Westlake Corporation (WLK) Earnings Call Transcript & Summary

Hi. Good morning. My name is Eric Petrie. I'm Citi's SMID chemicals analyst. And our next presentation will be from Westlake, and we have Albert Chao, who has been CEO of Westlake since 2004 and its Co-Founder. We also have CFO, Steve Bender, who joined a year later in 2005. And Westlake has been very busy lately doing bolt-on acquisitions, expanding into the building products business as well as getting into a new chlorine envelope into epoxies. And so here to tell us more about Westlake's businesses, I would like to welcome Albert and open up for a fireside chat. [Operator Instructions] So good morning, Albert. How are you?

Good morning, Eric. Very fine. Thank you. How are you?

Good, good. So as I discussed, you've been busy doing acquisitions, most recently, Boral and LASCO in your building products. Talk to us a little bit of the average multiples paid for those businesses. And what kind of synergies do you expect? And then is there any gaps that you want to fill in going forward?

Certainly. The M&A market has been very exciting lately. And we've been paying really market multiples for building products and market multiples for our chemical business. But our goal always is through synergy and growth, is to bring the investment, return back to above our cost of capital on a risk-adjusted basis over the cycle. And so we are working on that with the company that we have closed. And there's a lot of synergy with our existing business, especially building product business. And we have become a sizable player in competing with the large building product companies in the space. And the Hexion space, that's a very new exciting business. We're getting to areas that will serve the green energy from windmill blades and through light-weighting automotive bodies as well as structural components of more light-weighting and as well as potential battery cases for containing the lithium battery from fire and all that. So -- and also provide a place to put that form to back integrate into chlorine and caustic, which are some of the -- and propylene, the big star to make epoxies. So very excited about the new platform for growth into the future, especially in the ESG, in the green space as well.

That's a perfect lead in on the ESG front, which has become of interest across the chemical space. So you recently announced lower carbon caustic soda and PVC offerings I think in Europe. Can you talk about how much GHG savings these products offer? And then how do you price these products compared to conventional PVC and caustic soda? And then what is your outlook for expanding into other markets?

Certainly. We have -- in all our businesses, we are looking at products and process to improve the carbon footprint and to offer our customers with lower-carbon footprint products. So with our -- the GreenVin products, we have using renewable energy, low-carbon footprint caustic that we introduced this year as well PVC. So -- and we're working out also bio oriented and green PVC going forward. So these areas, we think our customers are very excited to have alternatives to the conventional PVC and caustic. And as they develop their markets, we're working with them, and we'll find the right price median for that. It's really -- we're not here to increase prices but more to offer alternatives to our customers. And also this year, we bought into Dimex, which is one of the leading usage of post-industrial plastics, whether that's PVC or polyethylene or thermoplastic elastomers. They turn in the consumer products like garden edging products and matting for homes, offices, commercial as well as industrial, and that's one of the largest user of post-industrial recycled material. And we're looking at other areas. So in our polyethylene, in our pipe, we have introduced a bio, actually, oriented pipe, which will use more -- uses less PVC for the same strength, so reduce the PVC consumption and reduce the carbon footprint for the right applications. So we're very excited to be able to offer these products to our customers. And I think the reaction has been quite positive in the marketplace.

That is a great lead in into Dimex. And just a few questions on that business. How is waste collected? How much recycling capacity do they have and your ability to scale that business up? We've just heard from Lyondell, who was talking about the ability to scale up molecular greater than mechanical. So any comments there, Albert?

Steve, will you take that?

Yes. And so, Eric, there, as Albert noted, there are a very large user of post-industrial recycled material. And certainly, today, you think about the applications, about 100 million pounds of recycled materials, as Albert noted, whether it's polyethylene, PVC or other plastic materials. The ability to scale is something that we are certainly very excited about. And certainly, as you think about the applications we're selling into the markets, we're certainly excited about being able to really take that business and expand it. And so that certainly is the expectation that we have and the expectation that we'll pursue.

Great. And then if I take a step back and look more broadly at circular economy, besides Dimex, what other ways do you see Westlake participating? And how do you view the impact on virgin demand?

