Westlake Corporation (WLK) Earnings Call Transcript & Summary

Good morning, good afternoon. Thank you all for standing by. [Operator Instructions] Today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would now like to turn the call over to Mr. Jeff Zekauskas. You may begin.

Hi, this is Jeff Zekauskas of JPMorgan, and I'd like to welcome everyone this morning to our virtual industrials conference. We've changed the format of our 2020 conference to a virtual one in the interest of health and safety. Thank you for attending this morning. It's my pleasure to introduce Albert Chao, who has been Chief Executive Officer of Westlake since 2004. Joining Albert is Steve Bender, the Chief Financial Officer of Westlake, who has been CFO since 2008. Albert and Steve have been a capable team in growing Westlake both organically and by acquisition, including Axiall and Vinnolit and NAKAN. Albert will -- and Steve will present and then take a few questions from me if there's time at the end. Albert?

Thank you, Jeff. Good morning, ladies and gentlemen. Thank you for joining us digitally or electronically. We appreciate your interest in Westlake. And we'll go through the slide deck. If you're able to access the slide deck, we are on Page 2. If you are not able to see the slide deck, please feel free to get on to westlake.com. And in our Investor Relations section, Presentations, you have today's slide deck. So starting with Page 2. Westlake is a leading integrated plastic materials company focused mainly in the Olefins and Vinyls business. And by olefins, we mean ethylene and polyethylene, and we have a small styrene position. And in Vinyls business, we include ethylene, chlor-alkali, PVC as well as downstream specialty and building products. We have a large position there as well, which consumes much of our -- of PVC. Our Olefins business which -- is about 1/4 of revenue and represented last year, 2019, about 28% of EBITDA. And our Vinyls business is 3/4 of revenue and last year was 72% of our EBITDA. And as mentioned, that in our Olefins business, the mainly -- main sellable product is polyethylene. As you may know, that polyethylene is the largest plastic used in the world, and it's an ideal choice for complex consumer products. And for us, we are -- and we'll go through it. We have a large position in LDPE and used mainly in food packaging, which extends the shelf life of many of the food products. And the vinyl products is focused on more the durable side of consumer products. As you know, only half of PVC is hydrocarbon or ethylene-based. The other half of PVC is chlorine-based, which comes from electrolysis of salt and which is now -- so the price -- or the cost does not move up and down with hydrocarbon or with oil and gas. As I mentioned, the PVC is focused mainly on the durable side of the consumer applications, and a large part of PVC goes into construction and infrastructure, such as water and sewer pipe or infrastructure. Caustic soda, which is a by-product of producing chlorine, is used in a wide variety of industries from caustic -- from alumina refining to general industrial applications and consumer products such as soap. The 4 points in our mission statement is very important to us. You'll hear more on each as we go. On the top line, number one is we pursue positive growth, and more of a bottom growth -- bottom line growth and create value for our shareholders. And second, we are focused on businesses we understand, namely Olefins and Vinyls businesses. And three, we do business globally in areas where we can gain an edge, an advantage, whether it's a technology advantage like in Vinnolit or our compounding business in -- feedstock advantage as well. And mostly importantly, we act in a financially disciplined or opportunistic manner. Some recent examples of applications of our strategy include the announcement that we took a larger ownership stake in our joint venture ethylene cracker in Louisiana; and as well as our PVC, VCM, chlor-alkali expansions in the U.S. and Europe. And we believe that with our conservative balance sheet allow us to grow optimistically in areas we can thrive. On Page 3 is -- depicts our commitment to sustainability. Westlake commit to corporate social responsibility and following our company's core values, which includes health and safety and environmental awareness of our employees, our staff and community and our products. Obviously, our people are the most important to us. We want to grow and develop our people. And quality and continuous improvement, we are a Six Sigma company for over 30 years, and we're continuing to improve our quality and