Westlake Corporation (WLK) Earnings Call Transcript & Summary

Good afternoon, everyone. Ciao from Cleveland, this is Mike Sison from Wells Fargo. I'm going to conduct the fireside chat with Westlake here. Representing Westlake on the line is Albert Chao, President and CEO; and Steve Bender, Chief Financial Officer. Albert has been with the company since 1996, potentially that was the last year the Browns won a playoff game, and became CEO in 2004. Steve's been with Westlake since 2005 and took the role of CFO in 2008. So I wanted to thank Albert, Steven for participating in the conference this year as well as thanking everybody on the line and hope everyone is safe and sound. If anyone would like to e-mail me a question, it's [email protected]. So thanks again, guys.

Why don't we kick it off here? Albert, you're off to a good start in Q1, and then, unfortunately, the COVID pandemic hit in combination with the plummeting oil prices. So I thought maybe what might be helpful is just to hear from you what you've done with the company since the pandemic, cost savings, working capital, CapEx. Sort of what was the game plan as the pandemic started to unfold.

Certainly, I'll comment. Go ahead.

I was going to say maybe, Albert, what I could do is just talk about what we've done a little bit with CapEx and then let you kind of talk a little bit about also what we're doing with the underlying business. And so Mike, maybe what I'd do is I kind of outlined in our earnings call earlier this week that we've curtailed our capital spending for 2020 and taking that down to $500 million to $550 million from our earlier guidance for the year of $650 million to $700 million. And obviously, we're tightly managing our spending across the board in operating expenses and obviously watching kind of any other discretionary spending item to make sure that it really is necessary and business-critical. So as we go forward through the year, we're closely managing our liquidity and our spending and looking at the business closely. We ended the quarter with $1.5 billion in cash, we had drawn earlier in the quarter under our revolving line of credit, but have nicely also spaced out all of our debt maturities. So we've got really a nice laddered series of liquidity. Our nearest is only -- is 2 years out. It's only $250 million, so a very small maturity, 2 years out. And otherwise, the next one is in 2026. So we actually have got a nice-looking series of laddered maturities and been focused really on, as I say, our spending levels, CapEx and operating expenses. And maybe, Albert, I'd let you kind of talk about what we're doing in terms of making sure that we keep that way.

Yes. Thanks, Steve. I think -- well, first of all, I think we also -- we said in the conference call that we are working on making sure that our employees are safe and make sure our plants, our operations are safe and maintenance, safety as well as environmental areas. Two, as Steve said, we're watching our costs very closely, both from people cost, discretionary cost spending and any unnecessary expenditures. We're trying to be very smart on how we spend money, including procurement as well logistics. Then we're working on making sure our working capital are well controlled. And maybe Steve can comment on our first quarter working capital. It seems larger, and Steve can comment on that. And we're looking at capital expenditures. As well as Steve mentioned, we are reducing and deferring about $150 million of capital for this year, plus we're looking at delaying a turnaround for our -- one of our ethylene plants. So we're doing everything we can. I'm sure more can be done, how to reduce our costs and make sure we can be competitive throughout the cycle. So I'll turn it back to Steve again.

Yes. And so, Albert, good point. Part of the benefit of the CARES Act was actually a nice tax provision. As some of you may recall, we made an investment in a joint venture ethylene business in Lake Charles, Louisiana, with our partner Lotte, and that generated for us a nice operating loss. And if you may recall tax code, prior to the pandemic, one could only use that going forward. But a nice benefit of the CARES Act was allowing us to take that NOL and carrying it back as many as 5 years. And as a consequence of being able to carry that back, we should see a nice benefit of getting a nice tax refund between $150 million and $200 million. So as soon as we can get our '19 return filed, and as you can imagine, we're promptly working on that as we speak, we'll be able to capture that. And you'll see that receivable sitting in current receivables that Albert mentioned. So it kind of expanded my working capital number, but it really became a nice benefit as a result of the CARES Act that was passed by Congress to address this pandemic. So we'll see the benefits of that tax refund here as we work forward as promptly as we can to get the return filed.

