Westlake Corporation (WLK) Earnings Call Transcript & Summary

Good afternoon. It's Laurence Alexander with the Jefferies chemicals team. It's my pleasure to introduce Albert Chao as the President and CEO of Westlake. It's really good to see you again. Thank you very much for doing the discussion today.

I guess given the time we have, let's just jump right in. So -- let's start with kind of one of the big themes of this conference has been carbon net zero. Can you talk about how Westlake is positioned to move its own footprint towards zero emissions? And also the -- maybe if we can also weave into this sort of the recyclability of the products and your investments in circularity.

Certainly. Well, thank you very much for inviting us again. Very appreciative of the ladies and gentlemen on the phone watching and listening to our call. Environmental issue is very important, not only for Westlake, for our employees, but for the whole world. And everybody should be doing the right thing to reduce carbon emissions. And Westlake, even though we didn't come up with a 2050, which is 30 -- or 29, 30 years away, go that -- but we are working on those issues as we speak. The last 4 years, Westlake had reduced greenhouse gas intensities by 10% already in the last 4 years through the efficient use of coal generation facilities and switching our fuels, so working on that. At the same time, we also has reduced carbon dioxide emission to almost zero and also reduced energy usage per ton of global production. And we're working on also reducing water usages. In the last 4 years, we reduced more than 13% of our usage compared with, say, 2015 and reduced hazardous air pollutants by over 15% in 4 years, and the process continues. We want to do our part as much as we can. And I know that to get to zero net emissions, that's a tall order and takes new technologies, which may or may not exist today, or at a cost that will not be practical for a company in our industry unless government mandated or have other issues. But even without mandate, without incentives, we're working, doing our part to bring our emissions down. On the issue of plastic waste, and that's a different issue. And Westlake, we're certainly very conscious of potential plastic waste, which is a problem noticeable by people seeing it, whereas global warming, we can feel it, we don't see it. And what 80% of Westlake's business is vinyls. And vinyls is end product, mostly PVC. As you know, PVC is used in the durable side of the economy. We make pipe and fittings for water and sewer, which also goes into the infrastructure bill that's coming up. And we are using the benefit of plastics, which is durability and inertness. So if you think of a pipe in the ground, buried in the ground for 30, 40 years, and it be as good as new, whereas you think of a pipe ductile iron or concrete pipe, you have quite a lot of corrosion and erosions and holes in them, which caused water and sewer to leak into the water tables. So from that sense, I think the vinyl business are really not in the single-use plastics as some of the polyolefins business has been in. On the polyolefins, we are the second largest manufacturer of LDPE in the North America and probably the largest specialty LDPE copolymer manufacturer in North America or in the world. And certainly, LDPE, just like other polyethylene, large new usage is in packaging. And I think the industry as well as our packaging company, they find ways to wait to engage as well as to find way to recycle. And a lot of work is being done on that. But I think we still need a lot of progress to come out, and we are very conscious of it. Linear low density, which was one of our products. One big use of it is for garbage bags. Now good thing about garbage bags, we all need it no matter what. We don't want the garbage to leak. But garbage bag, by definition, also goes in the landfill. That may not be an eye-sore from floating in the river or all that. But still, there's other ways to reduce garbage including incineration of waste. Talking about recycle of plastics, which is announced this week, we're buying a company called Dimex. They are one of the largest processor of plastic material that's post-industrial recycled plastic material in polyethylene, PVC and thermoplastic elastomers. And they've been in business for quite a while, have a know-how to collect the recycled material from plants around the country as well as the way to sort them out and select the right combination with right additives and to make consumer products. Maybe all of you have matting under your seat in your pickup trucks or in your office or in the plants and also hedges for gardening, those are -- Dimex is a major supplier to not the big boxes, but also Internet commerce to supply to consumers. And we just announced this week, and hopefully, we'll close it soon in the second half of this year. And with that, we want to build our post industrial and hopefully, post-consumer recycled business. We think there's a lot of potential for the smaller waste plastics around. They want to do our part to recycle these plastics. And we could take the technology and know-how to overseas to other countries as well, but we want to start in the U.S. We only have one plant at this company, and we plan to grow the business, to collect more waste and to turn it into usable products.

And can you flesh out a little bit your thinking around the recycling business? Where -- what the kind of incentive economics are to -- because we often hear from companies in the industry that it will be tough to get more than 5% of plastic collected because nobody is willing to pay enough for the plastic feedstock to go into the recyclers. And so how do you see the incentives in the chain? And I suspect that your choice of this company is partly a signal that you think that if there is value capture, it's going to be at this point in the chain. So if you can flesh that out a little bit.

