Westlake Corporation (WLK) Earnings Call Transcript & Summary

Okay. Welcome back, and I'm glad to host this next session with Jeff Holy from Westlake. I have to relearn to not call them Westlake Chemical, which we have successfully changed the name in our database that requires a significant level of effort in Bank of America. It just sounds like I can just backspace and erase the word chemical. But anyway, we're glad to have you, Jeff. So a year ago, you and I had a fireside chat, Jeff. And I asked you when you were going to split out of the Building Products business. And here, recently, you have. And I also brought something that is not going to surprise you that I wanted to bring up, but it's a little small for me. But anyway, what this is, is a PVC fitting. I'm a bit of a...

You bought it from the wrong person by the way.

Sorry about that. This actually came from the bathroom upstairs. So I'm a bit of a weekend handyman. And I figured out one day that PVC sells for roughly $1 a pound, but this cost me $3 a pound. So there's clearly a value proposition in being further downstream. And I wanted to really hear your view on this, Jeff. You're diversifying into more downstream businesses. Obviously, you're back integrated into the raw material that is used to produce this, but not everything that is in your Building Products business, now is based on a feedstock that you produce. So is there an argument here that, that whole industry is inefficient that you could drive efficiency gains? Do you want to increase going downstream in more products? What is it about building products other than that I pay 3x the price for this, then you sell the raw material for? What is it that is so compelling to you about building products?

Yes, it's a great question. And certainly, if you look at what Westlake has been doing over really many years now, but really accelerated by some of the acquisitions recently is moving further downstream. And so I think a large part of our strategy, frankly, is to execute on that downstream strategy and get closer to the customer. So the reason we like that is, in particular, we're adding something more value added by moving downstream. So if you think of that generic PVC resin, very useful product, obviously, easily exported. U.S. is in a very, very good position globally from a cost perspective and being competitive for that export market for resin, but being able to have that fabricated products business here in North America and take our own resin into those downstream product like this fitting, it gets us closer to our customer and it gets us, we think, a more value-added proposition that differentiates us. And one thing as well about that Building Products business is obviously part of the goal around our segmentation is to really highlight the earnings stream to investors that segment generates, it's an earnings stream that typically does trade at a pretty elevated multiple relative to, say, more commodity chemical companies. And a good part of the reason for that is that margin does tend to be a lot stickier as well because of that more differentiated downstream element to it. So that's something that we certainly like about adding those products into our portfolio is getting closer to the customer and building out that integration along with building out more resiliency and stability in our margin profile as well.

Do you see opportunities to cross-sell or to sell in new geographic regions, the other sources of inefficiency that are in that industry in -- that business?

Yes. And I think an important element to highlight, which you mentioned in the prior question is with the recent acquisition of Boral North America, that is an acquisition, which is a lot less about downstream integration in the sense that Boral's business uses very little PVC resin. But our strategy there is very much to build out on that building products business itself. We think having a lot more size and scale in the marketplace makes us more meaningful with our customers which helps drive revenue. And if you think of a lot of the distribution channels we're going into in that business, typically, you're dealing with a single salesperson for a lot of these products, and that's true not just with the PVC products, but with a lot of the Boral Building Products, for example, that we acquired as well. And so we think there's a lot of attractive cross-selling opportunities now by being able to offer customers a broader range of products that can deal with a single company versus multiple companies, which improves their ease of doing business. and they can do it with a company in Westlake's position as a very strongly rated Fortune 500 company, where the warranty and the backing and the financial wherewithal is without question as well, which helps in that space where there are some smaller competitors there that, I think, just can't offer some of those benefits that we can to our customers.

How much of this business is going through big home centers versus smaller distributors?

Yes. About 80% of our sales are going through typically either direct or mostly one-step distribution, and that's typically where you want to be in that space is really that one-step distribution because that distributor can really serve its end customer well, but you're not going through multiple steps that create a bit of inefficiency in the sense of each step taking a bit of margin. We sell a little bit into the Home Depot and Lowe's of the world, but most of it is going into those one-step distributors that are dealing more on the -- directly with the commercial side of those businesses. And we even sell directly into some of the homebuilders as well, for example.

