Cabot Looks Promising

 | Jul 23, 2013 | 2:30 PM EDT
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Ever heard of "carbon black" before? I hadn't.

But in the world of industrial chemicals, carbon black is in high demand. The fine black powder, derived from petroleum, is one of the most commonly used materials in a broad swath of products, including rubber, tires, inks, paints, batteries, belts and hoses.

In 2012, auto manufacturers and suppliers consumed nearly 80% of the global carbon black production. With auto sales expanding in China and India, along with the U.S., the global carbon black industry is scheduled to grow continuously through 2018.

One of the biggest producers of carbon black is Cabot Corp. (CBT). Founded in 1882 and headquartered in Boston, Mass., CBT produces and sells specialty chemicals and performance materials worldwide to automotive, construction and infrastructure, electronics and consumer industries. Its products also are used in thermal insulation, anti-counterfeiting security, energy and environmental applications.

With earnings per share estimated to expand 32% in 2014, and a forward price-to-earnings ratio of 10.1x those earnings, to me, CBT is an interesting opportunity. CBT also pays an annual dividend of 2.01%, or $0.80 per share, making the opportunity even more attractive.

Now, let's look at CBT's daily chart. As I've mentioned in recent articles, with the market at all-time highs and many stocks trading in nosebleed territory, locating good stocks that are not overbought is a challenge. CBT, however, currently shows a promising pattern on its daily chart.

Source: RealTick

Notice how CBT reversed off its November low of $32.57 and moved higher into the end of 2012. In the first quarter of 2013, price rallied to a high of $44.16. (CBT's all-time high comes in at $49.87, touched in April 2007.) Then, CBT dropped dramatically, as second-quarter results reflected lower sales in China and the disruption in its Japanese operation following the 2011 earthquake and tsunami. By April, price declined below its 20-day simple moving average (red), and its 50-day MA (green) and its 200-day MA (black), falling to an April low of $32.13.

But even as CBT's price fell, note the bullish divergence in its 14-day RSI (black arrows). The RSI became oversold, in the last week of March, falling to $28.88. Subsequently, the indicator reversed to move in an uptrend -- a positive signal. That signal occurred even though CBT's price was still in the process of falling to April lows. When you see a "bullish divergence," meaning the indicator and price are "diverging," or moving in opposite directions, it's usually a good idea to pay attention to the indicator. Many times it is hinting that price may soon follow the in its direction -- and that's exactly what CBT did.

By the end of May, the chemicals company had rebounded to a high of $41.38. It dipped back down to its 200-day MA in mid-June (following broader market action), and rose again to trade above its moving averages in July.

CBT reports earnings July 31, after the closing bell. Consensus is for $0.91 per share versus $1 in the same quarter a year ago.

While CBT may rise into earnings -- and I like the way price is acting because of the nearby earnings report -- my initial purchase at current levels of $40.75, will be one-quarter to one-third my intended position. After CBT's earnings announcement, should price rally above nearby resistance (May/June highs) at $41.38, I will consider completing my full position. My initial protective stop will be placed at $38 (trail). (For those who wish to hold CBT for the long-term, the stop may be lowered to just below the 200-day MA, to $37.40). My initial profit target is $44.

Carbon black should continue to increase in demand in upcoming years, and CBT is poised to profit from that move. So, in this case, knowing what "carbon black" is may deliver nice gains.

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