Westlake Corporation (WLK) Earnings Call Transcript & Summary

Great. Thanks, everyone, for joining us. My name is Arun Viswanathan, I'm the chemicals and packaging analyst here at RBC. Thanks for joining us for the Annual Global Industrial Conference. We're pleased to have Westlake Corporation, Jeff Holy and John Brennan from the company. So we have several topics that we want to cover. But if you do have any questions, feel free to type them into the Q&A box as well.

So why don't I just go ahead and kick this off and we'll start with some questions around polyethylene. So obviously, there's been quite a bit of storm disruption in that business. What have you guys experienced, I guess, Jeff, if you can just kind of review your operations on the olefins side and any impacts that you can share with us now, that would be great.

Yes. The fortunate thing on the olefins side of the business is our assets are either in Lake Charles or west into Texas. And so very fortunate in the sense that those areas were not [ awfully ] directly impacted by Ida. And so those operations are continuing to operate as normal. And so we shouldn't see a impact from the recent hurricane on the olefins side of the business.

Okay. Interesting. I guess just sticking with that olefins side of the business then, would you say that -- maybe you can just review the price nominations for August and September and October now. And what do you expect kind of on the polyethylene side, are markets pretty tight? I imagine inventories are still very low, and you haven't had really a chance at all to build any of that. Where would you put inventories if you could? And yes, maybe you can just give us your thoughts on pricing for the rest of the year?

Yes. It's a very good question. And as we look at the pricing nominations, we had $0.05 that was realized in July, August settled flat and then the industry in general has incremental prices out there for September and into October now. So as we look at the balance of inventories, things still do remain tight from a historical basis. And they have been slowly recovering here throughout the year and post the freeze impact that we suffered as an industry in the first quarter of '21 and on the backdrop of very strong demand levels that we've been seeing. Probably the best way to characterize inventory levels is we're probably back to at roughly pre-freeze levels of inventory as an industry, but not yet back to kind of the pre-COVID level of inventory prior to when things started to tighten up in the polyethylene side. And so inventories clearly still remain fairly tight. And then there has been obviously some supply affected by the Hurricane Ida. We'll talk, I'm sure, in a bit around our PVC and chlor-alkali operations, which is where Westlake had more direct impact from our assets having to proactively shut down. But as an industry, some assets clearly on the polyethylene side as well. And so I think as we go through the month of September, we'll be assessing kind of what that impact does have and what, to your point, is already a fairly tight market for polyethylene. Prior to the hurricane, it was one that felt like we were probably starting to flatten out from a pricing perspective. But certainly, it's one that still remains fairly tight and one where the recent supply disruptions will certainly add to that degree of tightness and potentially support some incremental price here in the near term.

And we know that there was some disruption with feedstock. So could you just comment on ethane availability and if there was any disruption in your own system on that side?

Yes. So the good thing is on the olefins side of the business and mostly on the vinyl side as well, we've run an integrated operation with taking ethane through ethylene and polyethylene and so those abilities still remain. And those assets, as I mentioned, were all west of really where the impact from Hurricane Ida was. So we really haven't had a material impact there from the ability of getting feedstock and being able to produce.

Okay. Great. Well, I guess we could shift to vinyls then. So yes, maybe you can just review the operational impact from the storms over the last month or 2. Obviously, a lot of force majeure's impacts on chlorine pricing, which is already very tight as well as caustic soda moving higher. So what should we keep in mind for the vinyls business post Ida?

Yes. So maybe a more direct commentary on Ida from the vinyl side. So Westlake has 2 facilities in Geismar and Plaquemine, Louisiana, which are in that more eastern side of the state in the Baton Rouge area, where we did proactively shut down operations ahead of Hurricane Ida. The facilities themselves suffered very little damage as a result of the storm. And so the restart process around those assets rely really just on the return of feedstock and utilities to those plants. The return of those utilities and feedstocks are occurring basically in line with our expectations. They are mostly back at this stage, and we are really just waiting on access to full rates of industrial gases to be able to fully restart those facilities. And once that returns, that restart process assuming everything obviously goes to plan is typically a week or so. And so hopefully, we're fairly close to being able to restart those facilities and get back to producing at normal operating rates. On the chlor-alkali side of the business and PVC side of the business, it was probably one of the most impacted chemical chains from Hurricane Ida. I think about 30% of U.S. chlor-alkali capacity was in the path of the storm and perhaps a bit higher at roughly 40% of PVC capacity. And so while the impact of the storm seems to be generally fairly minimal, certainly for our assets, there was a large amount of capacity that was taken offline initially as a result of that storm. Certainly, a lot of folks like us are waiting to restart those operations and getting access to feedstocks and utilities back. And time will tell if anyone does have more longer-term damage or situations to restart those facilities as that process continues. And so to hit on the maybe last part of that question, certainly, that likely is constructive to pricing. That's in a market that has been very tight on the PVC side. We continue to see very strong demand for PVC, given the strength in housing and construction. And that's been on top of having, obviously, a few weather events that have added to that and a few one-off operational issues at certain facilities across the industry as well. So that side of the market certainly remains quite tight. And as a result, you've seen the consecutive increases we've seen in both PVC resin as well as caustic soda.

