Westlake Corporation (WLK) Earnings Call Transcript & Summary

Okay. Good afternoon, everyone. This is Mike Sison. I apologize for delay. We had a couple of technical difficulties here in Cleveland. I cover chemicals for Wells Fargo. I do want to introduce Westlake Chemical, which is having a strong start to '21. Stock is up 25% year-to-date versus the S&P 500 up 11%. I had a longer opening, but I'm just going to introduce Albert Chao here, CEO; as well as Steve Bender, CFO. And we can just go right into some questions here.

Albert, I guess, initially, I wanted to maybe spend a little bit of time on how Westlake fits in the world of commodity chemicals and talk a little bit about your vertical integration strategy in the vinyls and olefins and how that creates value for shareholders.

Sure. I think close to 80% of Westlake's business is vinyl-related, which is mainly PVC, caustic and building products; and then 20% is olefins business is polyethylene, styrene and some co-products from ethylene production. So we are one of the most very integrated vinyl producer from low-cost ethane U.S. feedstock to ethylene, and then we have our own salt mine, we have our own cogen that produces about 1,000 megawatts of power for our chlor-alkali business. And we have -- many of our plants have salt domes ourselves. So from salt, natural gas we purchase, to power and the chlorine combined with ethylene to produce PVC. And then we go downstream. We're [ being ] #2 in PVC pipe in North America for water and sewer as well as for inside of homes. We also produce fittings, one of the biggest fitting producer for pipe. And we're also #3 in siding in North America, #1 in treatment and coating, interior, specialty roofing composite for making plastic tiles.

I think we might have lost him, Steve.

We might have lost his audio. Go ahead, Mike.

Yes. I guess, why don't we move on to just sort of the follow-up question was really to focus on your olefins business. You're a little bit different than your peers. You do LDPE and LLDPE. Why does that business hold a little bit better margins? And kind of maybe walk through some of the improvements that you saw in the first quarter and demand throughout the pandemic.

Sure. Well, the low-density polyethylene, or LDPE, really has got 2 technologies, and we're actually a very large player in the Americas with the specialty end of that low-density polyethylene. It's called the autoclave technology. And that autoclave technology has got a large number of grades or over 100 grades. And what that does is it actually provides the properties and the characteristics that our customers want, which gives us a high degree of clarity. And because of that, we get, frankly, an application into packaging, and this is the coating on all kinds of container packages, such as the -- whether it's potato chip bags or juice boxes, which allow them to be airtight and water tight. Because of those properties and the specialty nature of that application, it brings a higher margin, much more so than the more commodity grades of low-density in the, what we call, tubular technology or even the linear low, which you see oftentimes in the form of industrial stretch for trash and waste bags. So our focus really is on the more specialty end of polyethylene, specifically in the autoclave technology going into those various applications, brings us a better margin.

Right. And in the first quarter, your EBITDA doubled, your EBITDA margins at 40%, pretty impressive. I think the last time we saw margins there were in that 2017 timeframe. Can you talk about demand in '21 for your polyethylene, your olefins polyethylene business? What type of growth you're going to see and how sustainable you think those margins could be as the year unfolds?

Well, again -- I see Albert has joined us. But I think when you get the strong demand picture that we've really seen really going all the way back to middle of last year, back in June is really when we saw demand rebound. And of course, everyone has had packages delivered to their doorstep, and those packages are either cardboard packages or plastic packages or other cardboard packages, they have these plastic pillows, oftentimes in the side for cushioning. And so the packaging demand that we've seen has been very strong, not only in North America but worldwide. And given the growth that we've seen in demand across all markets, we've seen that polyethylene demand has been quite strong. And typically, polyethylene demand is a multiple GDP as we think about 2021. 2021's global GDP is just slightly above 6% at 6.2%. And when you think about the historic multiple of polyethylene demand relative to GDP, it's about 1.5x. And so even though we've got new capacity as an industry coming into both North America and Asia, the ability to really absorb that has been quite clear. So we've seen strength in demand in spite of capacity adds globally in the marketplace. And given the strong demand, whether it's in applications such as protective clothing, so a lot of these masks and medical applications are all using the applications that we produce, be it in the vinyl chain or in the polyethylene chain. But we've seen strong demand globally. And with the growth in overall GDP, that capacity add on polyethylene has been quite clear. Now we've seen challenges, obviously, in the logistics chain, and it's also complicated the ability to get for our customers to get the product. And of course, in North America, we've had a number of challenges weather-wise. Gulf Coast had 2 hurricanes and in the first quarter this year, the Gulf Coast and the Midwest all saw freezes, which constrained production for the industry in North America. So we've seen a combination of strong demand, some logistics challenges worldwide, combined with some production issues, weather-driven, for the industry. All that's translated into better margins longer.

