Westlake Corporation (WLK) Earnings Call Transcript & Summary

Good morning, everybody. This is Bob Koort. I head up the U.S. equity research effort on the chemical space for Goldman Sachs. I've also got my colleague, Dylan Campbell, on the line, who helps me cover the ethylene makers, PVC companies and, of course, Westlake as well. Just a note that if you're on the webcast, you can see there's an opportunity to ask questions during the presentation. The format will be Dylan and I asking Steve Bender questions. And then as you lob your questions in off the webcast, we'll try to insert those as well. [ I'm going ] to introduce our guest today. Steven Bender is the Executive VP and CFO at Westlake.

Steve, thanks for joining us. I think maybe a place to start. We tend to see investors compare and contrast across some of the equity opportunities in the U.S., particularly the polyolefin guys. So I was wondering if maybe you could give us a sense, an overview of where Westlake makes its money and how that may or may not be different from, say, the likes of a Dow or a Lyondell, the other ethylene companies in the U.S.?

Well, you're right. When you look at some of our peers like a Dow or a Lyondell and compare it to Westlake, we compare oftentimes with them in our polyolefins business in polyethylene. When you look at Westlake, our business is more highly concentrated more in a specialty end of polyethylene, specifically in low-density polyethylene, which is highly concentrated in the high-clarity or autoclave technology, which means we really go into flexible food packaging to a great degree. We do make some linear low density, but the bulk of our production is really in that high-clarity food packaging application. Most of our bigger peers, be it Lyondell or Dow or some of the others like INEOS and others, are more concentrated in more of the commodity end and high-density and linear. And to the extent they produce low density, they're more into the industrial stretch or the tubular low-density. And so our strength really is more on that specialty end of the business. But of course, when you think of our olefins business, it really only represents the smaller portion of our business. The bigger portion of our business is really over in the what we characterize as the vinyls side of the business, which for us is feedstocks to make PVC. So we produce chlorine and, of course, ethylene and go downstream into PVC. And again, unlike most vinyl players, we're actually integrated further downstream in vinyls, going into vinyl products, pipes, fittings, sidings and PVC compounds. So a wide degree of integration in the vinyls chain but quite different in terms of the makeup against our olefins peers such as Dow and Lyondell, who do not have a footprint in vinyls really.

And so Steve, what's that relative profit breakout for the company then between the olefins and vinyls chain?

Bob, it's interesting. As we speak currently, what we are seeing, of course, with the stay-at-home orders from so many states and so many countries around the world, food packaging has certainly seen a lot of strength. And people are going to the grocery stores a lot more than they were previously. And so there is, from a volume perspective, pretty good strength in the flexible food packaging business, as you might guess. Concurrent, though, with the outbreak of COVID, we've also seen a tremendous drop in oil prices. So while we've seen a volume pickup because of that heavy activity going into the grocery stores, we've also seen a significant reduction in the advantage we had by being a ethane cracker versus a heavier feed slate cracker. And so while we've seen strength in volume, we've seen reductions in margins in that integrated chain going from ethylene out to polyethylene. Now in our vinyls chain, we have seen actually some pullback in construction, mostly driven again by the stay-at-home orders. If you go back to the early portions of the first quarter, we actually saw strength in the construction markets in late '19, and that carried over until January, February. And it wasn't until late March and through that we've actually seen some pullback in the construction side of our business, so impacting PVC and some of the demand in our vinyl products businesses. So historically, the strength of the business is really on the vinyls side of the business, much bigger relative to our olefins business. But really, where we've seen the strength most recently has been in polyolefins and caustic soda because of the reduction in demand in PVC.

Steve, it's Dylan. I guess on kind of last point, could you kind of go through a little bit more in detail, kind of you and some of your competitors have recently announced that several consecutive months of caustic soda price increases, which is a bit different than everything else we're seeing in commodity chemicals. Can you just walk through kind of what dynamic or what's causing that recent price inflation and I guess also talk a little bit about the sustainability of those price increases?

