Westlake Corporation (WLK) Earnings Call Transcript & Summary

Got it. And if we stay with olefins for a second. Obviously, there's been a lot of new capacity additions announced in China. That's obviously weighing on the mind of a lot of investors right now and some of the margin outlooks. Could you talk about your take on the feasibility of some of these starting up, kind of what you expect? And what that could mean for integrated margins here in the U.S. over the next couple of years?

Yes, you're right. There has been a lot of capacity that has been coming over the last several years. And in 2020, we'll see additional capacities come in to both the Asian market as well as into the North American market. The predominance of that is really in the commodity spaces. So it's high density, linear low density and low density. And so when you think of those 3 generic grades, and many of you may not be familiar with each one of those grades. But when I think about high density, think of that as the bone milk jug, very rigid, very opaque. Linear low density, that's the black leaf bag or the white kitchen stretch bag. And when you think of low density, think of that really as the applications that you see in the film around a pound of cheese or the meat wrap or the application that is coating a cardboard juice container on the store shelves. The vast majority of that is being additives in the commodity end, where Westlake's position is actually on the more specialty end. So when you think of the specialty applications here, we're talking about the high clarity applications that go into typical packaging and coating materials, such as that coating on, whether it be paper for packaging of juices. So cardboard juice containers that are holding orange juice as an example. Those are coated with multi layers of polyethylene, high degree of transparency here so that you can coat it and print it. Same thing for some of these juice boxes that you see children will stick a straw into. That's an aluminum foil package, but it's coated with polyethylene to keep it air and watertight. That really is our primary focus, is really in those coating materials. So it does go into food packaging to a great degree and it keeps it both air and watertight. We're the largest player in this particular space. And while we compete with some of the very large names such as Dow and Lyondell and others, we're actually the much-larger player in this space, they're much larger in the more commodity end. Substantially, all the capacity being added is really in the commodity end. And while a rising tide will lift all boats, so will the same effect on a falling tide. So as we see new capacity, it will impact margins. But being positioned on the specialty end of this chain should be quite beneficial because those prices in that specialty business tend to be a lot stickier. And that really is the kind of dialogue we have with our customers today.

Got it. That's interesting. And sticking with the plastic topic and some of your specialty-type applications there. Obviously, sustainability has been a key topic among investors and all other stakeholders. I think in the past year or 2, it's really accelerated. When you think about Westlake, can you just talk about some of the areas your company is focused on, and kind of the effort you guys are doing to reduce plastic waste? Which I think has been maybe one of the key elements that people have overly -- or I shouldn't say overly focused on, but focused a lot on.

No, but it is an important area of focus, not only for the industry, but for Westlake as well. And so when you think of our 2 segments of our businesses, as I say, 3/4 of the business is in PVC and in that chain. And PVC is 100% recyclable. So you can make a piece of pipe out of PVC, bury it, dig it up 50 years later, completely recycle that, re-melt it and re-extrude it back into pipe. So it has a complete, 100% recyclability. Frankly, there is no limitation on that. And frankly, we also have what we call a cradle-to-grave or cradle-to-cradle perspective. So any materials in the PVC space that are brought to us, we'll certainly take, whether it's our product or not, reuse that and re-grind that material from its rigid form, re-grind that and re-extrude it into new products. So from a PVC perspective, PVC is fortunately very recycled and very reusable in the -- all manner of application. Most of the focus on single-use plastic has really been in what I would call bag bans. And that is typically a high-density polyethylene bag, or in some small applications, what we call a linear-low bag. So these are typically the more commoditized pieces of polyethylene applications that you see. If you just think about these films business, there are about 40 categories of films business, 1 of which is the bag. So today, in the North American market, nearly 100% of those bags that are being banned are actually imported materials, not being manufactured here, either in the chemical chain, or extruded and manufactured here. So that impact on addressing bags and that high-density application, for the most part, really is more impactful to the commodity end of the space. So that's where the impact will be. Where Westlake has been focused is looking to address recyclability in our Vinyls business and making sure, as we work with our packagers in our polyethylene space, that we're working with packaging applications that have high degree of recyclability. So to the extent that we're using cardboard or paper packaging that is encoated with polyethylene for juice or other liquid applications, all of those can be fully recycled. Now the FDA won't allow that to go back into the food handling side of the business, but those can be recycled and reused, but simply because of FDA requirements, they can't go back and touch food. But they certainly can go back and apply to many other applications. You can separate chemically the plastic from the cardboard or the paper containers and reuse those in different channels, but simply not in the food channel. We've been focused on that and working with our packaging customers in that space. We certainly are members with many of our other industry brethren and even our customers in something called The Alliance to End Plastic Waste, which you may have heard about. And this is an organization that was established last year. And it has not only chemical company participants, but also many of the consumer companies. So organizations like P&G and Pepsi and many others are also in this organization to all -- to work together to address much of the plastic waste that we see in -- predominantly that's going into rivers and therefore into oceans. You don't see that occurring here in the North American and European markets, but predominantly in Latin America and Asia. We're also members of organizations such as the Material Recovery for the Future. These are organizations working with our packaging customers to design packaging applications that are as efficient as possible, meeting customers' needs, but also designed for reuse and reapplication. Again, because of FDA standards, can't go into food packaging but can be repurposed into other channels. That and a variety of other organizations. Vinyl Plus in Europe, which is an organization designed to address and reuse vinyl PVC predominantly to be, again, recycled and reused. So a wide variety of functions that we directly are involved in and also working with our customers develop solutions.

