Westlake Corporation (WLK) Earnings Call Transcript & Summary

Hello, and good afternoon. I'm Laurence Alexander with the Jefferies chemicals team. Thank you very much for joining us with our discussion with Westlake. I don't believe, for most of you, Albert Chao and Steve Bender, will not need any introduction. So we're just going to dive right in.

Maybe just before I start with the questions I had in mind covered, Albert, are there any thoughts you want to give in terms of perspective on the lay of the land, given just the chaos? It feels like almost like week-by-week, the outlook changes.

Yes. Well, we are very fortunate. When we first went into it and not knowing what's going to happen, the sky is falling. So as you know, we took a precaution and draw down our line of credit. But as we go into it, many of our businesses are essential industries, and we want to thank really our colleagues who didn't stop a beat. 24/7 our plants run with a very few exceptions. When demand dropped, we did idle some lines, but we are surprised how quickly the market turned. I won't say it's a V-shaped recovery, but our products, polyethylene, LDP for packaging, food packaging, we'll talk a bit more later on, the demand showed up. And so that's great. And for our PVC, which is PVC resin and construction building materials, in the early part of January, February was doing very well. And then the pandemic hit and many local municipalities said construction was not essential industry, so everything stopped. That really hurt us badly from demand PVC as well as our building products. But as soon as the market, April, May-ish, [ people -- business that stopped ] started open up, pent-up demand because this is a conversion season. So everything that we make in construction is doing well, not only for single family or multi-family home, also in DIYs, people have more time staying home. They have more money on PPP money and they start fixing things up. So I think the demand is coming back when we talk about margins later on. But the issue now is whether there will be a second wave in October or earlier, we don't know with the flu season coming up. And also with the increase in infection rate started in June, July, we're seeing that in Texas and Louisiana. So far, we haven't seen a real impact on demand yet. And people still have to buy food from supermarkets and eat more at home. And people still want to finish construction, which is open doors, outdoors, so less impacted by the infections. But we hope that people wear masks, social distancing. Those are the 2 cures we have before we have vaccines. And hopefully, we can address the infection rate like Europe and Asia, even though they have -- they have a new wave of infection, but compared with the U.S., they are very, very small new wave, and we should do better. So that's my 2 bits.

And so maybe if we can start with kind of a very big-picture question. As you think about how Westlake was built through acquisitions over several cycles, where do you see sort of the direction and the opportunities in the -- over the next, say, 3 to 5 years? And are you looking for strengthening your upstream position? Do you want to shift the mix even more towards downstream businesses? Is there any sign that the gaps between the elevated multiples and sellers used to think they want to -- are starting to come down and adapt to this kind of new level of volatility? I mean how is the landscape? And what's the -- as you get opportunities presented to you over the next several years, what are you trying to do with the mix of the business?

Steve, do you want to answer the question?

Yes. And so when you think of, Laurence, the way the company has grown over time, it really has been through either organic growth and through acquisition growth and debottlenecking. And to your point, we've grown the business most recently over the last couple of years. In late '19, we invested, if you will, upstream and ethylene by investing in a joint venture that brought better integration by bringing in a little over 1 billion pounds of ethylene, 1.1 billion pounds. But at the same time, we invested downstream as well. We invested in a downstream PVC compounding business and a roofing business, a plastic roofing business that was really additive to our downstream products businesses. And so you see us in investing where -- really where we can find value in that chain and further integrate that chemical chain that we have. But it's all about looking for the right value, not just plugging holes, if you will, or connecting links in the chain. It's really finding an opportunity to do that in a value-additive way. It's easy to write a check. It's a lot harder to give the value. So our focus really is building out that integrated chain but only in a value-added way.

And then on PVC, can you flesh out what you're seeing in terms of demand? Particularly, do you have more leverage if housing starts and housing activity is more active in the suburbs than in the urban areas? Do you have a geographic preference if there is a recovery?