continuous improvement. Cost competitiveness, we are in a very competitive and somewhat commodity business, and so competitiveness in cost is most important to us. And we can talk to you later on about our cost position in both olefins and vinyls. And citizenship is important not only to support communities but also in areas of reducing emissions to the environment and also promote further recycling. We know that many of plastics are considered as not friendly to the environment. But for PVC, for example, because it's used for durable applications, actually, PVC, we do recycle post industrial, post production and potentially post consumer. And PVC is used for water pipe which can last 20 to 100 years in the ground. So it's a very environmentally friendly business, but we also -- we are conscious of packaging materials and plastics, polyethylene. So we joined many industry associations, including Alliance to End Plastic Waste. The industry is committing $1.5 billion from both plastic manufacturers, brand companies as well as waste companies globally to work together to reduce the plastic waste in the environment. And we are also joined in other industrial associations, so we'll continue to do more in those areas as we go along. We're going to Page 4, which shows Westlake as a global diversified product leader focused on the Vinyls and Olefins business. We are #2 globally in capacities for both chlor-alkali manufacturing as well as in PVC. And we also are the largest low-density manufacturing in the autoclave process. And we will talk about the 2 process of making polyethylene. And the more specialty, LDPE manufacturing -- low-density polyethylene and the more specialty product process is autoclave. And we have the global largest capacity produced in the area. On the global footprint point of view, in North America, we are highly integrated, low-cost producer of polyethylene and PVC and caustic. We have multiple sites, chemical sites as well as downstream products in Europe. We're the global leader in specialty PVC manufacturing and process. And also, we are a global leader in PVC compounds. In Asia, we have a high-quality PVC resin and film production plant in China as well as another PVC compound -- specialty compound plant in China. But these are relatively small positions for us, and we'll talk about a bit later on what we see in China. Move on to Page 5. Page 5 gives you a graphic illustration of Westlake's growth starting in 20 -- 1986, the first year of commercial production in Westlake. And we're using the capacity growth rather than revenues. Revenue has inflation in it. But even the capacity growth over the last 30-odd years, we have averaged a compounded annual growth rate of 16% per year, and this just shows our integration strategy and global presence. Going to Page 6. This shows our globally advantaged cost position with high degree of product integration. As you know that every pound of polyethylene takes about a pound of ethylene. So our Olefins business is integrated. Likewise in ethylene, both in the polyethylene and styrene side. Also, it takes about 0.5 pound of ethylene to make a pound of PVC. So on the gold -- we have a green section which shows the Olefins business. And our Vinyls business is the gold color, where we show our large position in chlor-alkali manufacturing and caustic soda and integrated downstream to PVC and the vinyl products downstream or the building products or other chlorine derivatives. And then we do sell chlorinated products as well. So we are highly integrated, but with our low cost position both from ethylene which is using U.S. shale-produced natural gas liquids, primarily ethane, we have -- the U.S. probably today is the lowest cost producer of ethylene, with a low-cost ethane position and -- to produce ethylene. And on the chlor-alkali side, chlor-alkali is made from electrolysis of salt, and in U.S., we have many of our plants. We have our own salt stores from -- salt domes. And we also have a large cogen -- self-cogen abilities by using natural gas, which is very inexpensive in the U.S., to produce electricity through our own cogen plants. So a large part of our electricity, we do buy on emerging markets, but we also produce our own power. And with those low-cost salt and low-cost power, we're able to produce chlor-alkali for both the caustic for the commercial market and chlorine for our downstream products, whether it's PVC or other chlorinated products. So we are among the lowest cost producer in the world in both polyethylene and in the vinyls side. Going to Page 7. On the left-hand side, it shows the integrated nature of producing