And is that opportunity increase by having a more diversified building products offering that you could sell more direct?

Yes. It certainly does in creating that larger scale and being able to offer more to your customers. I wouldn't say necessarily it increases our ability to go direct to the end consumer, but I think it makes us certainly more meaningful to those distributors and probably should improve our position with some of those, say, homebuilders or large buyers as well going forward.

Does it give you some pricing power to have a broader platform?

We hope so. I mean, it's a competitive industry but one where certainly being able to offer your customers the products they really want is meaningful. And as you know, as well, it's a little bit different than some of the chemical chains in the sense that brand also means a whole lot in that space. So for example, the Boral business that we acquired, they have leading brand positions across really their entire portfolio and sort of pick out one, say, they're the leader in decorative stone products, so that decorative stone veneer that you see in a lot of homes, they have probably 50%, 60% market share on the premium end of that market. And a big part of that is because people know the brand. They associate it with the very positive attributes of what that brand is offering and that offers an attractive margin profile as well, which helps you get price and importantly adds stickiness to that price as well because you're not just paying for a product, you're paying for the brand as well and what it means.

That's interesting. And it reflects a change at Westlake, and I wanted to bring up Roger Kearns, who had a very meaningful role in your last call. And he was a longtime member of the Solvay team. And I just wanted to ask you, if somebody like that, that's really been more involved in specialty chemicals and more focused on brand, is that deliberate that he is now taking maybe a little more active role in this movement downstream?

Yes. So I mean Roger has obviously got a great background working at Solvay and he worked really across the globe for Solvay running different businesses as well. So it really brings a great operating profile to Westlake. He was appointed our Chief Operating Officer, roughly 12, 18 months ago. I think really highlights the important role that he's serving on the management team. I think part of what we want to do as well with some of the outreach we're doing with investors, and we have an Investor Day coming up in New York on April 7, is really ensure that we're having investors see some of the folks on the Westlake management team beyond Albert and Steve, that you typically hear perhaps most on the earnings calls and some of the Investor Relations conferences. So Roger, obviously, is taking a very active role in that. We'll have Bob Buesinger, who runs our Building Products business or Housing and Infrastructure Products business presenting at that as our Head of ESG as well. And so we look forward to getting some of those folks more directly on front of investors as well to really show the strength of the management team that Westlake has built over the years.

Very good. I wanted to jump into Epoxy, another area that you've recently invested into. How long have you had an interest in Epoxy? And given our discussion about building products, is that another area where you could see Epoxy either you do more back integrating into the raws like Epi or maybe even downstream into building products that are derived or contain Epoxy resins.

Yes. It's a great question. And it's interesting because we've actually been studying the epoxy industry for a few years is something that we found to be quite interesting from a downstream application of some of our product portfolio. And again, going back to that comment I was making earlier about Westlake's interest in moving further downstream and Epoxy really represents an opportunity for us to do that on the chlorine chain along with caustic and propylene, which also go into Epoxy product. The biggest attribute that we find exciting about Epoxy and why it came up over the past few years and studying potential ways to grow some of that downstream interest is Epoxy's use and a lot of the more sustainable applications in today's society and going forward. Epoxy is a key element into a lot of more sustainable product areas such as wind turbine blades where Hexion has the #1 global position and producing Epoxy for the turbine blades for wind energy. And then a lot of applications that go into various light-weighting applications that are important for energy efficiency. So Hexion as well has the #2 position in both North America and Europe for light-weighting into automotive applications and the #2 position in European aerospace as well for light-weighting. And so as we think moving forward about renewable energy and energy efficiency, we really like the growth opportunities and sustainability change that the Epoxy business can apply into. And so we think that makes it a very attractive area to go into. And certainly, the integration benefit is why it makes sense to have that adjacency within the Westlake product chain. To answer the last part of that question, I think, certainly, it also gives us the opportunity given that adjacency within the integration chain to look at ways to build that out if it makes sense from a capital return perspective. And so I'm sure over the next few years, we'll be studying opportunities to invest capital in that business either to build out some of the operational integration or, frankly, as well to grow that business given those attractive growth attributes. And because most folks probably are aware, Hexion was a somewhat financially constrained company as well, and so not unlikely that there are some opportunities within the product portfolio that can offer some good returns that may just not have been acted upon due to their higher cost of capital in the past.