Certainly, as you know, the last few years, there's a move for people moving from the rural areas, urban areas, which means living in the cities or in apartments. And as a result of the multifamily units, typically, before the housing meltdowns, multifamily is about 15% of total residential construction. The number increased to 30%, it's came down a bit. But when you live in -- first of all, if you're a high rise in the city, you don't use any plastics, much at all. If you use apartment, multifamily dwellings, at best, you have 2 sides of units, your window -- you use less window, less sidings and older plastics and use less pipe for PVC. And footage, square footage, typical apartment, maybe 1,000, plus or minus 500. But in a single-family home today, I think U.S. average maybe is close to 2,000, plus or minus a bit. So you're doubling the size and you use more building materials. And now with people learn to work remotely, people don't have to live close to the city, and some people can work on a full-time mode basis. So they can afford to move further away, cheaper land, a bigger house, which means more and more plastic consumption. And this plastic is good because it's durable plastic. We're not disposing plastics in the waste pile, whether in our landfills or oceans. So I think this is a good use for plastics, and we are very much geared to supply more good plastic products into the building construction, both outside the house and inside the house.

And how are industry inventory levels, if -- given the strength of the housing market or how quickly it seems to be coming back? Should that ripple through to PVC? Are you still going to be an inventory work down mode for a few years?

Yes, inventory is very low. I think one of the publications, CDI said that inventory -- PVC now, the day of supply is down to 7.1 days, and this is the lowest level they've seen. And not only the U.S., on a global basis, because of the pent-up demand and the season and as well as mechanical problems of turnaround and also the oil price was low, so the Chinese coal-based without competitor. Demand for PVC is strong, very strong across the world. And of course, when the U.S. demand is so strong, we tend to export less, which drive export price even more. So right now, it's really -- that's why our industry, we have $0.03, $0.03 and $0.04; $0.03 price increased, $0.03 a pound in June. Industry now $0.03 for July, but one of the company sets the benchmark price, we get $0.02. But for August, industry was at $0.03. It went to $0.04 upon price increase and the same consulting company said, $0.02. So it's $0.07 to potentially $0.08 or $0.09 price increase coming up, yes.

And is there a -- given that the price increases are staggered over several months, do you see a sort of a bit of a prebuy happening before the price increases hit, and then kind of a seesaw shape for volume?

There's always the concern, but because such a low-level inventory, we really can't buy a lot in advance. But I'm sure there's some prebuying a little low. There's a price increase in a series. And also, the larger customers tend to have a delay in price increase, so we don't see the June -- big part of the June price increase happened in July and so forth, a 1-month delay in prices.

And it's been a while since I've seen sort of the trade press with very favorable comments about European construction. But it's been -- there's been quite a bit of that lately as well. How do you think about how the export market plays out? I mean is demand strong enough for the export pricing to move to levels we haven't seen in quite some time? Or is there a substitute material that can come in and prevent sort of start a little bit on the dynamics there?

We're not seeing the height of PVC resin yet by any stretch of imagination. Because when the oil price is high, PVC prices are quite high. So we're quite far away and the price dropped a lot because in March, April when demand dropped a lot, the price dropped tremendously, but export price was like $500-odd a ton, but now it's back to $750. And price in the past -- recent past was $800 -- over $800 and $900. So we're not near any time -- anywhere near the all-time high. But it's improving in the right direction. Europe, interesting, will produce both commodity-grade, the suspension PVC as well as the paste grade or specialty. The specialty goes into mostly nonconstruction, to autos, to -- some to the floor, PVC flooring and wallpaper and other applications, whereas the commodity PVC, the suspension-grade mostly into building construction. And during the pandemic, I think Europe recovered much earlier than the U.S. So the demand for suspension, commodity PVC was stronger than the specialty, which went into autos and other applications. So -- but we are seeing the demand now with auto industry coming back in Europe and we're seeing demand increasing. So Europe was also exporting some of the PVC. So I think globally, as I said earlier, our demand for PVC is quite strong, especially the construction grade of PVC.

And can we talk a little bit about the chlor-alkali cycle? I mean how do you see the balance between caustic and chlorine evolving as demand returns? Are there any inventory imbalances downstream that might delay the kind of sort of seesaw pattern that we see between the caustic and chlorine prices in an up-cycle?

