Westlake Chemical Partners LP (WLKP) Earnings Call Transcript & Summary

All right. I think we're going to start it. So hello, everyone. Before we get started today, I just have to read a quick disclaimer. For important disclosures, please see the Morgan Stanley Research closer website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, thank you, everyone, for joining us today for the Global Chemicals, Agriculture and Packaging Conference. My name is Angel Castillo, and I'm the packaging and SMID-Cap chemicals analyst here at Morgan Stanley. We're pleased to have with us today, Jeff Holy and John Brennan from Westlake Corporation. We have several topics that we want to cover today, but I want to remind everyone that if you have any questions, please feel free to submit them via the text box included in your webcast.

And so with that, why don't we just jump in? Jeff, John, just maybe starting at a high level, there's been quite an inflow of cash flow just given the move in commodities. As you think about Westlake, one of the biggest questions I get is how are you thinking about priorities and the usage -- or, I guess, options of kind of cash flow for capital allocation? And how should we think about these in terms of just parity, but also timing and what that could mean for going forward?

Yes. Thank you, and thank you for having us, Angel. It's always a pleasure to be here at the Morgan Stanley conference and your coverage. So I appreciate it. Good morning, everyone. No, it's a great question. It's a good first world problem to have, but a problem nonetheless, isn't it, with the strong cash flow generation that's currently occurring in the business and we expect to continue looking forward for the company. And so I think foremost, it's really no change in how we've always thought about it at Westlake. We're always focused on compounding long-term value and putting capital to work back into the business to create additional value for all of our shareholders. I'm sure many folks have seen our investor deck where we highlight that we've grown at a greater than 15% CAGR in capacity since the company was formed in 1986. And so we have a history of looking to put capital back into the business to grow it. But even more importantly, we have a history of doing that by doing it, not just to grow the business, but by growing true bottom line returns into the business as well and generating returns that are in excess of our cost of capital and in excess of our peer group. And so no different than how we're looking at the business going forward. The second half of '21, we've put about $2.6 billion into inorganic expansions through the acquisitions of LASCO, a PVC fittings business, which really complements our existing large-diameter leading position in PVC fittings by adding in a leader in small-diameter PVC fittings. We purchased Dimex, which we really are excited about as another extension of our sustainable product initiatives and representing a primarily PVC post-industrial recycler of producing consumer products. And then most materially, we closed on October 1 on the $2.15 billion acquisition of Boral North America's Building Products business. Obviously, very excited about that acquisition adding in a lot of leading positions across the Building Products portfolio, which really complements our existing leading positions with Westlake's legacy Building Products business. Primarily in vinyl products, Boral adds a lot of leading positions and not just some products which use vinyl, but more importantly, products, which are in stone veneer siding, polyeth siding, leading premium roof products and other leading building products that really build out that scale and diversification. So I think very accretive acquisitions to the Westlake portfolio from that. And going forward, we'll continue to look at those types of opportunities, doing it in a very disciplined way in how we choose to allocate capital. And if we can't find over time opportunities that we feel confident that are going to generate that excess return, clearly, we'll also then look at the appropriate ways to return money to shareholders. But overall, our belief is and we think certainly speaking with investors, who are in agreement with this, if we can continue to find these opportunities that generate excess return, that's how all of our owners should want us to allocate capital.

No, that's very helpful. And I guess as we think about the capacity of the organization, so you're integrating these 3 acquisitions that you disclosed on. Is it fair to assume that, I guess -- or I guess, how are you in terms of capacity to take on something else, whether it's bolt-on or another acquisition kind of in the near term given that, from a cash flow perspective or a balance sheet perspective, there's ample flexibility there. So it's more kind of from an organizational perspective as we think about timing.

I think organizationally, we're always a roll-up-the-sleeves organization. We get it done. One that gets into the details to make sure we understand everything and integrate assets to the fullest ability possible. I think the organization, certainly, those 3 acquisitions are a good amount of work to get that done. But certainly, we continue to look at opportunities, and we're not going to let an opportunity pass us up if it's going to be something that's truly going to add bottom line value. And there's still capacity, certainly, within the organization to be able to put the appropriate time and attention to integrate in those assets. The most important aspect is we're not going to become undisciplined and simply feeling like we have a need to spend excess cash flow next quarter, next 2 quarters and do something which isn't appropriate from a long-term value creation perspective. So that's really the foremost focus on how we think about those future opportunities.