And what about chlorine? Obviously, your merchant position in chlorine really isn't that material. But chlorine was already very tight. You're in the water treatment season. So I would imagine that the tightness there has increased as well. Is that a fair characterization? And ultimately, does that help lead to more pricing power in PVC? Or what do you expect for vinyls' margins here?

Yes, it is. That is a fair characterization. We are seeing very strong demand on the merchant chlorine side. And to your point, we are a somewhat smaller participant in that market given that the vast majority of our chlorine is downward integrated into PVC, but we do certainly participate there, and we're seeing that strong demand and we've seen price increases, a good amount of price increases to date and probably an expectation that you should continue to see some price there as well. And noting the consultants are looking for price, looking at, say, IHS's projections and certainly, we have price nominations out there given that strong demand that we're seeing.

So are you expecting any material kind of volume impact? Sometimes you've helped with that. For the quarter, has there been any update due to the force majeures or the downtime that you experienced? And if not, should we expect kind of margin expansion sequentially from Q2 to Q3 in vinyl?

Yes. So yes. So as you know, we did give guidance back in Q3 for, say, the impact of Hurricane Laura because that was an incident where certainly we did suffer some direct damage and there was a decent restart process and impact of the business. Going back to the prior comments on the impact of Hurricane Ida, they do seem to be quite limited from our perspective. Certainly no meaningful damage. And so this should be a much lower impact in regards to the dollar value of impact of the business and production that is off-line given our ability to hopefully restart these assets here quite soon, and get back to trying to obviously serve our customers and provide them the volumes that they want indeed.

So just, I guess, putting all that together then, you would expect margin expansion, I guess, sequentially for both businesses, just given the price increases in olefins and then -- and similarly, the price increases in caustic and PVC, is that right?

Yes. So certainly, we're seeing a good momentum in pricing, as you noted, and so I think that certainly highlights that we are seeing no expansion in the pricing on the chlorovinyl side of the business. And the olefins side of the business, we did have that $0.05 price increase in July. It's been effectively pushed out a bit in realization. But it highlights that there is certainly continued strength in both sides of the business.

Great. Well, maybe we can touch on the now larger part of your business as well post -- or as you -- over the next quarter or 2 as you close on Boral. So in building products, you noted still very strong activity in housing and construction. This has been an area of increased investment for you. But we are starting to see a couple of cracks on construction, potentially some supply chain disruptions pushing out deliveries. Does that have any impact on you? Or are you still relatively bullish on the building products and construction outlook? Maybe you can just give us some thoughts on those dynamics.

Yes. No, we're certainly quite constructive on the outlook for that side of the business. Certainly, there's a variety of chains that are dealing with supply chain and logistics issues and some of the building product areas are no different. But you're seeing still very strong underlying demand for construction. There's a lot of very positive trends in that side of the business. If you look at housing starts, the 50-year U.S. average is just under 1.5 million units a year. We've been building well below that really since the 2008 -- 2007-2008 financial crisis. And so that likely alludes to a pretty good degree of undersupply from those many years of underbuilding in the industry. You also see a good shift in demographics as there's an increasing number of the U.S. population in prime home buying age, that 35- to 44-year-old demographic occurring now as well as continuing to increase over the next decade or so. And then certainly, post-COVID, while things will, I'm sure, continue to somewhat normalize from where we were 6 months or 12 months ago, Delta variant and future incidents notwithstanding, there are certainly aspects around valuing quality of life at home. And as folks are likely able to start working more remotely and need both additional space at home to do so and may not value quite as much that proximity to the office if you're not having to commute in every single day. All of those factors help support driving that demand growth in new house construction, particularly for folks looking to move out of urban areas into suburban areas, which drive a lot of building product demand for that unit of housing. And certainly, folks are certainly looking to just increase the quality of life at home and looking to repair and remodel as well, which also drives that building products demand. And so we think all those factors together should add a very good degree of secular tailwinds behind the housing and construction market for some time, with the recently announced Boral acquisition certainly adding a very good degree of scale and product diversification to Westlake's existing building products business. On a trailing 12 months basis pro forma with Boral, we're probably in the high 30% range as far as the portion of Westlake's revenue that goes into that building products business. And if you add into that our U.S. PVC resin, which is really being driven by that end market demand in housing, construction and infrastructure, we're probably at or if not above 50% of our total consolidated revenue, including PVC, that's really being driven by that U.S. housing market. So we think that's quite a good place to be positioned and one that should be quite exciting and a good opportunity for our shareholders.