Steve, would you like to answer the question?

In the quarter, when you think about it, it's been a very interesting dynamic during the course of the first half of the year. In the first half of the year, we really saw really strong demand, as Albert was outlining in PVC, which pulls on chlorine. But as people got into the stay-at-home orders, and we saw a constriction of exports into those markets, PVC and therefore, chlorine demand was somewhat restricted. So -- and because caustic demand is not a seasonal product, we actually saw pretty tightening markets in the caustic market. And you therefore saw price nominations move forward very quickly. As Albert was outlining, though, we've seen with the relaxation of the stay-at-home orders that we've seen a real pickup in PVC demand going into construction materials, which has pulled more on chlorine. And as a consequence, we have seen more supply come back in the market from a caustic perspective. So it's really been a very interesting dynamic over the course of a matter of just a few months to really see how that dynamic play. Caustic demand is not a seasonal product, whereas PVC is. It's built around the construction season. But as we see hopefully a return of the construction ban, that will -- and that will continue until we get closer into the winter in the Northern Hemisphere. Hopefully, we see the industrial side of the business pick back up and that will pull stronger on the caustic demand side. As I say, that tends not to be seasonal like PVC is. And so we look forward to seeing, if we get back on our feet as an industrial base and see coal is starting to pull on caustic.

And has the caustic side of the equation seen any swings in demand anywhere close to what we've seen this cycle? Or is this -- or is the industry really grappling with how to handle this? Like how far outside their experience is? I find that when industries haven't seen it before, mistakes get made with either storage or distribution? Or are you seeing anything like that happening?

Yes, I think as Steve said, caustic is less seasonal, but with COVID-19, it has seen some impact. But a big part of caustic goes to the alumina refining business for making aluminum. And when you have less aircraft construction, machinery, construction, auto, the aluminum demand has come down also, and hence, the caustic demand for alumina. Second part is paper, pulp and paper. Even though we are buying a lot of the Internet commerce and shipping carton boxes, but we don't go to the office or the schools, which consume a lot of paper, copying and the students. So even within the pulp and paper industry, some plants are shut down because lack of demand and some are doing quite well. So you have -- certainly, the soap and detergent, which is caustic, that's doing quite well. And refining business for acid neutralization and all that, the refinery come down. So -- and also caustic demand has suffered from COVID-19 impact but not for seasonality. But as people go back to work and refineries, that people drive more and come back, the demand comes back. So it's more of industry-specific impact rather than seasonal.

What are you -- now Westlake historically has run harder than the industry because of both the vertical integration in vinyls and the LDP demand dynamics, what is the typical spread in operating rates? And how much higher than the industry are you running now?

Steve, you want to try that?

Yes. Well, and it goes to really the chain integration that we talked about earlier. Looking, as we did earlier last year, we build out that integrated chain either with ethylene upstream or with our products, both in pipes, fittings and the other applications downstream. So you're right. With the ability to have a more integrated chain, we do have an ability to run an industry -- at rates higher than industry. While we don't get into the specifics of the function of which product, be it polyethylene or PVC, it's clear that the better integrated your chain is, the more you can spread that fixed cost over more pounds of production because you're running your plants at a better operating rate because you have a dedicated offtake in each stage of production. And that's very important in a business such as ours, where you really have a highly integrated chain. We've built out a lot of those links in that chain that allows us to, over a cycle, really be able to run at those higher rates. Spread that cost and allows us to really go into more channels of products as a consequence.

Is it fair to think of the gap as being probably 500 to 1,000 basis points as opposed to a couple of hundred?

It's in that order of magnitude, yes.

Thanks for your patience with me. How do you think about the key moving pieces for 2021 and 2022? And in particular like the pieces that you know about? And how should people think about how much flex remains in your capacity to take advantage of a stronger demand environment if one emerges?