Great. Can we shift gears a little bit to your vinyl business? It's -- you manufacture chlorine, caustic, upgrade to PVC and building products. So can you maybe just walk people through what's the most important profit driver there? You have a lot of things going on right now with caustic potentially going up, PVC coming down. But at the end of the day, is PVC more important than caustic or other parts of your vinyl business more important in driving profitability?

Yes. This is a good question. This looks back starting from 2018 when the U.S. had this trade dispute with China, which caused industrial production in China as well as industrial production around the world to slow down because China consumed about 40%, 50% of the major materials in the world, whether it's concrete, cement, steel and plastics. So when China slows down, it has impact on the rest of world materials business. So we saw plastics prices and caustic prices coming down. Caustic, as you may know, is one of the most broadly used chemical and it touches many areas of the GDP, whether from soap making, paper tissues, carton box to refineries, to aluminum refining, to make aluminum and many other applications. So it follows the GDP. And as manufacturing side or PMIs came down, the caustic demand came down and caustic prices start dropping. So all the way until -- and normally, domestic caustic prices in almost all the countries are better than export caustic prices. And this applies to China as well. So export price has come down. And U.S. typically exports between 20%, 25% of the caustic it produces. So it went all the way until December of last year, 2019, when the U.S. reached a Phase 1 agreement with China. Then we see a little bit of stability and the confidence came back, and with the USMCA, further help to the manufacturing sector of the U.S. and global economy. So things are getting better. Export price improving -- improved. And domestic price improved until coronavirus came, and that kind of about change, and China slowdown was the first to shut down the economy. Price went down again to really -- at cash cost position for some of the Asian producers and some were shut down. So jumping back to the PVC side. As you know, when you produce chlor-alkali, you produce 1 ton of chlorine and same time produce 1.1 ton of caustic. So these 2 are like twin brothers. And majority of the chlorine produced in the world goes into PVC, more than half. So the production of chlor-alkali really depending on the PVC demand in each country. So PVC-wise, as you know, the housing from 2006, 2007, housing construction in the U.S. residential units are 2.3 million units. That's all-time high. And with the 2008 recession, the new demand for homes dropped to 400,000, 80% drop. And on the other hand, the 50-year average of new home construction was 1.5 million units. So from 400,000 units in 2008, it gradually came back. And I think last year, it was 100 -- 1.2 million, 1.3 million units. And the new home permits in February, it went to, on an annualized basis, 1.5 million units. So this year, I think maybe the southern part of the U.S., the weather was warmer, so the building season started earlier. And we were doing quite well for building products and PVC sales. And there was turnaround going on. So increasing prices, PVC. Demand was very strong. Globally, it was very strong. And then coronavirus came. And some of the -- in the early part, we were still allowed to continue with the construction sites. People could still work. But then many governments started putting restrictions, lockdowns. So much -- many of the construction sites were stopped, including in Canada. We are major supplier to Canada as well. So building products has slowed down, PVC demand slowed down, and U.S. exports, between 30%, 35% of PVC, mostly to emerging markets. And now the emerging markets are going through the same problem with the U.S. and being locked down. Like India, they've completely shut down. India was a big importer of PVC. So demand has come down. At the same time, the political issue between Saudi Arabia and Russia and on OPEC caused further price to drop. At the same time, we have demand drop on the coronavirus, the lack of consumption of oil. So oil price came down sharply. And most of the ethylene plants around the world are naphtha-based. Naphtha comes from refining oil. So that cost came down a lot. So the PVC, half of PVC is ethylene, so ethylene price all over the world came down a lot. So PVC price came down. And since U.S. exports between 30%, 35% is production PVC, we had to drop the price for median overseas price, and the result, domestic price came down. So you had a problem of reduced demand domestically and export PVC. You have prices dropping because of lower oil price. And so what happened since then is now we're in May, and many of the states now are coming back encouraging people to go back to work. And the construction sites are opening up one by one. So we see a demand for building products come back again. We are seeing some demand for PVC again. And so near term, we should see some pickup in the demand for building product PVC. But in the medium term, with the building permits being -- coming down sharply, as I said in February, is 1.5 million units; March, 1.2 million. We expect in April and May, the new building permits will come down furthermore, which means in the next 6 months or a year, new home construction will slow down materially. And you can expect that, people are either out of a job or they come back to a job or get a new job, first thing they will do is pay down debt that they have incurred, and two is save more money for another potential second wave. And buying a new home is probably not high on their list of things to do. So -- but we know that eventually, whether it's a year to 2 years takes for vaccine to come back -- not to come back, but to be developed, and this crisis will be over. And longer term, we believe that the way of life in U.S. and in any place in the world probably would change. People who are living in the suburban areas -- in the urban areas, sorry, in the high-rise apartments or multifamilies probably would like to move to single-family homes with yards and kids are going around, and there'll be more social distance from their neighbors. So we believe that single-family home construction will be -- demand will increase and which will use a lot more materials, including PVC going forward. So that's the PVC side. The caustic side, as I mentioned earlier, every time we produce 1 pound of chlorine, it is 1 pound of -- 1.1 pound of caustic. Caustic demand is much broader in the economy when PVC is mainly construction. And the demand for caustic did not drop as much as PVC. However, globally, the chlor-alkali production is really based on how much chlorine you can consume. It's mostly PVC. As PVC demand drops, there's less caustic produced. And hence, there's more demand in caustic than supply. And in the U.S., several producers of caustic and the sales control or allocation and which means also seeing caustic price usually higher in domestic than export markets. That export markets, sales has been curtailed. They allocate more to domestic customers first. And caustic prices really come up a lot over -- on export market and as well as in the U.S. And since April, there's been price increase announced in the U.S., in April, May and June. In total 3 different price increases in caustic totaling between $160 to $195 in the short term. So there is a price movement. Now your question was, is that enough to offset the decrease in eventual PVC and also decrease in caustic sales and the price drops without that? Back in 2008 or '09, with the housing meltdown, caustic price went through the roof and the highest ECU in record in those days. But we don't expect caustic price to move up that much. It helps to mitigate some of the earnings decline from lower production rate and PVC price decline. But we think -- and also the estimates from industry analysts like the IHS and the CDI are forecasting a pretty dramatic drop in operating rates for PVC and chlor-alkali plants in the U.S. in second quarter and a little better in the third quarter, about the same and it improves a bit on -- through the fourth quarter, and next year looks better. So the consensus view is second and third quarter is pretty bad and then gradually improves over time. So it's a long-winded way of explaining this, but this is what we see.

