Westlake Corporation (WLK) Earnings Call Transcript & Summary

Good afternoon. My name is David Begleiter of Deutsche Bank's U.S. Chemicals Equity Research team. Thanks for joining us for Deutsche Bank's Virtual Global, Industrials and Materials Summit. I'm very pleased to have with us today the team from Westlake Chemical, President and CEO, Albert Chao; and Executive Vice President and CFO, Steve Bender. The format of today's session is a fireside chat. [Operator Instructions] Albert, Steve, good afternoon. How are you guys doing?

Well, thank you.

Thank you. And thank you, ladies and gentlemen, for joining this virtual meeting. I hope they're used to it.

Perfect. So Albert, first on caustic, there has been a rebound in caustic pricing with 3 straight months of price increases. Looks like roughly 1/3 of the $175 per ton of renounced price increases have been implemented. Can you talk about the market tightness that has driven this rebound in caustic prices?

Sure. I think it's interesting that it takes -- every part of chlorine you produce, it produce 1.1 pound of caustic. So they are -- they come together with chlor-alkali production. And as you know that with COVID-19 started in March, the impact was on second half of March, some of the construction industry were shut down by local government regulations. And hence, the demand for PVC dropped and hence demand for chlorine dropped. And about 50% or so of the chlorine in the U.S. goes to PVC. So that's a major impact. When you reduce chlorine production, you also reduce caustic production and the caustic demand is much more broader than concentrated in the industry. With pulp and paper, soap all kind of applications. So the demand didn't drop as fast. So actually, IHS reported in March, caustic price already boost up because caustic was tight and there were turnaround going on in the first quarter as well as reduced production. So caustic was under sales allocation by many producers in the U.S. So IHS reported caustic went up by $5 in March, $20 in April, May, $35. And then, David, I talked about this $60 increase and this pend quoting for June, the $15 increase for June. So total $75. And as, David, I alluded to industry, we have announced a total of $175. So this is only a portion of it. So your question is going forward, what's going to happen? Well, as you know, that the market has reopened in the U.S. and construction is allowed to go back and there's a pent-up demand. Second quarter and third quarter typically are the strong season for construction in the U.S. because of the weather. And -- so demand has come back as well as export markets through countries like China or India, especially India, the big importer of the U.S. products. And they were shut down over months in places like Turkey and elsewhere that shut down. They're opening up. So demand for export has also increased. So with the increased demand for PVC, there's more production of caustic. And the expectation is that caustic will be more than enough supply to demand and a profit price should soften. So IHS is looking at starting in August, that price will come down and kind of use up some of the price increases that we have enjoyed earlier on this year. That depends because the caustic price, export price really has moved from the bottom back in March, April. And now has come up a fair amount. So I think it's a combination of the GDP recovery globally because caustic follows more the GDP. And we all know that for the whole year, I think, the global GDP probably will still go down. U.S. is an estimate to go down about 6%, Europe about the same. And -- but second quarter is the worst. I think people estimate between 30%, 40% GDP drop. But it could bounce back in third and fourth quarter. So when GDP bounces back, demand comes back. They could have also increased demand for caustic. So time will tell whether we'll have the price drops in the second half of the year, not in caustic. Steve, do you want to speak on that.

No. Well-covered.

Albert, just on caustic demand in June versus May, is it -- are we seeing a pickup in demand here?

Yes. I think demand is quite good. As I said, industry is coming back and product demand is coming back. And we're seeing inventory, the caustic inventory, it's about average. It's not a high side, it's not a low side. So it's not enough. As I said, some plans turn around going around the world. And by the way, the caustic prices in Europe is going up also. In China it's going up. And typically, domestic prices in each country are higher than export price. So we are seeing domestic prices in all these countries going up, even though Asia export price is still low, but it's a very small volume, that's been traded in Asia on caustic.

Albert, you mentioned that the rebound in the export markets, I read the export prices are up more than -- almost 90% since the beginning of February. Why are those prices increased so much more than, obviously, U.S. prices -- domestic prices?