Sure. Well, as I just noted, we've seen some pullback in construction, largely driven by the stay-at-home orders by many of the states domestically and some of the countries overseas. We also know that countries like India and many other countries really just brought their entire businesses to an absolute halt. And so it impacted the exports of PVC resin to many locations that would have been export markets. And even in markets such as the U.S. or Europe, it slowed significantly because of the stay-at-home orders issued in Europe and the U.S. So while in the U.S. we had certain industries such as home construction designated as essential services and critical infrastructure, certain parts of the country felt it differently. So in the Northeast, we certainly saw a reduction of construction. But in the Sun Belt and in the Midwest of the U.S., demand for PVC resin and, therefore, building products continue to remain firm. In Europe, we've seen also a pullback in PVC, even though there continued to be some construction activities continue to move forward. So the pullback in PVC, which is, of course, using chlorine, and the pullback in other chlorine derivatives such as polyurethanes has pulled back on the demand for chlorine because you cannot store chlorine because it is too hazardous to do so. It has also caused a demand pullback in chlorine, as I say, across PVC and others. And so we've seen strength, therefore, in the co-product or by-product of making chlorine, which is caustic. And as you noted, we've seen a series of price increases in caustic because we've seen actually pretty steady demand occurring still in other businesses that are using caustic such as pulp and paper, alumina, industrial applications that are going into detergents and cleaning, water treatments, of course, such as bleach and, of course, a wide variety of distributions of other products and manufacturing. And as a consequence, we saw price increases occur back in the first quarter, about $20 went in. There's between $20 and $30 price increase. $20 of that went in. And then we've seen a series of increases in March and April announced. And so when you think about those announcements in March, we saw prices moving between $60 and $70 a ton announced by industry participants; and in April, another round of increases, running between $70 and $85 a ton. We've actually seen those prices actually take hold. And so if you look at a very visible benchmark, which is the export price for caustic out of the Gulf Coast and Asia, you've seen prices steadily rise over the series of price increases. And that's because we are seeing that very steady demand in caustic, as I say, going into a wide variety of applications. And so even though we've seen pullback in many industries, I would say that we still see pretty good strength, of course, in paper and pulp; alumina, still; detergents; cleaning and, of course, in a wide variety of water treatment applications. And so that's sustained caustic pricing. And then Dylan, if you go back to the recession we saw in 2008 and '09, that kind of dynamic played out as well then. We saw prices for caustic move up because of a pullback. In this case, in '08 and '09, it was driven by housing reduction. And so we saw a pretty steady demand in caustic price because of the pullback in chlorine going into PVC that was going into housing, and that sustained itself for much of 2009 and into '10. And it wasn't really until we saw a slowing down of the industrial base later in that early portion of that decade that we see caustic prices begin to kind of come down. But caustic prices tend to be sticky as long as industrial demand is steady to up.

Steve, it's Bob again. Maybe dovetailing on that answer. We've had some clients ask, what is Westlake rooting for? Do you want to make a bunch of money on those merchant caustic sales? Or would you rather lose some opportunity there if the PVC, since it's a much bigger chain for you, is rolling along nicely? What are we sort of rooting for in a best-case scenario for market development for Westlake?

Yes. Both chains have actually been fairly snug if you go back to pre-COVID periods. And so there hadn't been any material capacity additions either in caustic or in PVC of any material size for a number of years. And so both markets were showing and beginning to show strength. We had seen weakness in caustic because of the trade wars in -- starting in '18 and '19, and we really saw strength in the construction -- new construction and repair and remodeling in '19 and early 2020. We'd like to really see more strength in the chain. And so when you think about where we make the value proposition here is, we won't probably be able to fully offset the pullback in demand for PVC by some of these price increases in caustic. It'll diminish the impact of reduced volume and reduced margins in PVC by having improvements in caustic. But certainly, as we march forward, if we can begin to get the return to normal beginning and by opening up the economies in Europe and the U.S., and Asia has started to open as well, we'll begin to kind of see those markets for PVC begin to open. Export markets are already beginning to open. As I say, India begins to open officially next week. The industrial side opened the last week, and the full economy opens next week. And so you're beginning to see demand for PVC pick back up, which is what we'd prefer to see. But in the meantime, the industrial demand has remained steady. And that's why you're seeing caustic being able to kind of stick with these price increases that we're seeing going through because while we saw pullback in PVC, quietly behind the scenes, the industrial demand remained ,not robust, certainly, but certainly steady.