Certainly, we are in many of the industrial association -- industry associations like AEPW and many others. And I think the goal for the industry is to utilize as much as possible the post-consumer, post-industrial products and reduce the waste that goes into landfills or into the waters. Whether it impacts the virgin materials or not depending on how much recycling goes on and also demand for products in plastic by far is still the most versatile material that's utilized as it's lower cost and replaces -- and many applications compared with whether it's steel or glass or aluminum, it has a lower carbon footprint than those other materials. So as people get more knowledgeable about the carbon footprint and the whole process that we think the plastics will have a very good position. On the other hand, I think our industry is very, very much aware, very much wish to use mechanical and chemical recycling you mentioned earlier to recycle as much as the waste that's being produced. So we are very much involved in all these activities, as mentioned, with our current applications, and we'll be announcing more products that we're offering to our customers of using recycled plastics in many areas.

Okay. And then coming to the inflationary environment, looking at raw materials, oil prices going up to $80 a barrel roughly, ethane prices now trading in the high 30s. Now what is your outlook on inflation and raw material cost for Westlake into the winter season as well as '22?

Sure. I think certainly, feedstock is a big part of our cost as well as energy. And unfortunately, those energy pricing, there's a lot of supply-demand, a lot of politics impacting the price directions. But by and large, the higher the oil price and the lower the gas price has a positive impact on Westlake because much of our power cost comes from energy, from gas-based power. And we are trying to get more renewable power, but majority of supply is gas-based. So when gas price is lower in the U.S. compared with Europe and Asia, we have a cost advantage. And likewise, when oil prices are high and U.S. gas prices are relatively low, our feedstock advantage. Our ethylene is made primarily from natural gas liquids, whereas the rest of the world uses very refined crude oil to produce naphtha for their feedstock. So we have an advantage from that sense, both from feedstock and energy. And in polyethylene, in chlorovinyl business, both are very important. So U.S. has by far the lowest feedstock position and energy position to make product supplies to the world market.

Maybe you can help frame for investors your earnings sensitivity to $1 per MMBtu change or a $0.10 change in the ethane price.

Yes. So Eric, yes, when you think about the change on $1 in MMBtu for natural gas, it's about $100 million of EBITDA a year. And so on a $0.10 move in ethane, it's about $160 million a year. But as Albert noted, when you think about the advantage that we enjoy relative to the global position where our competitors using oil-based feedstocks, given the high prices that we've seen for oil, even if we see moves in natural gas and ethane, we're still very globally competitive relative to our peer set. So while those are interesting sensitivities, the issue is everybody moves higher on the cost curve. And so North American producers still stay very, very globally competitive.

Great. Turning to chlor-alkali and vinyls, why don't you give us a broad overview of how you see ECU fundamentals in the near and medium term? Do you expect any new supply? And at what price level do you think we've reached reinvestment economics to build new capacity?

Yes, definitely. The chlorovinyl business is in a very good position. We have ECU, that's electrochemical units. That's 1 short turn of chlorine and 1.1 short turn of caustic. And we produce -- that's the ratio we produce from electrolysis. And the ECU value today is a record price in the U.S. primarily because chlorine goes into -- most of it goes into the vinyl business. About 50% of all the chlorine goes to the vinyl business, PVC. And PVC, with the demand for construction, not only in the U.S. but globally, being so strong that PVC prices has moved very well compared to other materials, and hence, the value for chlorine is quite high. And the caustic side, caustic normally is a leading indicator from a recovery of the economy globally. And as you can see that after the slowdown from the lockdown we had in early 2020, the global economy has bounced back, especially in the developed world and developing world as well. And the forecast for next year also will be quite strong. And caustic demand is very well because caustic is used in many applications in consumer products and industrial products around the world. And so demand has been very strong. The amount of supply in caustic and the PVC is relatively low, primarily because, I mentioned, we need this low-cost power and for chlor-alkali manufacturing and low-cost ethylene feedstock for the vinyl business. And rest of world, China, Europe, they don't have low-cost power, very high cost power. And as I talked earlier, they have feedstock very expensive. So very little capacity added. So we have limited capacity addition with growing demand for caustic and PVC. So the pricing power is within the producers, and hence, the margin has improved a lot. And as we go into winter now that normally, winter months, the demand for construction goes down and the demand for construction material goes down. But we're not seeing that. Inventory in producers and customers level for PVC and building products are very low, and people are getting ready for the next construction season in spring next year. So prices are still going up very strong. And actually, export price for PVC and caustic are higher than domestic U.S. price. So I think we're in a very good position going forward. And you asked about capacity additions. There's very little capacity added around the world. Actually, China is primarily coal-based for PVC. And with the direction the Chinese government is going with reducing greenhouse gas emissions, we see potentially even shutdowns in some of the high-cost plants in China rather than adding more capacities. So I think we are in a very good position going forward.