Yes. And I think at the end of the day, for Westlake, PVC pricing and demand is more important than caustic pricing and demand. Is that maybe one way to think about it?

Well, everything equal, when caustic prices are higher, we make more profit than when chlorine price or PVC price are higher, everything equal. But now you have -- you have 3 things. You have volume of caustic, you have volume of PVC and you have PVC pricing margin. So there are a lot of moving parts now.

Understood. And then when you think about the PVC operating rates that folks -- that the pundits are talking about, you normally would run maybe above that. In this environment, it's really challenging, as you noted. If you run at those levels or below those levels, is the decremental margin unusually larger than normal? And then when things come back, will you be able to flex those plans and the incremental margin be a lot stronger?

Yes. Certainly, we are watching our costs a lot, fixed costs and even variable costs, improving both sides. But in terms of integration, with -- I think in the conference call we said, we, generally, we run a bit better than industry average for most of our products. And the reason is that we are pretty much integrated in -- especially in the vinyl side, more than some of the players. So we have on ethylene. We have power. We have our own -- big part of our power is from our own gas-fired generating plants. And we have our salt brine wells, the leases we have. And we also integrate not only with chlor-alkali where I think we're the third largest chlor-alkali producer -- well, maybe the second. See, the second or third in the U.S. I know second in the world, but...