And as you think about that kind of, I guess, criteria, would you say that there's -- if you had to kind of rank order vinyls, olefins, building products or kind of opportunities that you have or you're seeing in your pipeline, how would you kind of rank order those in terms of what you're seeing?

Yes. We really look at each individual opportunity on a stand-alone basis. So we're not ones so much to think about, say, strategically, we have to expand in this segment or we need to do this to be in this market. Certainly, there can be reasons why that can add to the synergies or returns of building out certain parts of the business. But we really look at individually each opportunity, individually the synergies we can generate from that opportunity. And importantly, the price that we can acquire and give an opportunity at and really determine what that bottom line value is to Westlake. And so recently, that's happened to end up with several building product additions, but those could have just have easily been on the chemical side, for example, if we are presented with as-compelling opportunity set for something on that side of the business. It's fairly idiosyncratic just when those right opportunities come up across different opportunities and business segments. And I would highlight, too, that if you look at where we have allocated capital over the last couple of years. Very recently, we do have these 3 building products-oriented additions. But at the end of 2019, we made a close to $900 million investment to increase the capacity for ownership in our Lotte JV cracker. That's an ethylene cracker, which really feeds our vinyl side of the chemical business. And we also added in beginning of 2019 a PVC compounding operation, NAKAN, through an acquisition as well. And so if you look back over the last couple of years, we've also been putting large amounts of capital to work in chains change other than building products. And it's really that focus on individually looking at those opportunities and finding the ones that are going to generate the most bottom line return to us.

And that's actually a good segue. I guess as we think about kind of more organic options to maybe expand in the business, I know maybe expanding the Lotte cracker is maybe a little bit more longer term when that comes up for maintenance. But as you think about 2022 and '23, what kind of opportunities do you see across the businesses for whether it's expansions or more organic investments?

Yes. So through our acquisition of Axiall in 2016, enter existing chlorovinyl operation, certainly, that's a network of assets where I think we can continue to find ways to probably put some capital to work to find economic growth projects within those assets. At the end of -- and I actually didn't mention this earlier on the capital piece, but the end of 2019 as well, we had close to 700 million pounds of incremental PVC capacity come online in Geismar through an expansion project that we had put capital to. And that was also part of a broader expansion. We're also working on for our Vinnolit operations in Europe as well. And so I think that highlights that given the number of assets and interconnectedness around our chlorovinyl operations, in particular, I think we'll certainly be able to find opportunities there as well to put growth capital to work in very efficient ways. And the Lotte JV cracker, you mentioned is another good example. We do remain short, a little over 1 billion pounds of ethylene as a company. We increased our ownership in that cracker up to nearly 50% at the end of 2019, as I mentioned. But it being a new greenfield cracker, just typically our build, as you know, with a good degree of debottlenecking capacity upfront that you would typically look to assess no earlier than the first turnaround cycle typically. And so certainly, that gives us another opportunity to think about putting capital to work and, in effect, that would help lower our cost position by bringing in incremental producer economics on ethylene that we're currently buying in the merchant market today.

And just remind us again, I guess, when does that come up for kind of the next maintenance cycle?

Yes. So that cracker, it came online in the summer of 2019, directionally speaking. And typically, your turnaround cycle on a cracker is going to be somewhere between 5 to 7 years. Highlight, our current Petro unit, Lake Charles, is going through turnaround currently as kind of an aside to that. We were actually able to extend that one out even beyond that typical 5- to 7-year mark. But there, we'll hopefully have that back online in December and be back to getting producer economics on that 1.5 billion pounds of annual ethylene production, too, that, that cracker produces as well.

Got it. Okay. That's very helpful. I guess maybe kind of moving on from capital allocation. I'll spare you the questions on building products until we get more details on that here with the fourth quarter. But maybe diving into kind of olefins. I would just love to hear your thoughts on the outlook. I think IHS has another $0.05 coming out on contract in November and December, and typically get $0.02 to $0.05 kind of in those 2 months as kind of typical seasonality. How do you see the outlook, does that seem like a fair kind of assessment of the next couple of months? And as you're seeing kind of November evolve, where would you kind of stand on that in terms of your kind of outlook on prices for PE?