And just to tie that out, the -- a couple of years ago, we had a very good rally in Westlake's stock in the chlor-alkali chain and enthusiasm because the supply side looked pretty restrained. I think you had some mercury facilities -- based facilities that were being phased out and maybe some of the acetylene in China. Can you just sort of talk through, did all of what we expected to happen take place? And talk about the incremental that's still left out there in terms of new supply and/or potential shutdowns.

So you're right, Bob. We did see kind of the Europeans move -- the EU authorities move and pushing out mercury-based chlorine production at the end of '17. And so that prompted some producers that were using that process to either shutter their plants or force conversion, which meant they were temporarily shuttered as they reconfigured to move to a membrane technology. And we haven't seen a lot of additional capacity globally in PVC around the world. There have been some expansion, but we're talking probably single-digit percentages on a global basis, so almost no meaningful impact globally of additions and likewise on the chlor-alkali front as well. The headwind that we've seen in chlor-alkali or caustic soda was really going back to the trade tensions we have starting about mid-'18, and it had a significant impact on global manufacturing. We really had an industrial recession, even though we had a consumer strength through the GDP. So if you look at GDP around the world, it was growing, nicely growing. But the -- if you look at the industrial component of that GDP, you'll see it was actually going through a recession and largely attributable to the trade tensions between the U.S. and China, U.S. and Europe and U.S. and many of its even North American trading partners. And that really caused a pullback in industrial demand, which caused a pullback in caustic consumption. With the agreement struck by the U.S. and many of its trading partners in late '19, we actually began to see strength begin to pick back up in demand, not only in caustic, but also in PVC in late '19 and early '20. And that's really when we saw the onset of the COVID-19 issues. And so as we look at the supply-demand balance, I think, Bob, the comments you make about the balance not being added to on a supply side by industrial players is true. We've not really seen a lot of capacity add-on. On the demand side, we saw demand growing and beginning this -- tighten up that supply-demand balance. And that was occurring in late '19 and early '20, until we saw the onset of the virus, which caused a lot of industry to shut and people to reduce their consumptions and stay home. So we are hopeful that we see -- once we get this collectively behind us, that the supply-demand dynamics get back into the position they were previously, where we see, again, no industrial additions of PVC of meaningful size and really no chlor-alkali additions at all, and we get back to a better demand dynamic going forward. It'll take some time, but we certainly believe the structure we saw in February that was constructive both in the vinyl PVC and vinyl chlor-alkali were there.

Steve, it's Dylan again. I guess going back to kind of your comments on kind of the caustic soda market showing greater stability than chlorine and downstream chlorinated products, can you just kind of parse out some of the key end markets for caustic soda and then particularly U.S. alumina? What are you seeing in terms of caustic soda demand into alumina and how that compares to the ultimate end market demand for alumina into aluminum?

Yes. So Dylan, when you think about caustic soda, it goes into a very wide range of applications, everything from paper and pulp, alumina, as you noticed -- noted, soaps and detergents, textiles, water treatments, a very wide range of applications. Specifically, on alumina, we've actually seen a pretty steady demand. Right now, we continue to see that continue to move forward. And certainly, we had expected that with a slowdown in auto and aircraft production, it would slow. And it did from its more robust positions early in the year but has been relatively steady over the month of March and April and so far in May. And so I know that may be a surprise to some, but we've actually seen pretty steady demand on the alumina side for our caustic sales. So wide application of uses of caustic, but specifically to alumina, it's probably high teens in terms of the consumption of caustic relative to the other market syncs for caustic. But we've seen pretty steady demand on the alumina front, at least so far.