Third. Third in the U.S., second in the world. You're right.

Third in the U.S. Okay. Third in the U.S. But also, we're integrating to PVC and some chlor-alkali guys not include PVC. And there's a home for chlorine, and that's under our control. And then PVC were integrated to the downstream building products. And some of our competitors are not integrated into building products. So when you have more integration, you tend to have more control. I'm not saying that, that means everything, but helps -- everything helps a bit. And so we tend to run at a higher rate because of control of consumption downstream.

Understood. And then just to get a perspective of your building products business. How weak is it -- how weak is it now in April? And how do you see that business? How do you see the cadence of the weakness over the next couple of months?

Yes. I think it depends a lot on how successful the reopening of businesses and the economy as well. As I said earlier, we were doing great the first 2 months of the year and early part of March. And then when the COVID-19 came, things slowed down and gradually slowed down more. And now we are seeing some resurgence of reopening job sites and demand has come back, picked up a bit. But we don't know whether how long this will last. We hope it lasts quite a while because this is -- second and third quarter usually are the 2 busiest seasons for construction and for vinyl business. And the vinyl business also, we make all the large water treatment chemical, pool chemical, water treatment chemical. And also, we make chlorine products derivatives for refrigerants, for air conditioning, for cars and all that. So this is a season, they're 2 quarters, and yet people are forecasting lower operating rates for both quarters. So it will have an impact on our results.

Great. And then maybe shift gears a little bit to your olefin business. It is much different than your competitors, more focused on LDPE, more focused on specialty products. Can you maybe talk about some of those specialty applications? And for LDPE, in general, I don't recall that there was a lot of capacity coming on stream. It was supposed to be tighter than the other grades of polyethylene. So how do you see LDPE sort of progressing through this low oil and difficult demand environment?

Sure. We are the second-largest LDPE manufacturer by capacity in North America. We were the largest until Dow and DuPont merged. So they put their 2 polyethylene business together. So they are the biggest Dow now. But we are the largest autoclave LDPE manufacturer. And autoclave is -- there are 2 processes LDPE, the autoclave and tubular. And autoclave makes the more premium LDPE and a lot goes to the food packaging. So it also makes a lot of different copolymers with ethylene, vinyl acetate, metal acrylate and butyl acrylate and all that. So we are able to supply more and more the packaging needs. And as you know, that as people stay home more and they also stock up on their daily needs, what you see in the supermarkets, packaging, a lot of this is our various forms of polyethylene. And people, whether they will eat at restaurant, eat at home, so their consumption also increased on packaged materials. So our demand has been quite good. Now unfortunately, prices coming down. Again, earlier, we said because of the oil price collapse, but since then, oil price has recovered somewhat. But oil price collapse caused the international producers to have lower costs while using oil and the feedstock for making ethylene. And their price came down a lot. So export price came down a lot. In the U.S. export, 30%, 40% of polyethylene in general, so they had to reduce the price, which also caused domestic price to come down. So even though our demand volume is pretty good, the price has come down and for exports. So that put pressure on the U.S. polyethylene manufacturer. And you know that our industry added a close to 40% of new capacity in the last few years. And still, 2 tubular LDPE plant renovation that commodity type. They use less for packaging, but more for super sack and those things. But the 2 plants are yet to start. This is from the -- call it, the first wave of ethylene-polyethylene expansion. And then we have the second wave for which the 3 main plants are the Exxon-SABIC joint venture Corpus Christi; you have the Shell plant in Pennsylvania; and then you have Total's ethylene plants in Port Arthur. So you had the second wave which -- in the construction. And so whether 2021 or so, '22, that they forecast to come onstream. So we do have more capacity. And you have some Chinese plants, there are more naphtha cracking or crude oil to chemical. Those plant under construction and I'm sure some of them will be delayed because coronavirus. And we heard also that some of the U.S. plant were delayed because of local government rules not allowing people to work closely together in construction. But those are the second wave. So we probably will see a bit more capacity coming on. But majority of the capacity at the first waves are already on.