I think you said on your call last week that the industry and you achieved the $0.07 increase for polyethylene in April. There's more price increases in the [ hopper ] potentially for May. How do you feel about those? And how do you think pricing will sort of shape out for the rest of the year when demand is pretty strong, as you know?

Yes. You're right. And so there have been some announcements by the producers and even some of the consultants that have reflected price nominations that producers have announced. So in May, you're right, we've seen announcements of about $0.06 a pound in polyethylene across all grades. And that's reflective of, again, of the demand picture that I just outlined. And so we've seen significant run-up in pricing over the course of, as I say, since June of last year. So if you think about the run-up in pricing since 2020, we've seen $0.24 a pound increase in 2020. And with the $0.06 price announcement that I just mentioned for May, if that goes through, that would be another $0.29. It's pretty spectacular price increase. So it's not surprising that as the industry gets production better balanced, given the outage that the industry had because of the winter freeze and the hurricanes that struck the Gulf Coast, and hopefully, we get supply issues worked through, that we could see some reduction in price expectation over the course of the second half of 2021. But even should that happen, the strength in margins are still pretty strong relative to where they were pre-pandemic. So with the strength that we've seen in the second half of '20 and '21, incredible demand. But even if we see some reductions, and this is really what some of the industry consultants are forecasting, we still see very good margins even in the second half in the face of the forecasted reductions in price of polyethylene.

Right. And then when you think about '22 and beyond, every year for, I don't know, how long, I've heard 7 million, 8 million tons of polyethylene's coming onstream, never seems to happen. But I guess, maybe it could. LDPE is not as focused in terms of the capacity expansions. And a lot of your peers feel that supply-demand will remain more balanced in '22, '23, potentially because of demand being strong. And so just kind of your thoughts on the longer-term profitability for the industry. It does seem like there's been a step-up over the last 6 to 9 months.

Yes. I don't know whether Albert is going just yet or not, but I can certainly chime in here if he hadn't gotten on the line. But certainly, I would say that even with the capacity adds we see industry-wide at '22 and beyond, '22's GDP expectation is to be about a little over 4% growth globally. And if you think about the capacity adds for the industry, they're about 5.5% to 6%. And so again, given that 1.5x multiplier for GDP relative to PE demand, again, we ought to see a more balanced equation than I think had been predicted if you go back a year or 2 ago. And the growth -- and the global growth numbers were much lower to be honest.

Great. Why don't we shift a little bit to your chlor-alkali and vinyl segment. The outlook, you had an interesting slide in one of your -- and your first quarter showing kind of underinvestment for world caustic soda through 2025. The ECU margins, PVC margins look really strong near term and are expected to be well above the last historical highs and throughout '22. So just wanted to get your thoughts on the momentum there. And what do you think is driving some of that improvement relative to the last 10 years?

Well, you're right, [indiscernible] underinvestment by the industry over the last number of years in chlor-alkali. And part of that is because of the relatively high capital cost per ton of production that's brought into the market. And you've got to find a home for the chlorine because for every ton of caustic you're producing or, say, every time chlorine you're producing, you're producing 10% more caustic. So to be able to optimize the ECU or the electrochemical unit, which is 1 ton of chlorine and 1.1 tons of caustic, you really have to find a good home for that chlorine. And most of that chlorine actually goes into the vinyls chain to make PVC. And so with the still recovery from the 2010 -- excuse me, 2008, 2010 global recession gap, we haven't really seen a housing boom really since then. You have to go back to '07, '06 to see the last domestic housing boom. And worldwide, we saw growth in construction, but certainly not in North America. And of course, to capitalize on the very low cost of feedstock, meaning natural gas power install to make chlorine and caustic, you really saw most of that capacity add in the chlor-alkali business over the last 10 years or so, really in North America. And so chlorine is hazardous to transport. So you really saw a lot of underinvestment for a variety of reasons. And you haven't yet seen significant capacity adds even today. Some smaller adds globally, some -- but relatively small, small percentages on a global basis. And so I think we're really well teed up on the supply side. And if demand continues to play out as we've earlier talked about GDP growth, we could be in for a nice run.

In terms of...

Yes. I just...

Go ahead, Albert.

Yes. Go ahead.

