Materials Sector Leading the Pack in Q3 Earnings Season: 3 ETFs in Focus - ETF News And Commentary

We are in the middle of the earnings season, and the materials sector is gradually becoming the largest contributor to Q3 earnings growth. This is especially true as total earnings from 78.2% of the sector's total market capitalization reported so far are up 26.9% on 5.1% revenue growth. Earnings surprises were impressive with 69.2% of the companies beating earnings estimates and 53.8% beating on revenues.

These growth rates and beat ratios are much better than the recent quarters thanks to improving performance in the chemicals and steel industries. Most of the gains were primarily driven by operating efficiencies amid global growth concerns. In particular, results from Dow Chemical

have been robust. DuPont

has also provided decent numbers on the earnings front (read:

).

Earnings per share came in at 72 cents, beating the Zacks Consensus Estimate by a nickel and improving from 49 cents earned a year ago. Revenues grew 5% year over year to $14.4 billion and surpassed our estimate of $14.3 billion. The robust performance was credited to gains across the materials and plastics business aided by increased pricing and lower materials' costs.

The largest U.S. chemical maker remained committed to cost reduction and efficiency programs that will likely boost margins in the coming quarters. It expects to cut fixed costs by $1 billion over the next three years.

The company is also seeking optimization of its portfolio by selectively spinning off or selling its underperforming assets and gradually shifting focus to high growth businesses like Enlist, a new version of its herbicide designed to kill weeds. The company targets $4.5 billion to $6 billion of proceeds from assets sale by year-end 2015 (read:

).

Impressed by solid earnings and a revenue beat, shares of Dow Chemical rose as much as 4.1% on the day of the earnings announcement on October 22. However, the stock is down 1.7% to date post earnings.

The world's second-largest seed maker reported earnings per share of 54 cents, a penny ahead of the Zacks Consensus Estimate and 20% higher than the year-ago earnings of 45 cents. This is primarily thanks to cost cutting efforts that boosted margins in five out of seven business units and fully offset continued weakness in the agriculture business. Total revenue slipped 2.9% year over year to $7.5 billion and fell short of our $7.96 billion estimate owing to lower grain prices and rising competition in solar-panel materials.

Though DuPont is expected to face nagging headwinds from sluggish global economic growth, weak agriculture business, and currency, it reaffirmed its earnings guidance of $4.00–$4.10 per share for the fiscal year. This represents an increase of 3–6% from $3.88 reported in 2013 and the mid-point is much above the Zacks Consensus Estimate of $4.00.

Further, the leading U.S. chemical maker is confident in its ability to deliver strongly. This is especially true as the company is seeking to cut $1 billion in annual costs by 2019 and focus on high growth and less cyclical business by spinning off its chemicals business. Separation of the business is expected to be completed by mid-2015. This suggests a bright outlook for the company (read:

).

Following the earnings announcement on October 28, DD shares have been on a roller coaster ride and were down 1.6% over the past two days.

Despite the earnings beat, the two chemical titans are in the red to date since their earnings announcements. This trend might continue in the near future as both stocks have a Zacks Rank #3 (Hold) and fall in a poor industry category, with a Zacks Industry Rank in the bottom 9%.

This has put materials ETFs in focus for the coming days. Below, we have highlighted three ETFs that are heavily invested in these chemical giants. The trio has been modestly down over the past week and has a Zacks ETF Rank of 4 or ‘Sell' rating, suggesting that more pain might be in store in the days ahead (see:

).

The most popular materials ETF, XLB follows the S&P Materials Select Sector Index. This fund manages about $4.8 billion in its asset base and trades in heavy volume of nearly 5.8 million. The ETF charges 16 bps in fees per year from investors. In total, the fund holds about 30 securities in its basket. Of these firms, DD takes the top spot at 10.263% while DOW accounts for the third position with 9.25% allocation. In terms of industrial exposure, chemicals dominate about three-fourths of the portfolio while metals & mining and containers & packaging round off the top three.

This ETF tracks the Dow Jones U.S. Basic Materials Index and holds 59 stocks in its basket. The fund has AUM of nearly $751.8 million and charges 43 bps in fees and expense. Volume is good as it exchanges around 280,000 shares in hand a day. DD and DOW occupy the top and third positions in the basket with 9.59% and 8.31% of assets, respectively. The product is heavily skewed toward the chemical segment, as it makes up for three-fourths of the portfolio. Industrial metals & mining, mining, and forestry & paper take the remaining portion in the basket.

This fund has amassed about $1.4 billion in its asset base and offers exposure to 132 stocks by tracking the MSCI US Investable Market Materials 25/50 Index. The ETF has 0.14% in expense ratio while volume is moderate at 120,000 shares. Here, DD and DOW is the top two firms accounting for less than 8% share each. Chemicals make up for 51.7% of assets while container & packaging and steel also make a nice mix in the portfolio.

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