Steve, it's Bob. Could you talk a little bit about -- and then maybe we'll transition to olefins, where we'll have the same questions. But how the -- how important the export market is broadly to the PVC chain in North America into Westlake? And how that's changed over time? Any ramifications of that?

Sure. Well, it is an important market for the industry and certainly important for Westlake. Now because of our integration further downstream into vinyl building products, we do not export as much as some of our peers. If you go back to the -- to last decade, you can see that the industry was exporting probably 9%, 10% of its PVC. The onset of the shale boom caused the industry cost to come down because they're using natural gas to make power, and they're using that power to make chlorine. And they're using also ethane to make ethylene that goes into PVC. While we saw a pullback in domestic demand during the recession in '08 and '09, the onset of shale in the late portion of that decade caused the -- or provided the ability for exports to really move up substantially, between 30% to 40%, depending on what time period one is talking about. Today, the industry is still exporting significant amounts of PVC, in the mid-30s percent-wise. Westlake does not export quite that much because of our integration downstream into building products. We're the second largest producer of PVC pipes, second largest producer of large-diameter pipes, third largest producer of PVC siding and the largest producer of PVC fittings and the largest producer of PVC compounds that go into a wide variety of applications, auto cabling of all sorts. And so with that integration, it allows us to really service largely a domestic market in products downstream. And so we're not as reliant on the export market as others. We still export but probably half of the industry number.

Steve, at the beginning of the conversation, I guess shifting to Olefins here, at the beginning of conversation, you kind of mentioned LDPE has been -- or your autoclave technology has been a little bit more defensive than other types of polyethylene. Can you walk through kind of how you see that playing out, both in terms of pricing and in terms of volume as we look into the rest of the year?

Well, I think we're going to see volume remain pretty elevated. We certainly know that people are spending substantially more time at home than they've ever expected to and, as a consequence, they're going to grocery stores or going to take out. And a huge portion of that packaging material is flexible food packaging, which is low-density polyethylene and specifically the high-clarity form, which is the autoclave, which is autoclave of our LD is 80% of our low-density production, and low density is about 2/3 of our total polyethylene production. So it's a significant piece of our polyolefins business. We continue to see and, in conversations with our customers, continue to expect pretty solid demand through the rest of this year. We all hope we're not stuck at our homes for the rest of this year, but we, nevertheless, expect that the cautiousness of consumers naturally of making sure we've got enclosed containers for food and the various serving applications that you see in to-go orders and grocery store orders, we think, will continue to keep that market, from a volume perspective, pretty strong. And I think that speaks to the specialty end of the business that we service. Certainly, on the commodity side, I'm -- Dylan, I'm going to switch to you a little bit. On the commodity side of polyethylene in the linear low side, which goes into industrial stretch but also trash bags, we've also seen that show a fair amount of strength as well. So the linear low density, which is going into that white kitchen bag or that black trash bag, has also been a pretty firm market as well. As people consume more at home, they're also taking their trash out more often as well. So we've actually seen strength both in the low-density and the high-clarity form for food packaging but also in certain grades of that linear low or that trash can liner-type applications.

Got it. That's helpful. And I guess kind of looking at your feedstock falling, the decline in oil prices, when we look at ethane cracking for a month or 2 there and probably still now, naphtha cracking has become more advantaged. Propane is more advantaged than ethane cracking. Can you talk a little bit about your ability to kind of flex your cracker fleet? And how you kind of -- how that ability kind of compares to the rest of the industry?