the vinyls from chlor-alkali ethylene and the various stages of chemical manufacturing to produce PVC and into downstream. On the right side -- right-hand side, it shows the pie chart that over the last cycle -- business cycle in the Vinyls business, 10 years, we see that on the average, feedstock -- the raw material feedstock -- if we transfer price to the market price, the raw material to ethylene and chlor-alkali, and ethylene is the gold (sic) [ green ] color and chlor-alkali is the green (sic) [ gold ] color, to represent about 91% of the margin of the whole pie chart. And PVC, on the average, is 9%. As you may know, that in the past few years, the PVC margin has been negative. So right now, the PVC margin has improved by quite a lot, but we believe that over the cycle, PVC would still have a minor segment of the pie chart in terms of profitability and margin. But right now, PVC does have a higher margin. Going to Page 8. And it just shows that we are a global leader in the chlorovinyls business with our scale. So I mentioned that we are #2 globally from a capacity point of view of producing chlor-alkali, which is chlorine and caustic; and in PVC as well. And this scale gives ability to be better positioned to compete globally through chain integration. We're also able to serve our customers globally, both in U.S., Europe and Asia and also are able to have a footprint -- a large footprint in Europe through our Vinnolit business, and we talk about Vinnolit as the global leader in specialty PVC resin. And we believe in the strong fundamentals for PVC and chlor-alkali. As you may know, that unlike Olefins business in the U.S., there's very little PVC and chlor-alkali capacity added, and the demand for PVC and chlor-alkali are still pretty strong. PVC follow construction, and chlor-alkali follows the GDP. And the global GDP is still growing. Demand for PVC is strong. And we are seeing going over -- going in the future, that capacity additions in PVC and chlor-alkali globally are not meeting the growth in demand. And the 2 pie charts on the right just shows the diverse use of PVC and caustic soda, and they are used in a variety ways all across the globe. We are going to Page 9. And I mentioned earlier that Westlake/Vinnolit -- Vinnolit is our German operation. And they were former German Hoechst company and Wacker company's vinyl business, and they are the world leader in specialty PVC resins. And actually, PVC resin produced are used in various products, mostly on consumer durables like vinyl flooring, wall covering, artificial leather for cars, for furnitures, textile coatings and automotive coatings for rustproofing as well as for gloves -- medical gloves dipping, so very, very wide applications. And unlike suspension PVC, which is 90% of global PVC produced, those are primarily for construction for water and sewer pipe, sidings and window frames and many other things that goes inside the house and outside the house or institutional applications. So we are very pleased with our position, both on the commodity side with the U.S. low-cost position and with the specialty side and technology from our European position with Vinnolit. And one more point I'd like to point out on the lower right-hand side, you can see that specialty -- for the last 5 years, specialty PVC has received a very healthy margin premium over commodity PVC. Page 10, just to highlight again what we talked earlier regarding the capacity investments compared with the GDP. The PVC demand typically goes 1, 1.5x GDP growth globally, whereas the caustic demand typically goes 0.5 to 1x GDP growth rate. And we just use the GDP growth rate forecast from IMF compared with capacity -- global capacity additions. You can see that compared with that, there'll be under-investment in the world's caustic capacity going forward. Going to Page 11. Page 11 shows, and this is the IHS, one of the consulting companies, historical and future demand forecast for PVC globally. You can see that the blue bars are the demand for PVC globally. And you can see the only dip was 2008 when we had the U.S. housing recession. And even 2 years afterwards, 2010, global demands are already recovered and keep on growing and forecast to grow between 2020 and 2025 at 3.5% growth rate. The red line shows the U.S. exports of its PVC sales as a percent of the total PVC sales. And before the housing recession in the U.S., the U.S. export is approximately 10% or so. But after the recession, because of the lack of demand PVC and because of the strong cost position in the U.S., the U.S. start exporting a large amount, between 30% to 40%, of its production. And we