Absolutely. This company, it doesn't -- it's not only involved in collecting the plastic waste, but it's sorting it out, apply technologies and make a very good value-added consumer products. So it's wholly integrated all the way to consumer products, and it's making money. That's why we bought it. Everything we do have to make money. If it's charity, we'll do out of family, but this is -- Westlake has to make money. So we expect to make above cost of capital over the cycle. The -- as we understand, I'm not in a recycled business yet, we'll understand more after we close on the deal, that most recycling business today are not making money or losing money because they are collecting, it's a high cost and then sold out, but they are not making finished product. Most recyclers are making compounds or resin out of it and try to sell it. And so now the collection is a very expensive way and the cleaning and sorting. So unless there are government incentives or fees for that, today, actually, probably because of the high resin price, maybe there's a margin. But normally speaking, when the resin price has a normal price or pre-pandemic price, there's very good margin for recyclers. So we don't know our cost going forward, what plastics prices will do. But if you expect to go back to pre pandemic, then there's no margins and have to rely on other government incentives or mandate plastic recycled content in packaging materials. And some companies are already saying we want to have 30% recycled plastic material. But the issue is that if you're on a food content, food content FDA mechanical recycling or waste plastics post consumer, will be difficult to get it. We had to have use chemical recycling and chemical recycling is quite expensive. So it's better economics. I think technology is there, it's just economics.

And so I guess, can we switch to -- thinking about the construction markets. I think the U.S. housing market has been, to some extent, I wouldn't quite say flogged to death at this conference, but pretty well. But if you have a strong view there, please feel free. But I really want to ask about the European market, where there also appears to be significant pent-up demand, in part because of the shunting of wood to the U.S. market because of how strong the U.S. market was coming out of the pandemic. So I'm particularly interested in how Westlake may have operating leverage to a European construction cycle. But please don't let me hold you back if you have a strong view on the U.S. side.

Laurence, this is a very good question. Before Westlake finished our closing of Boral, LASCO materials company, where our building materials business are already over $2 billion revenue. We don't talk a lot about it, but this is embedded in our Vinyls segment. And with the Boral acquisition, will be over $3 billion. It's a sizable business. And if we include our U.S. PVC business, which sell almost majority of all of it into the construction material market is over 50% of the Westlake's revenue. So it's a sizable important part of our business. Now currently, the Boral business is all U.S., in some Canadian and potentially some Mexico-North American business. We have not closed it. So we are waiting for close it, and then we can also disclose more about the business. And we're looking at how much -- how and when to have disclosure because many of the investor are not seeing the benefit or seeing the details of that segment. So we are working on that. But also because it is U.S.-centric, we want to make sure we do the right synergy, we talk about $35 million synergy. And that's an area we are pretty confident we can achieve. There are other synergies, business synergy that we have not put that in a way to talk about cost synergies and immediate cost synergies from logistics, raw material purchase and a little bit of SG&A. But the benefit really is the synergy and growth synergy that we are looking at. So we want to make sure we put our management attention to capture synergy and grow the business. But you're absolutely right. In the U.S., we are blessed with a lot of lumber. So a lot of construction are lumber based, whereas in Europe and other parts of the world, they don't have the abundance of lumber and high cost. So other material -- alternative materials was much needed. And with the incorporation of Boral, we'll be able to cover a huge part of the house, interior -- exterior and interior from roof all the way to the siding, windows, doors and foundations and interiors was. We're not in the carpet business or drywalls, those are very -- at least the drywall is very commodity, and we're not in the plastic carpets so that almost everywhere else, we are touching in the house. So definitely, we have technology and product know-how that we can extend to other parts of the world. But again, make sure we do it right in the U.S. first, but that's not saying we cannot extend overseas. In Europe, we have close to 1,500 people in Europe, and we have chemical business as well as NAKAN global compound business that we acquired. They are supplying PVC and other compounds to building construction, wire and cable and automotive business in Europe. We have 4 locations. So we can easily introduce fabrication to the European market if the PVC fit the right time.

And we've seen sort of extremely high, even mid-teens multiples for commodity petrochemical assets recently on the M&A side. What are Westlake's M&A priorities once these 2 deals close? And does it have any sort of stranded or hidden assets that could be monetized to take advantage of the current environment?