Yes. So we -- and frankly, much of the North American industry moved over to an ethane feed slate. And I would say that probably only 10% or 12% of the North American market really has an ability to crack meaningful amounts of heavier feedstock. We've got an ability to crack a heavier feed slate in our Petro II ethylene cracker in Lake Charles, Louisiana. And if it were indicated on a sustained basis, we could think about cracking a heavier feed slate up in our plant up in Kentucky. It would require, in both cases, a change in logistics. In Kentucky, we have to rail or barge propane in. In the case of Lake Charles, we've got pipeline connections into the plant to crack propane. But as you know, we've got less production of ethylene when you're cracking a heavier feed slate. And as you heard me note, we're still using a lot of that ethylene in our polyethylene businesses. And while we've seen some demand pullback in PVC, the integrated margins still look attractive for us because we're a big buyer of ethylene still today in the North American market. We're the -- probably the second largest buyer of ethylene. And so when we think about the additional cost of just going to a heavier feed slate to capture that incremental margin, we look at the integrated margin, not only ethylene but also the integrated margin into PVC or into polyethylene. And certainly, we can also see that ethylene, because it's been long in this market, because of the new capacity adds by industry players, as we're a buyer of ethylene, we can also buy relatively inexpensive ethylene in the merchant market to fill our merchant purchases needs. So a variety of levers we can pull. We can think about going a little bit heavier with ethane/propane as a feedstock, but we can also think about how we move more into the merchant market and look to supplement that as need be, given the demand we have for ethylene as a very large buyer of ethylene in the merchant market.

Steve, it seems like that ethylene...

Bob, I was going to just -- yes, let me just -- I was going to say, and one other note to Dylan's question, one of the questions that we get asked too about the heavier feed slate is the ability to handle the heavy bottoms as a result of heavier cracking. And because of issues in the industry, TPC and others, to be able to handle those bottoms is going to be a challenge for many others. And so while on the screen it may appear to be advantaged to crack a heavier feed slate, I think, for many of the players, their inability to fully handle the heavy bottoms, the C4s and others, is actually more challenged for many others to be able to switch. We're able to handle that at our Petro II unit and at our Calvert unit. And so I think I'd just caution you about the ability to just necessarily be able to capture the full integrated economics because of the inability of some of the industry players to fully handle their heavy bottoms. I'm sorry, Bob, go ahead with your question.

No. And actually, Steve, there's a question that we've heard from some other players that the algorithms on naphtha cracking might look seductive. But if you can't stuff your butadiene anywhere, you're not going to be able to do it. So you mentioned you guys do have some flexibility. Where do you put that -- those by-products? And what is unique to your system that allows you to do that?

So Bob, we do have an ability at our Petro II unit to process those because we do have that flexibility that was designed into the Petro II unit. And of course, recall that our plant in Kentucky was originally a propane cracker. So we do have an ability to use those, co-crack those and to also put that into the market in that Midwest market. That's not necessarily true of everybody else who is actually using third parties to really rail that heavy bottom too because, as you know, we've had some industrial accidents at TPC and others that really pulled that processing capability off the market. And so they don't have in-house the ability to really process all those heavy bottoms. In our case, we've designed that into our plant. We do have some arrangements where we can merchant sell the final end product of those processing activities, both in Lake Charles and in Kentucky. But we're a much smaller player than others who might be able to do that, who had fully outsourced that versus in-sourced that.

Steve, a question here from our Q&A submission box. I guess, does the demand environment or shift in oil prices and feedstock vantage shifts kind of the weigh how you guys are looking at or thinking about potential asset drop-downs into the LP?

I think the market for ethylene has been strong enough that the crackers that we have -- remember, we're taking under a long-term contract the ethylene manufactured by Westlake's 3 ethylene plants. And so remember, we're a large merchant buyer, over 1 billion pounds, still today of ethylene. So that operation still remains pretty steady. And therefore, the offtake by the partnership of its pro rata share into Westlake's operations remains unchanged. The ability to continue to do drop-downs is a function of really making sure a transaction -- the partnership is accretive to both partnership and to Westlake Chemical. If you look across the space, we did what only a few were able to do, and that is maintain our distribution at the prior distribution level because of the stability, the incredible stability of the operating structure we have. That's not true necessarily of many of our peers in that midstream space who dramatically cut their distributions. In our case, our business model provides pretty steady income streams and able to maintain that distribution. To continue to run that model, we certainly have all 4 of those levers there. But certainly, we need a more normalized capital market, and we're just beginning to see that capital market kind of normalize. But we've got a little bit more time to go, on my judgment, before we get back to a more normalized capital market and valuations for all assets.