Well, U.S. pricing drop as much as Asia price or export price when people shut down countries, big importer country shutdown there is excess capacity, not only here but around the world. So export price is always more volatile than domestic price. And that's true with the U.S. as well.

And we did see that cost of dropping rates and chlorine rates dropped from roughly about 90% in March to 70% in April. What are your rates compared to the industry? Are they roughly the same or better or worse?

Yes. I think our polymer business is because we have downstream in vinyl for example, but we tend to do better than the industry average and polyethylene wise, we have LDPE, and that tends to do better. We have the autoclave much more specialty among the LDPE. So we tend to do better. But I think, generally speaking, because of -- while internal consumption of PVC, our chlor-alkali production tends to be better than industry average. And -- but we also have to sell the caustic. So even though PVC wise, will use more than the industry average, we had to sell the caustic. So generally speaking, we tend to operate at higher rates than industry average.

Understood. And last thing you did mention, obviously, IHS is forecasting caustic price to decline in August on the back of increased PVC demand, which will obviously increase chlorine production. Why wouldn't this happen? Obviously, I guess, it is the only upside, potentially a very strong rebound in the economy that would preclude this natural balancing to occur.

Yes. I think, as you know, there's seasonality in the chlorine caustic business each year. In summertime, generally, because demand -- the supply are together, but the demand is different. So the second -- third quarter, typically, PVC demand is strong. There's more caustic production and caustic price tends to go down. The winter time, less construction, less PVC demand globally, Northern Hemisphere. The less caustic production and caustic price tends to go up. So that's more seasonal. But the GDP, where there's a big move in GDP, both up and down, that also gives you more of a secular impact on the -- on caustic price and availability.

Very good. Maybe switching now to PVC, Albert and Steve. PVC was hit pretty hard by the COVID-19 pandemic. And we're now starting to see a rebound PVC demand, construction activity and housing pickup. Can you discuss this increase in PVC demand, what you were seeing in June versus the weak results in April and May?

Sure. Steve, do you want to take that?

Yes. And so Dave, good question. If you think about April and May, we certainly had strength earlier in the year back in January and February. And you're right, because of some of the weakness we saw, on the demand side, given everyone was staying at home and many states and municipalities didn't permit construction to proceed. We saw some weakness in pricing in both April and May. But now that we begin to see many jurisdictions beginning to open up their markets and construction markets showing even more strength, there's a price increase that we're seeing for both June and announced for July, $0.03 in each case. So we've seen certainly in the Midwest and in the Sunbelt, construction all throughout this COVID-19 period, where the stay-at-home orders were probably more stringent in other parts in the Northeast and the Far West. And so demand for not only resin but for some of those downstream products remain pretty strong, and you're seeing that with the price action that we've seen announced by industry players for June and for July.

And Steve, how do you see construction and how is demand recovering through '20 and into '21 here?

Well, as we started the year, we actually saw strength at the tail end of 2019 in the construction markets, and that was really carrying over into January and February before COVID-19 really kind of landed here in the U.S., and really caused a lot of that activity to really slow. But we -- as I mentioned, we did see in those states that were permitted to operate during this stay-at-home order, as I say, largely in the Midwest and the Sunbelt states. We continue to see really strong demand in our pipes, our fittings, our exterior siding businesses. And even some of our compound business going into medical applications here in wire and cabling. So as we start seeing many states begin to move back to normal operations, beginning to loosen up those stay-at-home orders, we do continue to believe we'll see strength in that market as we earlier did earlier in the year before COVID-19 hit. There is clearly an underlying demand in that construction markets that we saw before all this came. And I think given the proximity of so many people living in major cities that we're seeing signs that maybe people more willing and desiring to work outside in suburban areas and not be in so highly concentrated areas, and that could continue to drive construction and housing well into '21 and beyond.

Very, very fair and accurate.

