holdings. RSPM is an equal-weighted ETF and therefore is much lighter on large-cap holdings (17.91%). Instead, RSPM predominantly consists of mid-cap holdings (70.88%). IYM is heaviest on industrial gases and specialty chemicals at 25.41% and 17.55% weight respectively. Comparing Performance, Expense Ratio, and Dividend Yield XLB has a 10-year average annual return of 8.58% with a total price return of over 89% this past decade. The fund has outperformed VAW's 10-year average annual return of 8.27% and IYM's 10-year average annual return of 7.81%. Interestingly, equal weighted RSPM saw the best 10-year average annual return at 9.68%. All funds underperformed the S&P 500 over the past 10 years, which has benefited from strong performance in other sectors such as information technology. 10-Year Total Price Return: XLB and Compared Materials ETFs (Seeking Alpha) A key positive factor for XLB is its low expense ratio, at just 0.09%. This expense ratio is the best compared to peers and even lower than Vanguard's VAW fund. Additionally, XLB has a dividend yield that outmatches most peers and the yield of the S&P 500 Index. XLB's dividend yield has also been growing with an 8.67% 5-year dividend yield CAGR. Expense Ratio, AUM, and Dividend Yield Comparison     XLB VAW RSPM IYM   Expense Ratio 0.09% 0.10% 0.40% 0.40%   AUM $5.72B $4.05B $295.13M $676.29M   Dividend Yield TTM 1.85% 1.60% 1.89% 1.66%   Dividend Growth 5 YR CAGR 8.67% 5.87% 11.92% 10.57%   Click to enlarge Source: Seeking Alpha, 18 May 24 XLB Holdings and Materials Sector Growth Factors XLB is the least diversified fund compared and therefore carries a heavy 66.29% weight on its top 10 holdings. In contrast, equally weighted RSPM has only 30 holdings and is therefore more evenly distributed, with only 39.31% weight on its top 10 companies. Other than RSPM, all ETFs are heavy on Linde plc (LIN), an industrial gas company. Additionally, XLB and peers include mining companies such as Freeport-McMoRan Inc. (FCX). Top 10 Holdings for XLB and Compared Materials ETFs   XLB - 28 holdings VAW - 116 holdings RSPM - 30 holdings IYM - 39 holdings   LIN - 20.26% LIN - 16.64% FCX - 4.44% LIN - 19.35%   FCX - 7.26% SHW - 5.67% NEM - 4.30% FCX - 7.90%   SHW - 7.19% FCX - 5.57% IFF - 4.23% ECL - 6.12%   ECL - 5.74% ECL - 4.52% WRK - 3.91% APD - 6.07%   APD - 5.56% APD - 4.09% IP - 3.80% NEM - 5.20%   NEM - 4.80% NEM - 3.64% EMN - 3.79% NUE - 4.68%   NUE - 4.15% NUE - 3.22% AMCR - 3.77% DOW - 4.31%   DOW - 4.01% DOW - 3.11% ALB - 3.71% FAST - 3.89%   CTVA - 3.82% CTVA - 2.97% DD - 3.70% IFF - 3.52%   MLM - 3.50% MLM - 2.82% BALL - 3.66% LYB - 3.21%   Click to enlarge Source: Multiple, compiled by author on 18 May 24 Because XLB and most compared ETFs are heavy on chemicals and mining companies, the prospects for these industries will greatly drive future performance. Looking forward, there are three major positive factors for several of XLB's top holdings, including green hydrogen, copper, and clean water recycling. Each of these demand factors are discussed in detail below. Chemical Company Growth: Green Hydrogen The first major factor driving growth for the materials sector, and therefore XLB, is the green hydrogen industry. Green hydrogen, in a basic sense, is the creation of hydrogen without using fossil fuels. This hydrogen can then be burnt to create heat or create fuel cells to make electricity. This technology has application in automobiles, container ships, refineries, electricity turbines, and household applications such as cooking and heating. Globally, the green hydrogen market is expecting staggering growth, with a 51.6% compound annual growth rate through 2031. Forecast Global Growth for Green Hydrogen (Recharge; Transparency Market Research, www.ft.com) Several of XLB's top holdings are taking advantage of this green hydrogen growth. For example, Linde, XLB's #1 holding at 20.26% weight, has been aggressively investing in green hydrogen. One example is its Niagara Falls plant expected to start in 2025 that doubles Linde's green hydrogen capacity in the United States. Linde is not the only top holding that is poised to benefit. Air Products and Chemicals, Inc. (APD) is XLB's #5 holding at 5.56% weight and is also investing heavily in green hydrogen. Air Products is investing $500M to build and operate a facility in Messena, New York. This facility is expected to produce 35 metric tons per day, allowing production of green hydrogen and