expect the U.S. to continue to be a big player in exporting to the world market for PVC. Going to Page 12. I wanted to show again our advantaged position in polyethylene. As you may know, there are 3 types of polyethylene produced in the world: high density, HDPE. It is the largest share of the industry, and high density has a very broad application, going from soft and high-density film for t-shirt bags to blow-molded gallon milk jug or water jugs to injection-molded beer crates or kind of toys to high-density pipe for transporting natural gas, which is usually in orange color, as well as corrugated large pipe for storm drains. Linear low, which is the gray color of the pie chart, are used mainly for films for packaging such as stretch wrap, for bundling pallets, industrial applications as well as for garbage bags because of its strength. And LDPE, which is the dark blue section of the pie chart on the top left, which is the smallest amount of production and capacity in the total pie chart. The reason is LDPE is one of the oldest polyethylene. It's made under between 20,000 to 40,000 psi of pressure for the process, which entails very heavy metal, and so it leads to very heavy investments. And also because of the size of the metal, it's not so good in relieving the heat-up reaction. Hence, the productivity is not very high. So with high-cost position and high investment costs, some of its applications, more commodity-types, have been taken over by linear low or high density, which are lower pressure, you can build big plants and a more productive pound-per-dollar investment. So LDPE, over the last 30 years had to find its niche of specialty properties that can command a premium. So global capacities, you can see LDPE is only 22% of total polyethylene capacity, whereas for Westlake, on the bottom left, is about 58% of our polyethylene is LDPE. And why do we like LDPE? You can see the top right-hand side, that over the last 15 years or last 5 years, because of specialty nature of LDPE and lack of new investment, LDPE has found its niche where its properties can excel, and hence, LDPE has been selling at a higher price and higher-margin than other polyethylene, such as linear low and high density. And I spoke earlier about the specialty polyethylene, whether it's autoclave process or even there are small parts of polyethylene -- linear low density that's also specialty. So the bottom right-hand side, you can see that with specialty polyethylene, it is more profitable than the commodity side, from $0.04 to $0.06 a pound. Let's go to Page 13. As I mentioned, that 58% of Westlake's polyethylene is LDPE. With our competitors, because of their large position in high density and linear low, LDPE is the smaller position for them. You can see the right-hand side. As I mentioned, there are 2 types of process to make LDPE, autoclave and tubular. Autoclave tends to make even a more specialty type of polyethylene, and tubular is the more commodity type and lower cost of investment. So hence, globally, there are more tubular capacity than autoclave. So for Westlake, 80% of our LDPE capacity is autoclave. So if you look at our margins on the average, because of our large position in LDPE versus the competitors, and also with the LDPE, we have more specialty type of LDPE, so on the average, our polyethylene margin tends to be higher than our competitors'. And so we have a competitive position with our product mix. On Page 14, as we talked about, because of the low feedstock position -- low-price feedstock position with -- in the U.S. with the shale production of oil and gas, we have a low-cost abundant supply of natural gas liquids, especially ethane, so -- compared with high oil price and global cost position. So a lot of ethylene and polyethylene capacity added in the U.S., and on the average, 60% of all the ethylene produced in the world goes to polyethylene. It takes 1 pound -- about 1 pound of ethylene make a pound of polyethylene. So you can see in this chart we have -- the green bars are the percent of capacity added every year globally for high density, the gray is the linear low and the blue is LDPE. And you can see that -- there are 2 lines. One line shows the GDP -- 1x GDP forecast by OECD, and the other line is 1.5x GDP. So we -- from historical relationship, demand for polyethylene is within 1 and 1.5x GDP growth rate. So you can see that the LDPE, which is a dark blue, is the least amount of capacity added. And after 2023 then, that will be short of new capacities compared with demand growth. So with that, I'll turn over to Steve, our CFO, to go through our financial position. Steve?