I think I want to add one more thing. As I'm sure you heard us talking about it. The U.S., 50-year residential construction, 50-year average, 1.5 million units. That's including single and multi-families. Before the housing meltdown in '08, I think, '06, '07, the peak was 2.3 million units. Then '08 drop to 400,000. So from '08 until 2019, 11 years it took -- it came gradually from 400,000 to 1.2 million, 1.3 million units, and people are trying to get back to the 1.5 million units, whether this year or next year. But with COVID-19, that kind of slowed down a bit. So going forward, the goal is still the demand -- pent-up demand is still there with low interest rate. And as Steve mentioned. If people who have children living in urban areas in high-rise or multi-families, they may want to think about moving to the suburbs where they have yards for kids running around and isolation from the neighbors. And with more working from home, people can afford to buy bigger houses further away from the cities. So all that, I think single-family homes use much more plastics materials, PVC construction than in the urban areas. High-rise, you don't need much PVC. But single-family homes, you need windows, sidings, doors, deck and fence and pipe. So the demand for PVC for each single-family unit is much higher in homes than in high-rise apartments. So all that will drive more demand PVC on a longer-term basis.

Sounds bullish, obviously. So just nearer term, Albert, how are inventories in PVC? How much was run down during those April and May time periods?

Yes. Actually, PVC inventory is quite low producer level because people have cut down production because of the COVID-19. And now we have to ramp up production and as well as turnarounds going on. So PVC is pretty tight actually.

And are we seeing export sales begin to recover here?

Yes. Export volume, as mentioned before, countries like India is opening up, Turkey. These are big markets. Even China, the importing ethylene base. And China is the biggest capacity PVC, about 80% is coal-based. And coal has not been competitive, nonintegrated guys in China, compared with ethylene-based because ethylene, as oil price dropped so much, ethylene price -- ethylene tops the component of PVC. So the Chinese importing PVC from overseas. So we are seeing export price also improving from the low in March and April.

And Albert you mentioned the $0.03 price increases for June, July. It would seem, given what's happened to ethylene costs -- ethylene prices and ethane costs, there'll be strong support for -- at least a portion of those price increases, I'm not asking you to opine them, but it seems there's good momentum in the market for higher prices. Is that accurate?

Yes. I think not only that is that we are seeing the downstream in the pipe, sidings -- the downstream industry, the customers for PVC, they all announced price increases. So it's not people are trying to fight the price increase, they are passing the price increase to the customers. And -- but anyway, so we have outlook for PVC. The second half of the year, is somewhat getting stronger. I think IHS is looking at $0.02 a pipe, pumps, they have 0 for June, but $0.02 in July and CDI seems flat until, I think, November. So time will tell how much of the price increases. But we believe strongly, at least the June 1 price increase will stick.

Right. And just remind us again on China, how important is China for U.S. PVC export sales?

Not very much. China is a big producer themselves, and there was antidumping duty in China. And there was a tariff war with the U.S. and China. So really, U.S. did not export much in China at all. But I think it was October last year that China opened up with PVC and then U.S. started export to China. They did away with antidumping duty. And so who knows whether U.S. will enter into a war with China again on tariffs. But China was never a big importer of PVC. They are more exporter of PVC.

And how do structurally lower oil price impact the competitiveness of U.S. PVC exports?

Sure. It's quite important. As you know, half of the PVC is ethylene that have 100% of polyethylene. So PVC, ethylene price movements, has a bearing on PVC price. And as oil price dropped a lot in overseas, Europe, for example, their costs went down a lot and the PVC price went down because the ethylene was down. But now with the naphtha price, oil price going up and ethylene cash cost is much higher now in the U.S., in Europe and Asia from naphtha than U.S. on ethylene based. So we gain advantage, not as much as pre-COVID days, but it's becoming fairly substantial now.

Albert, you mentioned PVC production in China. What is the future of that -- of the carbide-based PVC capacity in China?