Okay. And then do you think there's been new discipline added to the industry with the largest ECU producer announcing capacity closures? And then similarly, is Westlake deselecting lower-margin business?

Steve?

Well, I think when you look at any rational producer, you're going to kind of make sure that you're pursuing the best netbacks that you can find in the marketplace. And so as you think about the very strong demand that we've seen across the chain, whether it be in chlor-alkali or a vinyls chain further on down, I think all of us are trying to make sure that we're maximizing our margins. So I wouldn't call it necessarily deselecting. What you're really trying to do is maximize your netbacks to the bottom line. And that really is a function of how we evaluate all of our engagements across the board and really trying to maximize the netbacks of our products across the chain, whether it be domestic customers or offshore customers in the export markets. So it's really a focus of really making sure that we're maximizing the value proposition, of course, working with our customers to provide reliable supply in a year that's been challenging with weather-related issues. So it's really trying to make sure that we can provide that ratable, reliable supply and trying to do as best we can for our shareholders by driving the best netback margins across both our domestic and export customer base.

Great. And then you entered the epoxy end market with your announced acquisition. Where does margin stand in that business compared to the rest of the portfolio? And then how integrated are you into the upstream versus downstream components of epoxy?

Certainly, the epoxy business, like many other plastic material business, that's oriented towards the renewable energy side or light-weighting. Automotive has been very strong. There's some cutback in production in China for various reasons, dual control and others, as well as the demand has been very strong globally. So the pricings and margins have been quite strong. And going forward, we believe that with a continued focus globally on increasing renewable energy and the demand for light-weighting vehicles, electrical -- EVs and even the conventional vehicles, I think demand for epoxy continue to be strong. And also, it produces to the platform, so backward integrating to chlorine, caustic and propylene, some of the feedstock used to make epoxy. So we are very excited to get into the new platform at the right time of the cycle, at the right position. They serve the global business. They are either #1 or #2 in many of the markets they serve. And we have experts who's been with the business management team of the Hexion's epoxy business for many, many years. So look forward to welcoming them and the rest of the team into the Westlake family and to grow and build its business going forward.

Just in terms of epoxy pricing, Albert. I think North America were around $3 a pound. Rest of world prices are high for epoxy. What's sustainable here? And you noted some underlying tailwinds from renewable energy. So what's your outlook on the price dynamic?

Well, we haven't closed the business yet, so we don't want to talk about the price dynamics of the business. But we are very optimistic of able to add value and grow the platform. As I said, this is a new platform for us, and we'll get into more deeper with the expert team that we are bringing on board into Westlake. And they are in presence, a big presence in the U.S., in Europe and Asia and major markets for windmill blades, automotive, aerospace and coatings. They have some green products coming on. And so we're very excited to grow that platform. We think a lot of opportunity to grow that platform, especially to integrate into our feedstock position that we have. So we look forward to that closing, which hopefully will be the first half of next year.

And then turning to PVC and downstream building products business. Now on a pro forma basis, will you be long or short PVC? And then how fast can you pass on higher PVC prices into those downstream building products and keep margins intact?

Steve?