Yes, that's a good question. And as we see the PE market, underlying demand is very strong, and it's really been strong throughout the last 1.5 years and remains very strong today. You do see supply coming back to the market and helping to normalize the market. And you do have capacity additions going into the market from a global perspective. And so what you're really seeing is a bit of a normalization of that market with the very strong demand that we noted but with supply coming back to be somewhat more normalized versus what had been tight earlier in the year, given a variety of issues, the freeze in the Gulf Coast back in the first quarter, some one-off operational issues. And so no big surprise that we're seeing what has been a pretty healthy run-up in pricing starting to come off a bit. I know one question you've heard in a few of our meetings, Angel, is the October price nomination where it was down $0.05. IHS did have a $0.12 change in the net transaction price as they've stated and that really relates to discounting that occurred throughout the year since their last nonmarket adjustment at the beginning of January of this year. And so we do see the October price changes having been $0.05 month-over-month. Looking forward, probably likely we continue to see a bit of price come off, given both the seasonality and as the market continues to return to a more balanced position. But if you look globally as well, given the strength in underlying demand and given the higher positioning of the global cost curve, given where oil currently is, and I think probably fair to say a general expectation in the market that we're more likely to see kind of a continued higher oil price environment. I think we're pretty well positioned here in the Gulf Coast given our feedstock advantage. And given where pricing currently is, do not see a significant degree of price erosion from where we currently are. But certainly as the market kind of returns to a more normalized position and given the typical seasonality we see, not unlikely to see some further price erosion here at the end of the year.

And to that point, I think one of the factors that a lot of people kind of point to when they're looking at kind of prices going down is the inventory levels and how those have kind of normalized and maybe moved up to the mid-40s here in the last few months. So I guess, as we think about kind of the right normal or what would be kind of the right level of inventories for the industry to have. I know that there's been some issues with what is the underlying representative sales number underlying that inventory number because of just whether it's allocations or issues with their ability to actually export more product. So how do you see inventories kind of at the producer level? And are we kind of at more normal today? And when you think about that days number, what is kind of the normal going forward as well that we should think about?

Yes. I think you're getting closer to normal. I'm not sure we'd characterize it as fully normalized yet, but you're getting quite a bit closer to that than what -- where we were earlier in the year. And so I think what you're seeing as things come back to a more normalized position, that's candidly not a bad position for all the folks in the industry, right? We want the inventory to be able to ensure that we're able to fully supply and satisfy our customers on the polyethylene side. And so we would certainly want to get back to a fully normalized inventory position. And I think to your point on days of inventory, it is a good question because as you see, given the expansions we've had in the last couple of years in the U.S. Gulf Coast, you do see more of those pounds going into the export market. And that does actually change then kind of how to think about those inventory days because a lot of those numbers that get reported will then have the inventory days of that product being on the ship as it gets shipped over to the global locations. And so it's not unsurprising to kind of see that number trend up over time, just given the higher export shift that we've been seeing in the Gulf Coast kind of production base.

And then I guess one last one before -- I want to make sure that we cover a little bit more on vinyls as well. But just one last one, I guess, you have a little bit more concentration within Westlake for specialty polyethylene. How has the advantage or of the margin kind of advantage in pricing here for specialty polyethylene kind of trended over what we kind of see, which is probably more representative of commodity products?

Yes. It's a great question and one that we certainly feel well positioned on in our autoclave low-density positioning in the industry and also one where, certainly, we've seen particularly healthy demand as flexible packaging, which is where that product is primarily food going into has been exceptionally strong in this post-COVID environment. And we see a very good degree of likelihood for that strength to continue going forward as well as folks appreciate the convenience of home food delivery, hygienic food packaging, et cetera, and the benefits that autoclave low density provide for that. As far as the margin advantage, it is a product which trades at a premium pricing to where you see either just generic low-density trade at or, obviously, the premium that low density commands over linear or high density in the marketplace as well. And so we've seen basically those sense of price premium certainly hold up throughout this period. We certainly like that positioning for the product. And going forward as well, it's certainly without -- I'd be remiss not to note that the global capacity additions that are out there, which is leading to some of the consultant projections of some of that price coming off later in the year and into next year, is very much more on the other sides of polyethylene. It's not in the autoclave low-density space. And so going forward as well, we feel particularly well positioned in that side of the business given the lack of global capacity additions there versus some of the other grades of PE.