Yes. Just wanted to echo on what Steve said. What is the long cycle in terms of housing, U.S. housing used to average last 50 years, 1.5 million units. And in 2006 and '07, I think we hit 2.3 million units of single multi-families; and '08 dropped to 400,000 units, which is 80% drop. And took -- all the time from '08 until now, I think this year early on, we hit 1.6 million, 1.7 million units on an annualized basis, but for the first few months of this year. So we just got back to the 50-year average with 1.5 million units for the U.S. So I think going forward, if everything being stable with low interest rate and good economy, hopefully we can stay above 1.5 million units for a while, which is a huge driver for material -- all material construction and especially for PVC. And we mentioned -- I don't know whether you heard, but I said earlier that we are one of the most integrated PVC producer in the U.S., both from having ethylene and chlorine with cogen and downstream integrated to pipe, sidings and roofings. So in U.S., we are blessed compare with rest of world with the low-cost, I think, feedstock natural gas for power for chlorine production. So the rest of world really rely on U.S. for PVC export, vinyl capacity added in the rest of world. China is only one, which is coal-based. Then we understand that with the potential greenhouse gas emission reductions that every country that we're looking at, the coal base is a big emitter of greenhouse gas emissions in China, whether they would suspend any more expansions, which they have right now because of the mercury catalyst, that's a different issue. But going forward, in China, it's not any more capacity. And the U.S. is the only country supplies rest of the world. The demand, not only for the U.S. production to meet the internal demand, the 1.5 million 50-year average housing, but external needs. So I think the PVC business going forward looks very good. And the other side is caustic. I think we probably hit the cycle low, this cycle of caustic prices in February and March of this year, a few months ago. And as global economy recovers, we should be good positioned to improve the demand for caustic and hence also price as well. So this is a tailwind addition for our business in caustic.

A question did come in, in my inbox. And sort of just kind of directionally the vinyl segment earned $1.4 billion EBITDA in 2018. And when you take a look at PVC margins, ECU margins, they look like they'll be well above 2018 levels in '21, '22. So if you're going to be able to run your vinyls facilities full out through building products, how do you think about the next potential peak. And could you add more capacity to even boost that from the last peak?

Sure. In 2018 -- that we bought the Axiall business 2016 in August. So 2018, you're absolutely right that we see the benefits of the vinyl business. Then in 2019 and '20, when we had the Saudi and Russia crude oil fighting and OpEx and then we have the Trump tariff war with China. So pretty much by now, these 2 events are over. And plus, with the improved housing demand, I think we're in a very good position. Now since 2018, we also added last year, 2019, 750 million pounds of PVC capacity that we haven't able to get benefit because last year's pandemic and then this year is a freeze. So we should be able to get much more better from that. And also, we acquired the a 47% interest in LACC ethylene plant with about 1 billion -- over 1 billion tons of ethylene that will benefit our vinyl business. And we acquired the compound business and roofing business. So all that will add volume, plus the margin improvement. So I think it should look better going forward.

Right. And then your balance sheet is in really good shape. And historically, you've -- you found opportunities for it to use that balance sheet for growth. What do you think the opportunities are now? Or are there more building products type of assets, which has been a really good business for you guys? Are there other areas to sort of grow acquisition-wise with the balance sheet?

Yes. So it's a good question. I think as we look at internally, we'll look at opportunities to expand our PVC production capacity. And while they will not be as large as 750 million pounds that we added in late '19, early 2020, we'll certainly look to do as much as we can on that front. And of course, the building products business, as Albert noted, has gotten bigger over time, and we'll look to add additional capacity internally. And certainly, as we look at acquisition opportunities, we're always actively looking at opportunities to grow the business and deploy some of that capital. So you're right, we've got a very solid, strong balance sheet and liquidity. And we expect that we'll have additional liquidity going forward to really deploy in a manner, whether it be through organic or inorganic growth.

Right. And then I guess, last question for folks. When you think about 2022 and '23 and beyond, '21 is going to have very, very good profitability, as you guys know, because of Winter Storm Uri. How do you grow earnings beyond '21? What are the areas that you could continue to push to keep sort of earnings on the positive track over the next couple of years?

Well, as I mentioned, we'll continue to look for opportunities organically. And so from a volume perspective, I do expect that we'll look at those opportunities that gives us production volume and sales volume really to add and not just be only reliant on price. Certainly, running the plants reliably to make sure that we have full operability as the market is there, but that's also key. And of course, as I mentioned, looking to see if we can continue to deploy capital and grow inorganically to be -- to bolt-on opportunities as we did in '19 and prior years to really grow the business as well.

Great. Well, I'll try to keep everybody on time. Albert, thank you very much. Steve, thank you very much. And hopefully, we'll be able to see you guys in person soon.

Thank you, Mike. Appreciate it.

Great. Thank you, Mike. Thank you, everybody. Appreciate it. Take care.

Bye-bye.