Yes. So Eric, we're fully integrated in the vinyl needs that our downstream building products has. In fact, we're a large customer -- internal customer of our PVC businesses. And certainly, with the addition of the portfolio with Boral that, that brings, it really expands greatly the offerings that we have in our downstream building products business, very significantly allows us a broader geographical footprint and a wider customer base. And certainly, as we think about the run that we've seen in pricing and given the very strong demand we've seen in building products materials, we're able to adjust those prices based on market conditions and based on supply and demand conditions fairly promptly. So the intent really is here is to make sure that we're offering our customers a good product offering and making sure we offer them at fair and value prices. And we've seen over the course really since mid-2020 through 2021, prices for resin have risen. And as a consequence, we've had to raise our prices in PVC building products. Put simply, that's our function of kind of supply and demand dynamics. Our intention really is to bring best value to our customers in that downstream building products business.

Great. We had an investor question come in. Does Westlake expect to face demand issues from China next year, given the well-documented issues with developers? And he stated that developers are currently paying their bills for existing projects but may not for new ones.

Well, the Chinese economy is huge, and the projection has continued to grow. And the construction business is a major part of the economy. But having said that, China does not export a lot of its PVC. And its PVC, 80% of it is coal-based, and the government has decided to really take a strong initiative to reduce greenhouse gas emissions. And you see the dual control was an indication of determination of government to reduce greenhouse gas emissions to the targets of GDP -- per unit GDP of value creation. So we think going forward that the high-cost, less-efficient -- energy-efficient plant will shut down. And so the rest of the world really is counting on America to produce and supply PVC needs to do their needs. And we mentioned that China and Europe both have very high energy cost and the high ethylene cash cost from raw materials. And U.S., we are blessed with a great gas price for energy as well as the gas price for our ethylene feedstock. So we are really the major producer or the only producer that supply to the rest of world vinyl needs. And because of the heavy investments to be integrated producer, not many countries or companies want to invest that much money in the business and have high feedstock position -- feedstock cost position. And so I think the industry in the U.S. and Westlake, we're positioned a very good advantage position to supply to the rest of the world and, of course, to the U.S. market which is also growing.

Yes. That's a good point, Albert. Demand for domestic PVC has been strong. So how much do you export versus historical trends? And then same for caustic soda, how much do you export versus the caustic market?

Typically, we export less than industry for PVC because we have a very large downstream integrated building products business. And on the chlor-alkali side, since we don't use much chlor-alkali, we are pretty much average to the industry average. It's like in the mid-20s percentage of production chlor-alkalis exported.

Very helpful. And then you noted that there might be closings of higher cost capacity in China. Now could you help frame how much in terms of 1,000 tons or 1 million tons you might expect that coal-based capacity could be rationalized?

Well, that's a good question. I don't think there's a good study out there. As I said, 80% of PVC in China is coal-based and could be -- I have no idea. Maybe 1/3 or 1/2 are considered high cost and not integrated, and the rest are integrated coal mines. But if China is going to even phase out coal use consumption, even the integrated guys, not because of cost basis, going long term based on the short term, that people can save on more ethylene based on lower carbon footprint of PVC than them having to go into ethylene base, which is expensive to convert and invest.

And then last, just on the pricing front for ECU and PVC. Now what are the trends that you're seeing in the fourth quarter? And typically, with the seasonality in historical periods, you can see lower chlorine utilization, higher caustic soda prices. But any comments there, Albert?

Certainly. Caustic price is still -- export caustic price are higher than domestic caustic price. Likewise, in PVC, export price of PVC are higher than domestic PVC. So I think U.S. position-wise, there's a potential going up in price movement. But I think, as Steve said earlier, we are conscious of the value we'll bring to the customers. So it's a balance between the supply-demand and price domestic and export. So we are very conscious of the value that our customers can foresee and utilize the PVC in the best way they can.

And turning to the Olefins business, Lyondell in the prior presentation was saying that they did not experience the net transaction price decline that I had just marked in October of $0.10. It was less than that. So what's Westlake's realized pricing in that month? And do you view the additional or incremental $0.10 decline by year-end to hold weight?

Certainly. We are not -- we are second largest LDPE manufacturer in the U.S., but we are not that big in polyethylene, totally [ equally ] low and high density. So we pretty much follow the market. And I think the market, I can speak from our knowledge, that is -- the demand is still very strong. Export price has come down somewhat because of the Chinese capacity additions and also U.S. capacity coming up. And industry consultants are saying there's potentially $0.05 a pound reduction in October, November, December, and we're seeing some of that. And -- but we have very high price increase during the last 12 months. So as more supply come out, the inventory is getting a better position in the U.S. Price will be more moderating from the height that we have increased in the last 12 months. So I think it's a very transparent dynamic to supply and demand market. It is what it is, so that we are just following the market. We don't have a pricing position in that since we're not that big in that market.