Yes. And we've gotten a lot of questions on strategy, I guess, post the acquisition announcement. So maybe you can just give us your thoughts on the portfolio as it stands. It looks like you're really leaning into building products a little bit more while the acquisition was a little bit higher multiple pre-synergies. Post-synergies, it definitely does look quite attractive. So what are some of the synergies that you're looking to get out of this transaction? And are you still on track -- when are you on track to close? And I guess, what are some of the dynamics in the integration that we should be paying attention?

Yes. So we're still on track to close in the second half of the year. So we should be closing on the transaction prior to year-end. From a synergy standpoint, there is certainly some attractive synergies, both on the cost and revenue side. From the discussions we've had immediately after the acquisition around the announcement, we noted mid-$30 million number for cost synergies, that's obviously what we identified from the initial diligence around the acquisition. I want to highlight that that's just on the cost side. Certainly, as we shift over to the more revenue side of the business as we look at combining a lot of the leading positions Westlake has with a lot of the different leading product positions that Boral has and being able to sell those into a wider range of customers and distribution channels, that should lead to some very exciting cross-selling opportunities to enhance our revenue within the combined business. And to add to that, it's a good degree of geographical diversification we're getting to also help drive some of those synergies. Westlake's existing building products business is really strongest in the northeast and midwest of the U.S. as well as having a leading position in Canada, while Boral is stronger in the southeast and southwest area of the markets. And so we think also having that combined business and being able to leverage those relative strengths and geographic footprint should also help support some of those revenue synergies we can go after once the acquisition closes and we look to start integrating and driving value out of the business.

And then from a portfolio standpoint, following the acquisition of Axiall and now Boral, again, you're tilting the portfolio away from olefins. Is that the right way to think about it that you're finding a little bit more attractive opportunities in markets in vinyls and building products? And would you consider building products now as a main platform of growth? How are you thinking about the portfolio overall?

Yes. So we certainly wouldn't characterize as that we're shifting away from chemicals, but we are shifting more towards being a leading player in building products. And we certainly think this opportunity, as we are able to execute on it, offers a really compelling opportunity set to grow out that building products business and deliver value. If you think about the businesses within Westlake, the ability to find attractive opportunities. In the U.S. olefins market, there's not a lot of necessarily natural sellers of assets. In the chlorovinyls market in the U.S., from a competitive standpoint, it is a fairly concentrated market. So as well, probably not a lot you can necessarily do there from an acquisition standpoint. But we can certainly look outside the U.S. for those markets to grow and look at adjacencies as well on the chemical side in the U.S. We're very opportunistic and disciplined in how we look at those opportunities. As you know, it's all about trying to find those opportunities that are going to drive real bottom line value and be accretive to our shareholders and generate that excess risk-adjusted return. And we feel confident that the Boral acquisition should do that in the building products side, but we'll certainly continue to look across all areas of the chains we're in and adjacencies as well at opportunities that could drive that bottom line return to us and benefit our shareholders.

Great. So -- and then just continuing on the cash side, how are you thinking about the balance sheet at this point and prior uses of cash, leverage really isn't still that high. There's still a high level of insider ownership, though, which makes buybacks a little bit more challenging. So again, where maybe you can just reiterate your priority uses of cash at this point and then maybe even the target leverage, if there is any.

Yes. So for the balance sheet, we certainly look to maintain the solid investment-grade metrics that we historically have and even day 1 post the debt financing and purchase price for these 3 acquisitions, I think the balance sheet is still in very good shape. And you've seen that from the rating agencies all confirming our solid BBB flat investment-grade rating post debt financing and acquisition announcements. So I think certainly, we are in a good position from a balance sheet perspective. And certainly, the business continues to perform well and generate good levels of free cash flow. As we think about priorities for allocation, certainly foremost is always to reinvest back in the reliability and maintenance of our assets. And we're also spending some growth CapEx on finding ways to smartly debottleneck and grow our existing asset footprint as well. You probably saw in August, we also raised our dividend by roughly 10% or so. So certainly, we understand that increasing that at a good growth rate and returning value to shareholders that way is important as well. But really, these recent announcements of the acquisitions, 3 acquisitions totaling $2.6 billion roughly in purchase price, highlights that we're still finding opportunities to reinvest either back in the business organically or inorganically and finding those opportunities at pricing that we believe can certainly generate the excess return to our shareholders. And so we think that's certainly the way to think about how to allocate that capital is if we're able to find those opportunities to generate excess return that's what both management is incented to do and how our shareholders should certainly want us to allocate that capital to also generate bottom line value clearly to them as well.