Interesting. Maybe another similar type of question on polyethylene. Is there opportunities to move downstream in polyethylene that you are looking at that could also be a bolt-on on to building products?

Yes, it's a good question. So I know it's something like PEX pipe is one that can get brought up. The challenge there is, if you think of where we've chosen to compete in polyethylene, and we very much feel like this is the right position for us to be in, and we've really focused on that more specialty or differentiated and specifically in low-density polyethylene. And looking forward over the next few years, we think that's a great position to be in because there's much lower capacity growth in the global marketplace. Now there's more capital involved in building that out. The markets are more differentiated. And so we really like that niche we've carved out to be a leader in supplying low density and in particular, autoclave low density. Those are, however, applications that are mostly going into a lot of packaging applications. And so I think that's most likely kind of where we want to be in polyethylene because building out some of those other potential areas probably means moving over to the more commoditized end. But certainly, we always look at opportunities over time and where things make economic sense. So we never say never, but I think for now, we feel well positioned where we are on that side of the business.

And then maybe just jumping back to the Epoxy question. Now that you are basic in it. Would you now look at maybe bolt-ons that are in Building Products that would be downstream. I mean you're not going to get into wind turbine blade manufacturing, I assume, but there could be a lot of other opportunities. But now that you have an Epoxy business, might you expand in that direction?

Yes. I think that can also certainly offer a potential attractive set of opportunities. And I think that's one attractive element as well about Westlake. And I think certainly, Albert's reputation in the marketplace and proven history over time with Albert and Steve and the team of allocating capital very effectively that we have a lot of different areas where we can choose to allocate capital between whether it's polyethylene, the chloro-vinyls chain and chlorine, caustic, PVC or building out -- building products in a variety of different materials. It really gives us the opportunity set to look across multiple product portfolios that still make sense on an integrated basis, but where there are different return dynamics and really be able to most effectively allocate capital only in those areas that are really going to generate bottom line return. And so we're not going to feel compelled to do something in an area just because we have our product there if it's not going to get a return. And I think having those multiple avenues gives us attractive optionality set there.

And on the topic of focusing on higher return projects, it takes me back to a fourth quarter earnings call comment about at least it appeared, Westlake was more interested in adding capacity, whether it's EDC, VCM or PVC but not chlor-alkali. At least that was our take. I welcome your comments on that. Is that based on a view that there you have sufficient capacity in chlor-alkali? Or is it driven by higher returns by expanding capacity downstream in EDC or beyond?

Yes, it's the latter, but it's also driven by our existing asset portfolio and the opportunities we have within how those assets are positioned. So I think over the next few years, we're likely going to be able to find a variety of interesting debottlenecking opportunities that should generate good returns on the capital invested. They're probably not going to be hugely meaningful from a global capacity perspective, but meaningful from the returns that we can get on deploying that capital to grow out some of those assets. And really, then you're looking at the individual assets and how to optimize that asset portfolio. So I would take the fact, and you're obviously correct, Steve, that we're looking at working on some projects this year to start building out EDC, VCM and PVC. And that's really dependent upon kind of that existing asset portfolio we have and how best to optimize it with how those assets are currently positioned. So it's not directly a comment that the return in call it, PVC is necessarily more attractive than the ECU side, it's just based on those existing assets and how they're positioned we think the best return of capital is to build out the EDC a bit to optimize that asset portfolio.

Okay. Is the outlook for chlor-alkali, it's more difficult to be -- debottleneck might be one way of looking at it? Or is there, do you see opportunities to maybe partner with other chlor-alkali producers if you needed additional chlor alkali capacity that might be a pathway as opposed to you're going sole sourced and adding new chlor-alkali capacity?