Right. And then if we think about restoring your earnings or margins in this business longer term, can you maybe help us understand the importance of where oil needs to be, where operating rates need to be? I think LDPE, you mentioned, was running in the $90s in the first quarter. It's going to drop -- industry open rates are going to drop to the $80s or so. So when we think about rebuilding the earnings power there, how would you help investors think about that over the next couple of years?

Well, Steve, do you want to start with that first?

Yes. And so as you begin to see, and I think, Mike, it's really a function of how you think about the return to work as we see this. But certainly, the way you try to model this, we've tried to give some pricing sensitivities to our products. And so I think we've talked openly about $0.01 a pound and PVC being about a $55 million impact. And so as you see prices begin to move, as you see demand begin to pick up, you'll see the leverage and the earnings begin to come through. We've also given some sensitivities to caustic that Albert spoke of earlier. A $10 price in caustic is about a $34 million EBITDA contribution. And we've seen price nominations out in the marketplace so far this year, 3 of them actually in terms of nominations by various industry players. And so as we see the kind of the restart of the economy, we hope to see some traction built. And it's a function, as Albert noted, it's a function really of how quickly you get the consumer and the industrial players back into place. But those sensitivities give you a sense of how we see things moving. And just for the polyethylene kind of degree of sensitivity, $0.01 a pound is about a $24 million benefit to EBITDA. So Mike, as you think about a restart and whether we're seeing a lift in third quarter, fourth quarter or beyond, as you see that those operating rates begin to improve, as the economy gets back on its feet and we start seeing industrial and consumer demand pick up, that's really how we get our feet back underneath us, both as an industry and as a company from a recognizing the real earnings potential of Westlake.

Yes. I'd just like to add also that we said in conference call, looking at the futures pricings for oil and natural gas and ethane, we believe that U.S.-based ethane actually today -- today's price or yesterday's price, ethane-based, the ethylene cracking is almost on par with propane and the naphtha in the U.S. So we think the $0.01, $0.02 apart. And because coal product, when you crack naphtha, you produce a lot of coal products and where there's like benzene or BTX and butadiene and propylene. But those coal product prices come down a lot also. So -- go ahead.

I was going to say, I'm sorry, didn't meant to interrupt. I was going to say, so you really don't have to get back to high double digits for oil prices. As Albert was noting, you really begin to get that benefit of that shale boom that Albert was talking about. We get that benefit of ethane pricing. Sorry, Albert, I will just turn it back over to you.

Yes. So the future prices looks like by the end of the year, early next year, the U.S. ethane-based ethylene manufacturing will regain its cost advantage compared with oil-based or naphtha-based ethylene. And second thing is that I mentioned about the capacity additions in polyethylene, U.S. and also overseas in China. Whereas in chlor-alkali and PVC, caustic and PVC, very little capacity added around the world, the only area is really in the U.S. and the Chinese because of the 80% of China's PVC is from -- based on coal. And from coal to make PVC, they need a mercury-based catalyst. And because of the Minamata Convention that outlaws using increasing demand for -- or using mercury, China put a ban on new permits for new chlor-alkali PVC construction for coal based. So we don't have much capacity adding on for PVC and caustic. And demand -- as caustic demand follows the GDP, between 0.5 to 1x GDP, and PVC between 1 and 1.5x GDP. So as the global economy recovers, and they will eventually, the demand for caustic and PVC would help to improve the pricing. And we don't have overhang of capacity as we have in some of the polyethylene business.

Great. Well, our 30 minutes are up. Albert, thank you very much. Steve, thank you very much and everybody else on the line. I wish everybody safety, and hopefully, we'll see each other soon. Thanks again, guys.

Thank you very much. Thank you, and be safe. And thanks for your interest.

Thank you very much.

Call us anytime you have questions. Yes.

Thank you, Mike.

Thank you. Bye-bye.

Bye-bye.

Bye.