Got it. That's very helpful. And then maybe switching gears a little bit into kind of the vinyl space, in particular, PVC. So there's been -- obviously, I think this area where you get a lot more discussion around what's happening, particularly given everything with China dual control with power outages. So if you could just kind of maybe update us how is Westlake seeing the vinyls and the PVC world evolving in terms of demand and also production and kind of balancing the market?

Yes. The core vinyls side of the business is one that we certainly see as being very tight right now from the supply-demand dynamics. And the most important item to note really within the chlorovinyls chain is, as you look forward, and as you know, there's little global capacity additions out there as well in the market. And so a bit of a contrast to maybe some of the projections out there for polyethylene, where you do have a healthy amount of capacity additions occurring, albeit in a market with very good demand. In chlorovinyls, you have that same good demand, but you don't see that wave of new capacity coming into the market. There's a few reasons through that. I think, first and foremost, the cost and complexity to build out that chain. As you know, there's a host of plants and interconnectedness that's really involved with building out integrated PVC. You have the ECU unit. You likely have co-gen power to power that. Salt input from brine. You have the EDC, VCM, PVC piece and you have an ethylene cracker on top of that. So all in, you're looking at big checks to write for putting new greenfield facilities into the market. And really, generally speaking, you haven't seen a large return on the PVC side of the molecule for all that long either. So I think it's fair to say that people are rushing out to put new capacity into the market after seeing maybe a short period of decent economics in that PVC side of the chain. That said, we see very strong underlying demand for PVC. The strength in housing is very, very good. And if you look at the demographics and expectations out there in the marketplace, I think fair to say a general expectation that, that strong demand on both new construction and repair and remodel markets that drive a lot of that PVC demand, along with infrastructure is going to continue. And so we see that market remaining in a very good position going forward. And certainly, from a Westlake perspective, we think that integration downstream from chlorine into PVC and with PVC being probably the highest return for chlorine currently of any material application for the chlorine molecule is a very good position to be in today and also looking forward into the business for at least the next few years.

No, that makes a lot of sense. And I guess with that positive outlook on PVC, and as you noted, not a lot of new capacity coming online. I guess how is Westlake thinking about that opportunity? As we talked about earlier with the cash flow and the flexibility, how do you look at that opportunity of potentially adding PVC capacity into kind of that positive outlook? Whether it's '22, '23 and considering starting to construct something.

Yes. So Westlake is actually the #1 global chlor-vinyl producer. We're #2 in chlor-alkali; #2 in PVC; but in combination, the largest overall when you look at both that ECU and vinyls piece of the chain. And so I think given our existing asset portfolio as having that leading position, and we've got a good degree of assets with a good degree of interconnectivity in how they are integrated. And so I think we will be able to find going forward opportunities to put some capital to work to build out some of those facilities to generate returns. Obviously, we're always looking at those opportunities internally. And we'll continue to look at ways to put capital to work that's going to generate good bottom line return. I think we, in the industry, certainly expect, at some point, you will see capacity coming to the market because, one, you have demand that continues to grow; and two, you currently don't have material additions coming into that market for at least the next 3 or 4 years based on lack of anything having been really announced today, and then how long it would take to get back to production. And so at some point, I think you'll certainly see folks put in more capacity, just given the fact that the market will need it to satisfy underlying demand.

And as you think about -- maybe from a regional perspective, obviously, there's some cost advantages, and you noted some of the integration that you have. As you think about maybe the regions where that might be attractive to add capacity, any kind of points that you'd flag as some of the cost advantage differentials that look maybe more, I guess, favorable in certain regions? But then also, how do we think about maybe China dual controls playing into that and a lot of the production being impacted in that region?