And just continuing on the growth side, I'm just curious about your investment opportunities for either greenfield or brownfield capacity. You made a lot of debottlenecking investments a couple of years back at Petro 1 and 2 and Lake Charles and so on. Are those opportunities done? How should we -- and then similarly on chlor-alkali, we've seen some of your competitors and peers shut down capacity and limit production, would you expect any new capacity in chlor-alkali? How should we think about capacity across both olefins and vinyls?

Yes, yes. So let me hit on -- I'll take the olefins side first and then switch over to vinyls. So on the olefins side, you're right that we have in the past recent history expanded really all 3 of those crackers at Petro 1, 2 and Calvert. And so at this stage, that probably does limit the amount of economic debottlenecking capacity there, and we are still short a little over 1 billion pounds of ethylene in our operations. We did make the large investment to increase our ownership in the Lotte JV cracker to roughly 50% back in the fourth quarter of 2019. So that represented an important way for us to close part of that ethylene short position at an attractive price. That being a new greenfield cracker, it is built with debottlenecking capacity into it. And so in the future, that's something that we and our JV partner can certainly look at for potential expansion opportunities as well to further close that ethylene position. And then if we switch over to the vinyl side of the business, we have been expanding some of those assets. You may remember that we expanded our PVC operations in the U.S. Gulf Coast, roughly 700 million pounds back in the fourth quarter of 2019, taking advantage of some of those economic debottlenecking opportunities. And we've also done a few expansions in Europe as well through our [ Vinnolit ] operations, both in chlor-alkali and PVC. There has been a bit of capacity, as you mentioned, taken out of the market recently, but you do have some incremental capacity coming online with Shintech and Formosa here over the next few years. The important point is when you look at the chlor-alkali and PVC markets globally, you can see that there's really limited capacity being added to that market. Pretty much anything over the next 3 or 4 years would have been already announced given the time to permit and then actually build those facilities. And so when you look at that from a global basis, very limited capacity getting added. You do have some of this capacity areas that have been taken out, as you mentioned, as well in the U.S., which is constructive. And so that, we believe, really sets that market up to look attractive for the future because you're not seeing meaningful amounts of capacity getting added. And those are markets that continue to grow really in line with GDP. PVC is probably roughly 1x multiplier to GDP and caustic soda is probably just a tad bit below that. And so as you continue to see the global economies recover post-COVID, you're seeing increases in demand that are certainly in excess of the expected growth in capacity here over the next few years and should make for a very constructive outlook on the industry.

And we can come back to some fundamentals, but I did get a question the other day that I wanted to ask you, which was, is there any anything you can share on succession planning at Westlake? I know Albert has been involved for a very long time, but -- his family is as well. So what could you share with us as far as succession planning, if anything?

Yes. So certainly, it's something that the Board takes a very active dialogue in and has a plan for around succession. Certainly, Albert is a very -- has been the architect of building Westlake over these years as well as James, our Chairman and the Chao family. You've seen several of their sons on the Board as well be added, so certainly ensuring that outlook and mentality on values there from a Board level for a very long time to come. And you also look across our organization, and you see a very experienced commercial management team. Roger Kearns, our COO, very impressive career, many multinational posts and having worked for Solvay for many years and similar across the business with Bob Buesinger running our vinyl products business and having run a lot of businesses across the globe in the past as well. So very -- very capable management team and certainly one that the Board has a plan for it to continue to ensure that that operational expertise and focus on creating value remains for a very long time here at Westlake.

Great. So it sounds like there's a nice trajectory of growth involved over the next couple of years as you realize the pricing power in vinyls. I know there's an attractive market in LDPE for you as well. And then now you have the building products expansion. So looks -- and in the near term, it looks like the storm actually could be a positive driver for pricing. So everything seems to be going pretty positively. Is there anything that you'd point out from a risk standpoint at this point? Or are you guys relatively optimistic here?

Well, I mean we're always looking out for what could be out there. And certainly, we'd like to build in a good margin of safety in how we're thinking about the business and what could happen. I think your points are certainly accurate. There's very constructive environment out there. We're seeing very good underlying demand in our products and expect that to continue. Certainly, we look at ensuring that we're managing supply chain and logistics as best as we can. Certainly, we're watching input costs, natural gas is somewhat elevated, and you're seeing that partially come through on the ethane side as well. But to date, I think we've done a good job managing that. And with the strong underlying demand, we've certainly been seeing that ability to push price despite some of those inflationary aspects in input costs as well. But clearly, we'll continue to watch things closely, and ensure we're managing the business to take advantage of the opportunities and manage the risks that are out there.

Great. We're just over here. So why don't we leave it at that. Thanks to Jeff Holy and John Brennan from Westlake. I definitely appreciate your participation here and good luck with the rest of the quarter as well as year and look forward to speaking again very soon. Thank you.

Appreciate it. Thank you, Arun.

Thanks.