Well, I think the chemical business, actually, we have very high, probably even 30% EBITDA margins, very high business, depending on the segment and time. We are very confident with our business. And as you know, the Vinyl business, we're one of the most fully integrated from ethylene salt or to power all the way down to consumer -- finished consumer products. So probably one of the most integrated, most cost competitive in our space. I think Boral adds the depth as well as breadth into complementary products that we can become major factors in our customers. These are -- whether they are 1-step, 2-step distributors as well as big boxes. So that adds a lot of product breadth and reach. But on the chemical side, certainly for PVC, we need chlorine, caustic and ethylene. Again, we are one of the largest buyer of ethylene in the U.S., over 1 billion pounds of ethylene that we are buying on top of the 5 billion-or-so ethylene that we generally produce ourselves. And polyethylene as we are the second largest LDP manufacturer in the U.S. and probably the largest specialty copolymer, specialty polyethylene in the U.S., in the world. And that commands a much double-digit margin over the commodity grades of linear low or high density. So it's a very good business. And we are, again, moving more to the nondisposable side of polyethylene applications, like we make adhesives for carpet backing from our copolymers. We're making asphalt stabilizing for a hot sun, hot weather areas, which for growth become more and more so. And for -- high VA/EVAs for solar panel [indiscernible] . So we are getting into -- more and more into more durable applications. And of course, in low density, where we're making -- supplying the garbage bag market. No matter what happens, we need garbage bags. So I think we're happy where we are, very good margins. But opportunity comes, we'll look at both acquisition or divestiture if people offer price that's beyond what we see our value. But we are comfortable where we are. We think both segment business, but more so on the vinyl because there's very little capacity added globally, and we are a leading integrated supply and lowest-cost suppliers among the U.S. producers and global producers. So we have a very good position. And I think some of the industry consultants are seeing that margins and prices are improving to next year and beyond next year with the limited capacity added. In polyethylene olefins, there's more capacity added in the U.S. and China and Asia. So we'll see how global demand, whether any regulatory impact on recycling and the limitation of single-use plastics would have any dampening effect on demand. Otherwise, the projection is that between 1 and 1.5x GDP growth, the demand for polyethylene around the world, the holding capacity can be absorbed over the next 5-year period.

Now you showed a lifted chart recently in one of the investor presentations of the chlor-alkali has been underinvested. And it looks as if like on average, it's about 7 years out of every 3, it's underinvested and then it's overbuilt. And -- but the forecast is underinvestment as far as the eye can see, at least in the next 5, 6 years. Is there an implication that we should be thinking that the industry forces will lead to a large leg of capacity in 2026, 2027? Or is there something structurally different about the cycle which will keep the chlorine -- the ECU dynamics more favorable?

Yes. That's a very good question. I think that chlor-alkali, we are only listing what's being announced. So it was not announced. It was just people have to guess, and guess can be anything you wanted to guess. But I think chlor-alkali, the biggest issue, most possible world is the use of chlorine. And chlorine, there's limited use. You cannot store it and the PVC is the biggest application for chlorine among all the other applications. And the investment for PVC includes, if you want to be competitive globally, have the ethylene plants and power plants and there's a huge amount of investment. And historically, for new investments, especially in areas where you have high cost of ethylene in Asia, Europe, high-cost power like in China, Middle East, you're not turning competitive or you have a small caustic market, domestic market. You had export caustic, which is 50% water, so high freight cost. So all those factors make them less competitive and return being less. And coupled with that today, China has the world's largest PVC capacity as a country. And 80% of that is coal based and government in China looking at the greenhouse gas emissions and see the coal based, the power supplies and whether that's the way to go or not. So coal price has been elevated, I think, maybe by the government designed to increase the cost of power and reduce consumption, I guess, will be more efficient. So all that means that Chinese coal-based PVC production with higher cost and maybe less incentive for them to continue doing that. So I think because of the high cost of investment for chlorine derivatives, it makes it less attractive unless you are in the U.S., have the low power and low-cost ethylene and big domestic caustic market that you can produce a PVC at a very competitive cost position, they can serve the rest of world. And U.S. has been probably the only country in the world that really become a dominant exporter and supply the rest the world with PVC with those competitive cost factors.

And so lastly, I think we spent a lot of time talking about mid-cycle margins. So let's ring it in terms of peaks. I think in 2018, I think, your peak EBITDA was $2.1 billion. You've layered in some acquisitions. There's the new PVC investments. There's structural underinvestment in chlor-alkali, possibly a steeper cost curve, a long construction cycle. If we roll that all together, why shouldn't investors look towards the next peak, middle of the decade being north of $3 billion?