Yes. Steve, maybe dovetailing on that, Westlake is certainly highly regarded in its historic capital allocation. You guys have been pretty clever in asset purchases. You haven't built a bunch of new kit as some companies have. So a couple of questions around that. One, how long do you think until the market would -- margins would justify new investment? Are we going to see a stifling of incremental investment in the U.S. broadly? And then two, how opportunistic with your lean balance sheet could you be? Could you pull the trigger on something now? Or is there enough uncertainty in the world that you'd need to wait? And what would you look at?

So I think that the challenge for, I think, for industry players to figure out building out new facilities is really kind of what does the demand outlook look like. As I mentioned earlier, we had really very little investment made in PVC or even in chlor-alkali and just beginning to see the onset of a tighter market in February and January of this year. As we see some demand pullback, that certainly has loosened up the supply-demand balances. So I don't expect any new greenfield or even large brownfield plants come into the vinyls chain for a while until we see that supply-demand situation really tighten up. We've seen a number of investments made in ethylene and polyethylene, and we've got still 2 low-density plants yet to even come on. And I would expect they'll come on later this year. This is the facility at Formosa and Sasol. There are a couple still in the pipeline that are still underway and under construction. But I think, certainly, as we look forward, I think people are going to look really hard at the economics of the large capital investments they have to make and the variability of margins and the certainty around that variability to really be able to plunk down billions of dollars to make incremental capital. So I think that greenfield and brownfield are going to be looked at to a much closer lens as we march forward. From an opportunistic perspective, you're right, Bob, we've built out the business over time by either buying, building or debottlenecking facilities. And we continue to be very focused on opportunity sets. I think prior to the onset of COVID-19, we were of the view that prices have gotten -- expectations had gotten pretty elevated. We made a couple of acquisitions in '19, but we felt like that acquisition opportunities are a bit harder because people's elevated views of values. So we'll see how that works through over the next coming months or years. I think it's only been a few months that people have been working out of their kitchens, and I don't see that sellers' expectations have changed much, but they might. And so we continue to maintain all those dialogues that we're having before the onset of COVID, and we'll continue to look to see if there are opportunities to grow the business. But we're not going to jeopardize the business for an opportunity. But there is bandwidth to be able to do something that if it's accretive and attractive for us and if the valuations make sense. So we continue to look very hard and continue to look for opportunities. We're not going to jeopardize the business, of course. But certainly, there's bandwidth to do something if the opportunity presents itself. Bob, Dylan, are you still there?

Sorry, Steve, I was on mute. Still getting used to this. I guess one more -- one last question here before we kind of conclude things. When you -- kind of dovetailing off that last answer there, when you look at inorganic opportunities and you look at kind of your business set, can you go into a little bit more color in terms of areas of your business that you want to grow, both inorganically and organically, between your upstream business and your downstream building products business maybe, and also between vinyls and olefins? Kind of where you want to see most of the growth going forward?

Well, we've looked across the chain, both in our vinyls and olefins business, but we've also looked at downstream businesses. As I mentioned, we acquired 2 businesses in our downstream products businesses last year. We also look at what I would call a third leg, if you will, and that would be businesses that are adjacent to the vinyls and olefins businesses, where we could find synergies, similar skill sets and capabilities that we can apply. And so it's not looking only in the areas that we've historically invested, say, in '19. But if you look at the investments over the last, say, 5 years, we've invested in chemical businesses in Europe. We've invested in products businesses downstream just last year. So if you look across the spectrum over the last, say, 4, 5 years, we've invested in chemical businesses in the U.S., in Europe and downstream businesses in the U.S. and in Europe. So we continue to look across the spectrum and as well as looking at opportunities that could be adjacent to the 2 businesses that we're in. I don't want to end up being a portfolio of wide-ranging businesses where there's no synergies. So if we look at a third leg, they'd have to be closely aligned and have good synergies and capabilities to bring skill sets and know-how to the table that would be adjacent to our 2 existing segments.

Excellent, Steve. Unfortunately, that ends our time for today. Really appreciate you participating. Thanks to all the clients that logged in. And everyone, stay safe. Thanks.

Thank you very much. Stay well.