Well, certainly, we are concerned about the single-use plastics and the consumer sentiment on the plastics waste, whether it's on land or in the ocean. And we don't know that the future, whether it's federal, state, city governments would enact various regulations. The various cities and maybe states had plastics ban going on, I think, starting end of the year or next year. Before COVID-19, then it's a moratorium because they find out the plastic is really good or something, which keep you safe and healthy. So it's really a plastic waste management issue. Plastic itself is very good. But what do you do with it? So the industry, we formed the AEPW, Alliance to End Plastic Waste, last year, and 40-odd companies globally are putting up a target, 1.5 billion and the Westlake is a member of it, to find ways to -- we either recycle them, dispose them properly and helping countries. I think there are some people saying that 90% of all the plastics in the ocean comes from 10 rivers around the world, 7 in Asia, 2 in Africa, 1 in South America. So even in Western world, Europe and U.S. has 0 plastics going to the ocean, the 90% will still be there. So I think we're working with developing countries well to help them to recycle, help the governments to have less plastic going to the ocean. So we are doing our part. But I think we're concerned is that the various governments, especially in the developed countries, will enact laws and regulations to either use less plastics or put a ban on it. So I think industry we have [indiscernible]. And we also -- that's more on the polyethylene side. Now there are 2 types of disposal. If we have a T-shirt bag here, all it does is just carry your stuff from supermarket to your home and throw it away. But in LDPE, with a larger polyethylene end use is that it's packaging. So we can have a box, a can or a jar. They can sit on the shelf for months and -- or refrigerated freezer bags in freezer for months and it's not a single-use disposable for 5 minutes or half an hour. It's for months and months, keep the food fresh. So hopefully, people don't think as a disposable, even though it is. Eventually, you'll dispose it. On the PVC side, luckily, it's all durable. We want to use as long as we can for sidings, flooring, wallpaper, pipe and -- but still there -- we are using all our imposed industrial waste that we generate in our plants. We recycle all of them. And we'll take back. We have a cradle-to-grave. We'll take back anybody who takes our products back to us. We'll use them and chop them up and use it again. So that's the benefit. And we expect that if interest rates continue to stay low with the pent-up demand, the 50 new residential units, the single-family, multifamily, average by 1.5 million units. And after the housing meltdown in '08, went from 2.3 million down to 400,000 units, 80% drop. And now we're back to 1.2 million after 12 years. But we're still below the 50 every 1.5 million. So I think that a lot of pent-up demand and now people moving into suburb or exurbs, even outside of suburbs, bigger housing and all that, I think consumption will be increasing. And so we -- hopefully, we can play a big part in the area.

And just in that vein, as you look at -- I mean there's quite a lot more discussion about recycling versus molecular recycling versus contamination issues with respect to additives and so forth. Where does PVC fit on that spectrum in terms of how easy is it to break down, and how easy is it to reuse for [ another without contamination being the problem there ]?

One thing good about PVC is that it does not -- we don't use it for food packaging or anything [ what will bring ] contamination. So where if I have PVC siding, only have is the pigments, right? And the rest, you can chop it, again pipe same thing what window brings. So what we could do is put in the middle of the substrate so we can have a nice clean white or whatever color you want. On one side, you can put the backside being the reclaimed material, different color, or you want to make it look better, which have both sides, A, B in the middle is the reclaimed material, and A, the A inside, A outside looks virgin material. [ I've seen that like ABA ] type. So I think PVC is very -- and its applications are very suitable for recycled materials.

And what's the -- as you look at your geographic footprint, what's the degree of appetite for expansion outside the U.S.?

Well, Steve, want to comment on that?

Yes. And so our focus really in those investments we've made. Let's say, in Europe, as an example, are really focused in areas that bring either a value-added product or technology. So if you look at our example just last year with an investment in NAKAN, a PVC compounder, it brings a really unique set of technology to bear, allows us to also penetrate markets that we're previously not in. So a good example would be in the medical applications business. Those compound resins go into a wide range of industries, many of which we were not servicing already, be it auto, medical and many others. So it really is looking at an ability to go into a unique product technology to tap different markets that we're not currently in. So our focus is not so much geographic-based as it is so much looking at the product that it's going to serve the customer base or bringing a technology to bear that allows us to penetrate market with, frankly, better margins with -- if you find some of these specialty products. And that was the entry point to go into our European operation in 2014, which as Albert said, is kind of a specialty business and that kind of paste are emotion-based product or even the investment we made last year, which is this NAKAN PVC compounding business with operations in Europe and Asia and in North America.