Right. And then on polyethylene demand in terms of pandemic impact and higher use of plastics for packaging, we've seen 100 to 200 basis points above historical growth rates. Do you see that sustainable into '22 and going forward? Or what's your view in terms of the demand?

Sure. Domestic demand is still very strong and growing. But the U.S. capacity-wise added 50%, 60% in the last 5, 6, 7 years, so huge amount of capacity added. And that will be absorbed by domestic demand growth, and U.S. was exporting 20% before the capacity additions, and it's grown to 30%, 35%, sometimes even 40% of production is exported because of the large increase in capacity. And -- but U.S. has a good cost position compared to rest of world. So we are able to compete and export. And some of the country in the rest of world are not able to -- for example, in China, the integrated ethylene and polyethylene guys on a cash basis are losing money because the prices are lower for polyethylene and the high-cost naphtha they have to use as a feedstock from oil. So dynamics are different. And the U.S. is still able -- even the price decline before forecast, we're still able to enjoy pretty good profits.

And like you said, you don't have the exposure to more commodity HDPE, rather LDPE and LLDPE. So how much of your PE sales are into that packaging end market, which tends to be more stable?

A large part LD -- we are the second largest producer of LDPE in the U.S., and 60-odd percent of our polyethylene is LDPE, and we make various copolymers and even adhesives, elastomers with that. So we are better insulated and higher margin than the conventional polyethylene or even than the conventional tubular LDPE. 80% of our LDPE is autoclave, which is a more specialized polyethylene, higher margin than the new additions, which are mostly tubular, which is the commodity type. And most of our product goes into packaging. So I think when package demand goes up, we will be enjoying there. And we have our copolymers, as said, which goes into other specialty non-packaging and more durable products like the carpet backing, adhesives and all other things. So I think we have a very good position in the PE position. But we're still impacted by the grand industry dynamics that's happening with more capacity coming on.

And then on margins, industry IHS margins were above $0.60 per pound recently. How do you see that going forward in a normalized versus historical average?

Well, I think, as I said, some of the industry analysts are forecasting price declines quite like $0.05 a pound for the rest of the year. And then early into next year, there are different viewpoints on how much next year the price will decline. But net-net, even after the worst decline these people are forecasting, the net-net still compared with the price increase enjoyed the last 12 months, there's still a positive contribution compared with before the pandemic. So I think, well, time will tell what will happen. But at least the outlook is that the margins will still be good, not as good, of course, before when the pandemic -- when the margin has a $0.60 increase, but it's still acceptable margins.

Great. And then I know we're coming up on time. So maybe a last question. Westlake short of roughly over 1 billion pounds of ethylene. Do you expect to further integrate? Or are you comfortable being a net buyer in this environment where we're at, ethane prices in the high 30s? Or how do you see opportunities to further integrate? And are those economics attractive?

Steve?

Yes. So we have opportunities to think about debottlenecking, and we'll certainly evaluate those. We started up this joint venture cracker in 2019, and there's opportunities to consider debottlenecking that new unit. And certainly, as we assess really what the capital cost is on a dollar basis per pound and what the value proposition is, we could probably fill up to half the shortfall we have with a potential debottleneck. So we'll assess the economics of something like that to invest. But there are opportunities to pursue such as that, and we'll assess whether that makes good sense. So I think there's -- it's a good position to be in to assess how we fill those short positions. And it's always nice to have some flexibility in your integrated chain from an ethylene perspective.

Great. Well, I have no further questions from investors at this point. So I want to wish you both a happy holiday season, and thanks for taking your time and talking about Westlake and your businesses and recent bolt-ons. So I appreciate it, Albert and Steve.

Thank you, Eric, and happy holidays, everybody. I appreciate your time, yes.

Thank you. Happy holidays. Thank you much. Bye now.

I appreciate it. Bye. Be safe.

Bye.