Thank you very much, Albert. And I'm looking now at Slide 15. What I thought I'd do is describe our disciplined investment culture, our strong balance sheet and the higher margins that we earn on our products. So let's turn to Page 16 in the presentation. Our disciplined approach to spending and the competitor -- competitive factors that Albert just spoke of earlier rank Westlake among the top in our peer group in returns. You can see on the left, the bar shows that we're putting these assets to work much more effectively than our peer group in generating returns above our peer average. The middle bar on this chart shows we're achieving these margins with far less capital employed, and the bars that you see on the right shows our average EBITDA margin is much better than our peer set. We'd attribute these superior results of these -- really to our operating philosophy and execution; the focus in growing the integration and that integration does drive significant value; the advantaged feedstock that we still enjoy in ethane; and of course, the specialty product mix that Albert spoke to just a few minutes ago. So let's turn to Page 17. The chart at the top of this page shows our debt to total cap. And as you can see, Westlake has consistently been less leveraged than our peer group, yet during the same time period, we've deployed billions of dollars of capital on our business and profitably grown our business over that same time period. We didn't extend ourselves as some did during that same time period. And even now, after these multiple acquisitions, we still are below the average of our peer set, as you can see from the chart. In 2017 and 2018, you can see that we've continued to pare down the debt. So in 2017, we paid off $500 million of debt and $1.2 billion of debt in 2018. In 2019, we issued EUR 700 million of 10-year debt, very attractive interest rate on that at 1.6% for a 10-year period to fund our increased ownership of the joint venture ethylene cracker that we have in Lake Charles, Louisiana. That continues to lower our cost of ethylene for our businesses. There are a number of takeaways I think you should have from this: that we have ample capacity to fund our growth and we have the patience and the discipline to invest when the risk/reward trade-off is favorable. You can see at the bottom of this page that we also have a master limited partnership. That master limited partnership has provided advantages for us to raise equity capital over time and to fund that growth, very important as we think about the ability to raise equity capital at attractive rates. So let's turn to Slide 18. On this slide, you can see that we've made significant investments over time, and we will continue to expand our business and integrate where it brings attractive margins and good opportunities. The items that you can see here are the acquisition we made in 2016 of Axiall; the ethylene integration and expense that we've had over time, including the recent acquisition of our greater interest in the Lotte joint venture for ethylene in Lake Charles, Louisiana, the 2014 Vinnolit acquisition, which brought that specialty PVC phased business as well as more recent acquisitions of NAKAN in 2019 and the PVC expansion in Louisiana in late '19; as well as the recent joint venture in ethylene that I earlier mentioned. These are just a few of the important integration projects that continue to grow our EBITDA. And with that, Jeff, I'll turn it back over to you if you have some questions for us.