That's a good question. Carbide based, the first was more polluting. And two, it is used a lot of power in China as -- it's a lot of power because they use coal to generate power and use coal to -- with electricity to make calcium carbide and it all soots because of the process. They then dispose of soot, which goes with -- combined with concrete. And it's not good because those soots could be carcinogenic. And then they use mercury catalysts to make VCM from the acetylene and HCL. And because of the ban on mercury usage, China has stopped issuing any permits for new PVC capacity expansions. So there's a hold on any new PVC construction in China. But they have existing capacity and they're not running at full rate. But as I said, some of them are integrated back to coal, so they are more cost competitive. Some of them are buying carbide from coal companies and those purchase can be expensive. So some of the less competitive, non-integrated ones are running at low rate, so some have shut down because of high-cost, losing money.

So given this, what's the outlook for longer-term supply-demand fundamentals in PVC?

Yes. So I think. U.S. -- primarily U.S. has expanded -- we have expanded capacity. I think 3 of our competitors has also expanded capacity. But in the scheme of things from a global growth point of view, it follows the GDP, then there's a shortage of PVC going forward.

Understood. Albert, can you talk about building products -- can you talk about the role of this business in the portfolio, obviously, it pulls in PVC. But how important is it to your overall vinyl franchise?

Sure, Steve, do you want to comment on that?

Yes. It's actually a very important element in a variety of different ways. If you think about the integration model that Westlake has, it's very important because it allows us to really extend that integration model, not only into the feedstocks of chlorine and ethylene, but all the way through PVC resin, all the way into products. So it allows us the ability to capture the margin because, as you know, David, the margin moves back and forth across the chain over the course of a business cycle. And since we occupy a huge portion of that chain at each stage of production, we have the ability to capture that margin. Importantly, also, as I mentioned, we have an ability to really pull a large portion of our resin through into those products. That allows us really to have an ability to keep those operating rates higher than industry average because we have a dedicated offtake at each stage of production. That allows us to spread that fixed cost over more pounds of production and allows us a lower average cost per pound than some of our peers who don't have the same degree of product integration. As we mentioned earlier in our comments and questions, we saw strength in the construction markets, even during some of this COVID-19 stay-at-home order, and it allowed us, therefore, to keep a higher level of operating of those chemical plants that are upstream because of the pull of those products, pipes, fittings and siding further downstream. So it proved, I think, an important benefit versus those who don't have the degree of integration. So you can see a variety of benefits by being integrated into those products downstream.

That kind of -- that's a great segue to my last question on really chlor-alkali. IHS forecasts pretty sharp downturns in ECU margins in '20 and '21. But given your integration, how do you -- should your profitability in Vinyls segment be far less sensitive or volatile than the ECU margin forecast put out by IHS?

Yes. I think the fact that we integrated PVC, that we do absorb the margin and down to the building products, whereas if you are in a chlor-alkali business without PVC, and rely really on your customers' usage. If their consumption goes down, then you have to reduce production. So from that sense, I think, Steve mentioned about integration, that is really a benefit for us.

Very good. Maybe switching to the ethylene polyethylene chain. It looks like the U.S. policy market is turning. I think earlier in the quarter, you had CIMdata and IHS calling for PE prices to fall $0.07 to $0.10 a pound in Q2. Now there's a chance that price could be flat in the quarter. So what really changed in the market? And why do the consultants get it so wrong this time?