Got it. That's helpful. And switching over to the capital deployment front. Obviously, it's always been a question, and I think it's picked up additional traction or interest among investors. Obviously, following a Bloomberg article suggesting you guys could potentially be interested in the Orbia assets. So I know you won't comment specifically on that. But when we think about capital allocation in the next 2, 3 years, relatively integrated today, you like being short ethylene, kind of how should we think about Westlake the next 2 or 3 years? How should we think about your priorities of spending excess cash?

So when we think about the investments that we've historically made and those that we prospectively can think about making, it's really been about being integrated, again, across the chain. Because that degree of integration allows us to make sure that we have the ability to capture profit wherever it happens to sit across the chain. So if you think about the fact that margin, over time, will move back and forth across that integrated chain, if you occupy each stage of that chain, you're able to actually capture that margin across the chain. The importance of that integrated chain also gives you the ability to run your plants at higher than industry average operating rates because you have a dedicated offtake at each stage of production. It allows you to spread your cost across the entire chain, allows you to capture margin across the chain. It does require capital to make that investment. So as we think about the investments that we have made to integrate that chain, you have to be opportunistic to make sure that you're investing or buying assets at the right stage of the cycle so that you're getting the return on capital that we choose and want our investors to be able to benefit from. And frankly, when we choose to build, it's only after we've looked at joint venturing or buying assets at below replacement costs that we choose to invest. Because then, you're investing at replacement cost. So when we think about building or buying these assets, we're always looking at can we do so in a manner that's going to give us the kind of return threshold we're looking to achieve? We look at everything that's in the space. But if you look at our history, we are very selective in terms of how we position ourselves in various markets and servicing various market channels, and always with an eye on return. It's very -- we're very focused. And if you'll look at some of the investments that we've made. Most recently, we made an investment in an ethylene plant that does not even grow EBITDA -- excuse me, does not grow revenue, but does grow EBITDA. And that's this joint venture we have with our Lotte partner. And the focus there was growing our EBITDA but not growing revenue. It actually took out cost of goods sold. And so as we think about this focus, it's not growing revenue that we're so focused on, it's really growing EBITDA. We have made billions of dollars of investments over the last 5 years to grow EBITDA, but not necessarily revenue. Our focus is not necessarily getting big on the top line, but getting quite big on the bottom line. And so our investment, I think, thesis, I think, is frankly different than some of our peers because we're very focused on return and growing cash flow, not necessarily revenue.

No. And you point to the Lotte JV, which I think, again, you got that at a fairly compelling valuation relative to newbuild costs, relative to some other investments, so I think that's a great example there. I know we have a couple of minutes left. I do want just one last question for you before I turn it over to the audience. I would be remiss not to mention your MLP structure. Maybe spend a couple of minutes talking about Westlake Partners, kind of what that adds to the overall Westlake entity, and kind of how you see the growth for that entity over the next, say, couple of years here.

So we created the partnership, the master limited partnership, back in 2014. And it was really designed to allow us to monetize some of those qualified income streams at a multiple significantly greater than our trading multiple. And it continues to be the case. And while the partnership space in the MLPs tend to be quite challenged today because of a variety of reasons, we think there still makes good sense for us in this space. The capital needs we have for the partnership, frankly, are very meager. And we've designed it in such a way that our needs to grow the business over time can be dealt with meager external access to capital, that allows us to continue to monetize the qualified income streams, which happen to be ethylene, over time, repatriating that capital out of the master limited partnership into Westlake Chemical, which allows us then to then grow the business without adding leverage, but bringing very cost-effective equity into the business. That cost of capital has been and has continued to be very cost-effective relative to the C corp, or WLK, cost of equity capital. As long as we can do that, we'll continue to sustain that model and continue to run the business that way. And it allows us, as you can see, to raise capital at very cost-effective means. In our organization, there are very few things that you can manage. The only thing that you really can manage is cost. I can't manage the input price and I can't manage the selling price. Those are market-determined. But what I can do is manage the cost of our business. This is an example of trying to manage our cost of equity capital in the most cost-effective way that we can. So if I can raise equity capital at a cost that is much cheaper than raising Westlake Chemical cost of equity and use that to continue to grow Westlake Chemical's business, that's the ideal position. And while the MLP space is a bit challenged, we do find that it's improving this year relative to '17 and '18 and '19. So as long as my needs are a little bit meager, we'll continue to run that business and continue to do that for the benefit of all Westlake shareholders.

Got it. And the one thing I do -- and the yield on it, I would argue, is rather compelling today. The one pushback I get from potential investors sometimes is, look, I love owning it for my personal account. The issue I have professionally, liquidity is a bit lower than some other areas. So I guess when you think about the liquidity of the vehicle, how do you think about improving that over time?

It will take time, and that is the balancing factor. Because to be able to grow that liquidity to the marketplace over time, one has to attract capital at a cost-effective manner. As I just said, the partnership space is a bit challenged today with equities -- equity capital flowing into that space. So I agree that one of the challenges is a less liquid entity than I would prefer, and it will take us time. The key here is that we have multiple levers at our hands to be able to grow that business over time, and it's purely dependent upon the capital flows into the space. We're looking to broaden the distribution of the equity ownership in that master limited partnership to address all investors' needs for more liquidity. That will just simply take some time. But from a return perspective, it's a very compelling return. When you think about the fact that you've got an instrument that's yielding over 8%, nearly 8.5%, yield, 80% of which is tax-shielded, looks pretty compelling to me, even if it's less liquid. I can think of a lot of other companies that are in the C corp space that are, from a return perspective, not giving that kind of return. And remember, you're taking that yield with an investment-backed company behind it, and 80% of that is tax-shielded. So whether it be for your PA or whether it be for a more corporate portfolio, it should be a very compelling return.

Fair enough. I guess we have a couple of time, over a little bit, but we have some time for Q&A. If anybody has any questions. Going once, going twice. Off to lunch. All right, guys.

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