low-carbon liquid hydrogen. Metals and Mining Growth: Copper The second key growth area for the materials sector is copper demand. Due to a supply gap, copper prices have recently gone up considerably. This trend is not expected to subside any time soon, given China's demand as a massive importer and increasing uses in artificial intelligence. Copper prices are already at $9,860 per ton, greatly exceeding 2021's $9,317 per ton. Copper Demand Growth Sources through 2035 (S&P Global, 18 May 24) One top holding for XLB is Freeport-McMoRan, a metals and mining company that predominantly focuses on copper. FCX's share price is up 54% over the past year and the company displays several strong fundamentals including a 10.3% YoY revenue growth and 39.9% gross profit margin. AI data centers alone are thought to drive demand for copper by one million metric tons by 2030. Additionally, given China's growth as the world's largest copper importer, companies like Freeport-McMoRan are postured to benefit greatly. Global Water Shortage A final key area where XLB's top holdings stand to benefit is in water filtration and production. Due to increasing demands on fresh water in industries such as agriculture, industrial, and household use, global demand for fresh water has reached 4.3 trillion cubic meters per year. Such demand has resulted in an impending water crisis. According to the United Nations, one in four people may see chronic shortages of fresh water by 2050. XLB's #4 holding, Ecolab Inc. (ECL) at 5.74% weight, stands to benefit directly from this global water crisis. Importantly, Ecolab provides water technology to reuse and recycle water. Due to the company's investments, it aims to have capacity to recycle 300 billion gallons of water annually by 2030. The company has also seen solid fundamentals including a 15.8% YoY EBITDA growth along with a 41.6% gross profit margin. Therefore, inclusion of ECL primes XLB well to capture the expected demands of clean drinking water over the next decade. Current Valuation XLB has seen strong one-year performance compared to peers with an 18.2% price return. Despite RSPM's outperformance over the long term, XLB has seen slightly better returns recently. Consistent with their long-term performance, all materials funds examined have underperformed the market, as measured by the S&P 500 Index, over the past year. One Year Performance: XLB and Peer Materials Funds (Seeking Alpha) As a result of its strong recent performance, XLB has a slightly higher valuation compared to peers with a P/E of 21.5 and P/B of 3.05. However, XLB and peer funds are more reasonably valued than the S&P 500 Index, which is well above its historic mean with a current P/E of 27.56. Despite a slightly higher valuation than peers, I believe XLB is primed for growth given the strong potential of green hydrogen, copper mining, and clean water production as previously discussed. Valuation Metrics for XLB and Peer Materials Sector Funds     XLB VAW RSPM IYM   P/E ratio 21.50 20.70 12.05 20.23   P/B ratio 3.05 2.70 2.50 2.77   Click to enlarge Source: Compiled by Author from Multiple Sources, 18 May 24 Risks to Investors XLB has a standard deviation of 20.05 along with a 5-year beta value of 1.19. Therefore, I consider the fund relatively volatile, particularly compared to more stable market sectors. By comparison, State Street's Utilities Select Sector SPDR ETF (XLU) has a beta value of 0.50 and 5-year standard deviation of 17.22. Additionally, many of the industries touting strong potential growth are based on forecasts and projections. Should competing technologies for clean energy become more affordable or efficient, assumptions driving green hydrogen forecasts will likely be invalidated. Similar risks exist for the demand for copper provided by FCX and clean water technologies provided by Ecolab. Concluding Summary  XLB is a low-cost ETF with strong potential thanks to developments in green hydrogen, copper demand, and clean water recycling. However, this potential does come with risk as it is based on projected growth in industries where competing technologies could steal market share. Additionally, despite XLB's strengths, peer materials ETFs have greater diversification and more attractive valuations currently. However, I consider XLB's positives outweighing its negatives looking forward and therefore see the ETF as a buy.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2436248391"}