Well, consultants aren't wrong, you just your comment is based on the information you have at that time. And as you know, that oil went negative in the first time in the history of mankind probably, that $40 negative. And so we made the overseas naphtha-based ethylene cracker much less competitive or the cash cost was negative also, where we had to pay ethane, high cost, ethane, all that. So people said, "Gee, if export price dropped by $0.10 a pound, we should have the same domestic price drop, but to do it over 2 or 3 months. So they are being generous. So we had a $0.04 pound price drop in April, we had actually what $0.04 a pound price increase in January and $0.02, I think was in February. But we gave back the $0.04 in April and it's supposed to be another $0.03 in May and $0.03 in June. But what happened was, first of all, the demand for polyethylene, especially LDPE, which goes a lot into food packaging, consumer product packaging is very strong. And two, oil prices start moving up. And three, ethane prices are moving up because of the reduction in associated gas production from reduced oil production. So then, rather than having price reductions, I think, May price was flat, and the industry saw the demand, not only in U.S., but globally, it was strong. And so we announced price increase $0.04 in June and $0.04 in July. So we believe there's a strong reason for price increase in June. So time will tell when June is over, but we believe that, again, downstream prices are moving up. Demand is strong. So we believe that's a good reason for price to go up in June. And I guess the CDI and these guys are looking at really flat prices all the way from May, all the way until October, and CDI is [ forecasting ] $0.03 price increase in October. Whereas IHS was looking at, I don't know, the latest or not. They were looking at $0.04 a pound price increase in June and then flat until October and the price going down in October. So I don't know whether they changed the forecast or not. But May, they thought it would be negative $0.02, but really May was flat. And the price increase in our industry for June. And I think IHS is putting the $0.04 in June as well. So -- and I think inventory wise for industry, that I think some of those consultants reported that day sales inventory has come down for all 3 categories of polyethylene, so which means some people have reduced production to reduce inventory, but also sales has been pretty strong. So we grow inventory and high cost and high demand so the price increase, we believe, is justified.

And how important was the opening of export markets back in May to this recovery in the polyethylene market?

Yes. I think it's important. China is probably the world's largest importer of polyethylene. I think about 40% of Chinese needs are imported. And when they open -- when the economy -- China is the first country, first major country that opened up the economy after the COVID-19, and the demand for packaging and polyethylene has increased, and so they start importing products. So that helped the U.S. because of the capacity expansion we had in the last several years. U.S. exports approximately 40% of its own polyethylene production. So export market is very important, and China is the biggest export market globally for import market or export designation for polyethylene. So the fact that China is back and buying -- it's important for the U.S. PE business.

Very good. Albert switching to ethane, they've been quite volatile. They've more than doubled from the lows of late March. Where do you think ethane prices should trade at or will trade on an absolute and relative basis? And relative basis, meaning, of course, relative to their fuel value going forward?

Sure. As I said, before COVID-19, it was about 1 million barrels a day of ethane being rejected. And ethane was very cheap, and the frac spread between natural gas and ethane was almost 0, it went down negative a little bit, but $0.05 to $0.00 per gallon. With COVID-19 and with the Russian-Saudi war, supply increase in oil globally and then with COVID-19 demand drop. So the U.S. start reducing oil production and hence, the associated gas production went down. And hence, there's less ethane available. But because of the million barrels a day of ethane rejected, they had to get ethane from other places coming to the consumer areas through the Gulf Coast. So there were some transportation costs that involved, hence the price went up. But now since oil price has increased, people are finding ways to get ethane to the Gulf Coast. Ethane demand has come down. We mentioned that polyethylene is strong, but many other ethylene derivatives that goes into automotive and other areas have not been strong. So if you're on the ethylene production operating rates with all the new ethylene plants, some of them are merchant ethylene sellers downstream is not running yet. So the ethylene operating rates come down, which means they use less ethane. And also that ethane naphtha being cheaper, the overseas countries were importing U.S.-based ethane in those large ethane carriers. Many of those shipments are canceled or converted to propane shipping rather than ethane shipping. So really demand for ethane has come down a lot as well. So now with increased oil production, people are going back to fracking as oil price moved up. We believe that a supply of ethane and logistic wise will help. So we believe that ethane price should trend downwards. And if you watch the future price for ethane and future price ethane also is trending downwards. So we believe that's the trend in the future. If it's flat, the effects of ethylene gas and ethane will come closer.

And Albert, given that the U.S. cost advantage became a disadvantage for April and May, based on IHS data. It looks like it will be restored, given the rise in Brent to the low $40s and ethane maybe coming off its highs. Do you think the U.S. will maintain an advantage cost position going forward from a global ethylene perspective?