And on the European side, how does -- how is -- how are Westlake's business operations position with respect to the new green deal and the broader push to decarbonize the economy?

Yes. The Vinnolit operation, we have over 1,000 employees primarily in Germany, and we are the largest, as Steve mentioned, the specialty as paste resin and specialty suspension, our largest manufacturer in the world. And technology is helping us in the U.S. and globally, [ where we licensed technology ] to other people around the world. And as you know, Europe, they're very conscious of sustainability. And I think we are -- Vinnolit is, we see, the gold standard, right, Steve, for reaching the most -- highest level of sustainability. So there's a lot of recycling in Europe. You mentioned about recycling and additives, Europeans. In Germany, PVC considers it green plastics because a huge amount -- I think 10% of all the PVC produced is recycled. Primarily from old buildings, we have -- we don't have PVC siding, but PVC windows. And they're taking the -- knock the old building down, take the PVC window. We use them again in various applications and put it back again.

And are the returns on recycling attractive enough for Westlake to invest in that area directly? Or is it something where it's better to handle that than someone else to handle that?

Yes. Westlake -- as I said earlier, we used a lot of post-industrial. We haven't gotten in the post-consumer, and there are various company in the U.S. and around the world in a post-consumer. The problem is government unless there's subsidy with the virgin material being so inexpensive with lower-priced hydrocarbons and capacity expansion we have that it's difficult to take post-consumer, clean them up and recycle them and then sell to compete with plastic virgin materials. So a lot of these recycling association companies, I think, are losing money, when shutting the plant down. So I think from an economic sense, it takes government subsidy to help them. I think -- my feeling is that it will come. Government will track whatever the consumers or the producers use the money to help recyclers. So that's good. I think we do need to solve the problem.

Yes. And it seems like each downturn -- curious within a kind of a lesson or kind of an impulse for the industry. Back in the late '90s, I think everybody switched to a more balanced global footprint. The energy shock, everybody was looking at security of supply. Then it was balance sheet and access to lines of credit. What do you see for Westlake as being sort of the key impulse where it might take 2, 3, 5 years to fix, but you need to fix some things that where vulnerabilities were exposed that you didn't expect?

Well, I think just from an industry perspective, the waste management issue for post-consumer is a big issue for single-use, primarily polyethylene and polypropylene, the polyolefins segment. And I believe with all the industrial scientists we have and business people will find a solution. It may take time. I said, it may take government help as well. On the vinyl side that it really serves a good purpose. I don't think there's a lot of other materials that can -- in a low cost way, provide cheap housing, good housing and clean water and sewer to the people and maybe 1/3 of the people in the world don't have a clean water. So I think we serve a good purpose. And with the U.S. feedstock advantage, we are able to provide low-cost material for the world. Having said that, I think the COVID-19 may come out with different megatrends and we're looking at it. So certainly potentially is the migration from urban area to suburban or exurb area definitely change the lifestyle. And certainly in the medical side, health care industry, could not be this pharma, per se, but the health care industry, as Steve mentioned, we provide plastic compound for the health care, blood bags, blood tubes, machineries for, what do you call it, plastic machines. [indiscernible]. So a lot of these things, I think, people really appreciate having a robust infrastructure for health care. And I think in the U.S., we find out we are not as good as European countries in terms of hospital beds and training and PPEs. Most of the PPEs are made overseas, probably onshore more likely. So we are looking at a megatrend and see what else Westlake can do to serve consumers and economy in general.

Okay. Great. And I think that's it. I think we're coming up on the half hour. So thank you very much for the chat today. And again, thank you, everybody, for listening in. Just -- thank you.

Wish everybody keep safe, and we'll do more of these virtual meetings. Laurence, thank you very much. Thank you. Take care.

Thank you very much. Thank you, all.

Thank you.

Thank you.