Thanks very much. Thank you for that very nice presentation. Historically, Westlake has not been an aggressive repurchaser of its own shares, but we may be in new territory now. When you look at the intrinsic value of the company, how do you view it? And do you think that your share repurchase pattern might alter?

So Jeff, as you might well know and the investors know, the Board has authorized us to be opportunistic in our share repurchase plan. And from time to time, when the opportunities present themselves, we have repurchased shares. And you're right, the environment we're in today is very unique and certainly provides opportunities for us to assess the value and use that authority, if we think it's appropriate, that the Board has authorized.

Okay. One of the things that's happened over the past week is that the price of oil has dislocated downward and that maybe at the beginning of the year, it was $65 a barrel and now it's roughly $35 a barrel. In your opinion, when those kinds of large changes in energy costs occur, are there changes in patterns in the global polyethylene market?

We've continued to see good and solid demand both in polyethylene as well as in PVC currently. And I think that as we see these new reset prices flow through, we could see some in the market begin to kind of react to prices. But as you would guess, we've seen pretty strong demand, and we've seen price increases across the board. I don't know, Albert, if you want to kind of add to my comment.

Sure. Jeff and attendees, you may know that the domestic business is quite strong for polyethylene and PVC. Polyethylene, we raised prices by $0.04 a pound in January, and the industry has announced a $0.05 a pound price increase for February, which has been moved to March. I think now it's $0.04 a pound. And since we're in the middle of March, only time will tell what the March end up with. But in February, because of the strong demand for LDPE, LDPE alone and not linear low or high density, the LDPE alone was able to raise another $0.02 a pound in February. So for LDPE alone, there was $0.06 a pound price increase in February and shows the fundamental strength in demand for polyethylene and more so for LDPE. Now since Monday, oil price dropped dramatically. And globally, over 50% of ethylene are produced from naphtha cracking, and naphtha comes from oil refining. So we're expecting with the lower price of oil and naphtha coming up, that potential polyethylene price will drop globally and would have, later on, impact on domestic price. But on the PVC side, as you may know also, this is the start of the construction season. The weather has been warm. So there was $0.03 a pound price increase effective in January and an additional $0.02 a pound price increase effective in February. So with all that done and our downstream building products, whether it's pipe or siding and trim and molding, the business has been quite strong, and even export price in PVC has been quite strong. Now the U.S. is the largest exporter of PVC in the world because, as I mentioned earlier, of our cost position. Then the second large -- or the largest capacity in the world as a country is really China and they -- rather than import, they do export PVC and caustic. And over 80% of the Chinese PVC comes from coal, and many of the companies are really owned by coal mine companies, whether they are state or government or major government-owned companies. And as you know, coal price, since they're only coal, the cost is more or less fixed. So Chinese -- despite the oil price drop, the Chinese coal or PVC costs will be relatively flat. The other regions that could be more competitive is Europe and North Asia, North Asia primarily Korea -- South Korea, Japan and Taiwan. But the total capacity is not that big, but they -- potentially, half of PVC is ethylene, and ethylene cost for them will be dropping because of low price of naphtha. But -- and then the other place is Europe. Europe is almost -- a big part -- biggest part of ethylene is from naphtha cracking. And so their cost will be dropping. But not all the PVC integrated naphtha into ethylene, so it may or may not impact the cost of PVC producers. But Europe is not a big exporter of PVC. They're more balanced domestically. So we don't see the threat of oil dropping impacting the price and resulting margin for the Vinyls business, whereas more -- it will be more impactful at the Olefins side. And just want to remind the listeners that Olefins business is only 25% of Westlake's business.

In your presentation, I think that you said that the PVC margin as opposed to the margin that a producer makes in ethylene or in chlorine tends to be relatively small. And I think your belief is that this year really may be different in that, in the United States, PVC prices are rising. And I would imagine that your cost of production both on the ethylene side and on the chlorine and caustic side are falling. Is that correct?

Yes. I think as we mentioned, that it takes power to produce chlorine, and with a lower price of natural gas, which is primarily the energy to produce power in the U.S., power costs will be coming down. And with lower price of ethane somewhat in the U.S., ethylene costs will come down. So the cost of producing PVC is coming down, whereas PVC demand is good. As mentioned, price increased, so the margin should improve over last year in the Vinyls side.

Maybe as a very last question. We've had a long series of months where the price of caustic soda has fallen month by month, but it may be the case that, that market is turning a little bit. Can you talk about trends in the domestic caustic soda market and in the export market briefly?

Sure. Caustic, as we mentioned, the applications are very broad. It follows mainly the manufacturing side of a global economy. And for the last 1.5 years, the PMI for manufacturing has been below 50 or so and so impacting -- indicating there's a recession in manufacturing. And end of last year with the phase 1 agreement between U.S. and China and as well as the passing of USMCA, we see a switch, a change in outlook for manufacturing and prices for commodities such as caustic soda improving. But the coronavirus has changed that picture somewhat this year. And as you know, China starting -- right before New Year, in January until now -- but what we hear is that traffic jams in Shanghai is coming back, so China is pulling itself back to -- people coming back to work. And now because of the inventory, the buildup during the first phase of coronavirus concern in China, people have to spend a month or 2 to work through the inventory buildup before they'll increase the manufacturing imports. So it takes some inventory adjustments to go through that. But we believe China is coming back gradually, and demand for products will be improving. The issue now is how much the rest of world will be impacted by the coronavirus pandemic. As we said, so far, we don't see the impact, both domestic U.S. and export for us so far, but who knows.

Thank you very much. Thanks for your presentation, and we hope to see you in New York next year.

Thank you very much. Thank you for inviting us.

Thank you, Jeff.

Okay. Good.

Thank you. Take care all.

Thank you. This does conclude today's conference. You may disconnect at this time. Thank you, and have a good day.