Yes. So from a global perspective, the Gulf Coast makes the most sense to put in new capacity. We have both the advantage of shale gas-based ethane here as a cost position in ethylene as well as electricity cost from primarily nat gas-driven power as well as easy access to salt brine for the salt feedstock? And so from a cost positioning standpoint, the U.S. Gulf Coast would make the most sense to put in incremental capacity. As you know, PVC is an easily exported product as well. And so in the U.S., we're in a very good position then to monetize that cost position and serve the global marketplace with that product. And to your point on China, certainly, dual control policy and the general trend of China looking to limit their emissions activity over time. And with most chlor-vinyl and PVC activity there being fed with coal-based electricity and 80% of the PVC there that's on the ground being not ethylene-based but carbide or acetylene-based from coal as well, which is more polluting, I think, fair to expect that you will continue to see some of those regulations around emissions likely continue to kind of limit what that looks like on a go-forward basis.

Okay. And I guess you kind of alluded to this, but I guess, with margins where they are today for PVC, it seems like that's already, at least from a chlor-vinyl kind of integrated perspective, that's fully reinvestment economics territory. Do you see chlor-alkali also approaching kind of reinvestment economic territory? And do you think we'll start to get announcements kind of in 2022 within both PVC and kind of chlor-alkali?

Yes. So the issue with chlor-alkali is we do see caustic also recovering. And not surprising. Typically, caustic is a bit lagging in an economic recovery. So typically do see chlorine pull initially, and then caustic come a bit later as the global economy industrial manufacturing sectors kind of continue to recover. Really no different this time other than perhaps the initial pull in chlorine given the strength in housing being particularly strong versus perhaps some prior recoveries. That said, the challenge with just looking at the ECU piece and what do you do with the chlorine. As you know, chlorine is a hazardous and difficult and expensive gas to transport. And so you're really looking at having some type of derivative or offtake for that chlorine close to the ECU facility itself. And so generally speaking, I don't think you're going to see folks look to only build for the ECU economics because that leaves out the importance of finding something for that chlorine, and PVC is about half of where that chlorine molecule goes into the various chlorine derivatives. And so I think you're going to generally see any of those build-outs really being that more integrated ECU through PVC-type facility.

And as we think about timing, do you think we could get an announcements in 2022? And kind of getting back to your earlier discussion around ethylene expansion maybe needing to wait for maintenance. As you think about your own kind of debottlenecking opportunities as well, is there kind of some time line like that, that you have to wait for? Or are there opportunities that we could see kind of taking place in '22 or '23 in terms of announcements?

Yes. I mean, certainly, we're going to -- and I'm sure all folks in the industry are going to think the same way. We'll kind of assess where we think good returns on capital are and the appropriate ways to put capital to work. Institutionally, we have done greenfields in the past, certainly. But our mindset is typically in the chemicals industry that through the cycle, you can acquire assets at least at points in the cycle at below replacement cost. And so our bias is typically really institutionally to think of looking to acquire stuff cheaper than you can build. And if you have a patient approach, I think history has shown that you can find those opportunities, and hence, really get a cost basis in assets which are more attractive than purely greenfielding something.

And I guess just maybe to follow up on that. Are you seeing anything in that realm, I guess, in your pipeline of kind of opportunities right now? I guess I'm just thinking if I'm a producer or I have an asset, and this seems to be the best margins that I've kind of seen in terms of a PVC product. So would -- are there opportunities out there that would be willing to kind of sell at kind of below cost economics, given what we're seeing in terms of margins?

Yes. So there's always stuff out there, right? And it's, from a Westlake perspective, and I spoke at the beginning of our disciplined approach in how we think about that capital allocation. Part of that discipline is we'll look at, at least at a kind of initial stage, a lot of potential inorganic opportunities in any given year. And so the vast majority of stuff that we look at, obviously, we're not actually successful at closing and acquiring. And so part of that discipline, frankly, is looking at a lot of opportunities and finding those that we truly believe are a good fit from both integration into Westlake and at a price which makes sense to us.

Yes. Got it. No, that's very helpful. And I think that brings us kind of to the end of our time here. So Jeff, John, thank you again so much for joining us today. And I think, we'll, that -- we'll just close it out. So...

No, thank you, as always. Thank you, everyone, for listening in.

Thank you so much. Take care.