Yes. Based on the future prices of crude oil and future price of ethane, we were -- in the first quarter conference call, we mentioned that by the end of the year, we believe we'll regain the ethane advantage. Well, we already have an ethane advantage now. And -- but it's not as big as before. And as we -- I think looking forward to the end of the year, next year, the ethane advantage should improve better. So again, barring unknown how COVID will turn, will there be a second wave and global demand, oil price and what OPEC would do after July. All that are unknowns, which impact oil price, which will impact global chemical prices or petrochemical prices, all that's out there unknown and also U.S. drilling. But based on what we know so far, based on what consultants are looking at and the future prices, again, we must -- when the consultant looked at -- with the March, April, were they wrong? No, I think they're looking at -- based on information they had at the time. And now things have changed. We're looking at information we have at this time. That's all we can do and it's based on what we know today that makes an educated guess, but -- yes. Maybe Steve will talk about, we believe the economy is more -- somewhat or V-shaped. We were a little surprised at the recovery and all the central banks and Steve, will talk about it just the general view of things.

Yes. I mean, I think as Albert was saying, we've seen really a strength come back. And I think with all the stimulus we've seen from not only the U.S. government, and its Federal banks, but also around the world and other governments. We've actually seen a pretty strong recovery compared to what many were thinking of back in February or March. So I think as I see is a driver for that, going back to the construction markets that we were touching upon. Pretty good strength in the construction markets, and we know that's a big multiplier for GDP growth. So we remain relatively constructive as we look forward into the rest of the year.

Yes, And we also paid down our revolver, which we drew down revolver, not knowing how things are bad, the financial markets and all that we go and have a better view, we're more comfortable now we pay back revolver last week or something. And we just priced our bonds today and to refinance our bonds coming due high-yield -- high interest rate coupon rate bonds due in the second half of this year. So we're just priced to refinance at a lower rate.

Great. And last couple of questions from my end. Just Albert, you showed about 1.1 billion pounds of ethylene. What's your strategy with this? Do you intend to be short ethylene going forward?

Yes. Well, ethylene, the spot price is still pretty low today, and we are enjoying net consistent with net bioethylene, actually low ethylene prices are good for us. But ethylene is a big component for vinyls, 50%. And one of our slide shows that over the cycle of 10 years, for example, that the margin on the vinyls chain going from chlorine ethylene to PVC, 90% is in the upstream in the ethylene and chlor-alkali side. So we do want to narrow the gap on the right time. And this last year, acquired the -- our interest in LACC joint venture with Lotte. And with new plants, they can certainly be debottlenecked if we want to. So that's something that we could at a lower replacement cost basis, debottleneck our plant and produce more ethylene. But right now, we're enjoying the low ethylene prices.

Maybe last question given the time. Westlake Chemical Partners, is it -- does it still play as important a role in the portfolio as it did or will going forward?

Dave, I think the question is the arbitrage value remains. The issue is being able to act on that arbitrage, and that's a function of the capital flows into the space. Our needs for capital in that space are relatively small. And so as we think about potential partnership transactions over the next number of years, the amount of capital needed is relatively modest. In this space, I think, is one if there's a multiple arbitrage, we'll act on it as long as there's capital flows into that space.

Very good. And I'm going to squeeze one last in. Albert, you've always been a very patient buyer of assets, especially at the bottom of the cycle. Does this bottom of the cycle interest you again to be potentially a buyer of assets?

Well, certainly, we look at all opportunities in our space. Before COVID-19, there were a few of potential transactions, and people have generally pretty high expectations for pricing. I don't know, depending on how long the COVID-19 issue impacting our industry. And so far, there's no distressed sellers. And depending on how long it goes and what people's views are, prices may have -- may come down in the future. So we don't know yet where things are. And there's very few transactions right now going on.

Excellent. With that, our time is up. Albert, Steve, thank you very much, and thank you, everybody else for coming, for joining us on the webcast. Have a great day.

Thank you very much, Dave.

Thank you, David, and thank you ladies and gentlemen for your interest in Westlake. Have a good day, and take care.