Yes. I think our existing asset portfolio, we can still find opportunities to build out some of the ECU side as well. The challenge -- a few challenges. One is, as you know, it's very capital-intensive to greenfield new chlor-alkali. And so that's part of the reason in the industry that you're not seeing much capacity getting added to that market. And we certainly think that because of that, the outlook for chloro-vinyls looks very constructive to us because you have pretty minimal supply additions occurring over at least the next few years, which is the time period of when anything that has been announced now would be built. And yet demand continues to grow at good rates given the growth in the global economy. And particularly on the chlorine side, given the strength in North American housing and global infrastructure. So it's very capital intensive, which adds a bit of a challenge to building new capacity. And then if you're talking about partnering with somebody, the challenge there really becomes optimizing the plant from a utilization rate and the chlorine offtake. And I think that probably becomes a bit more challenging with the partner as well, not to say that that's a definitive statement based on how this, the particular arrangement might be done. But I think, certainly, our view is we really like the integrated chain of chloro-vinyls through PVC because it gives us guaranteed offtake all the way through the chain. And it really allows us to run those assets more efficiently because we control them and have that guaranteed offtake all the way through.

Is it your view that the market in chlorine has gotten more disciplined, and we're likely to see higher pricing for the ECU products in a more sustainable way? And if so, does that help or hinder PVC pricing down the road?

Yes. It's a very good question. And I think the largest driver of that really goes back to the preceding comment that we're not seeing meaningful capacity getting added to that market. So a good part of that ECU strength and the strength in chlorine we're seeing is really that you're continuing to see a better supply-demand balance because demand continues to grow and capacity is not keeping up with that demand growth. The other comments to it is a little bit of perhaps chicken and egg response to the chlorine growth affecting PVC because as we see it PVC is really what's driving the chlorine strength foremost. In North America, PVC demand is about half of all chlorine off-take. And as everyone I'm sure is well aware, the housing market has been exceptionally strong, whether it's new construction starts or repair and remodel activity. And looking ahead, likely infrastructure spending ticks up as well with the infrastructure bill and globally with infrastructure projects taking place. So we see a very robust outlook for PVC demand, and we really see that driving the strength in chlorine.

Okay. That's helpful. Some export pricing on PVC has fallen, contracts staying still more stable? Are you concerned about that?

We certainly watch the export market and supply into the export market. But I think what we have seen over the last 6, 9 months or so is that the export market is becoming probably a bit more volatile just with a variety of supply-demand events globally in the PVC market, probably most notably dual control measures in China that can tend to turn stuff on and off, and you'll see some of that flow through in export pricing. But the majority of our PVC we, of course, sell domestically, and we actually have a higher weighting to that because of our downstream building products, which we sell only within North America. So that actually gives us more resin offtake that's going into the North American market. And in North America, we continue to see this very, very strong demand outlook given the strength in housing and given that inventories are still quite tight on the Building Product side. And so we think that gives us a lot of optimism for how we see domestic pricing continuing to play out for PVC, given those dynamics.

Do you see Epoxy pricing at a peak here? Or do you think it's sustainably high?

Yes, it's probably, you never want to say peak, but we do see it at elevated earnings relative to what we think it's probably going to do, call it, mid-cycle or run rate. What we do see is most likely a market that structurally improved from where it has been in the past. And so we think pricing is probably not going to stay where it currently is, to be fully transparent, and probably the back half of this year is not as high as the first half, for example. But we also don't see Epoxy pricing going down to, say, the 2019 or 2020 type levels as well. And so we do think it is structurally improved going forward, but probably not at the current levels. And just to add a little bit of additional comment or support to that. At a trailing 12 months basis, we would have paid below 4x for the Hexion business. So clearly, we weren't paying a price for that business, assuming that the current earnings were going to continue in perpetuity, but certainly think it's going to be an attractive business over time nonetheless.

And your disciplined [ ROI ] contribute to that?

We hope so.

Yes. I wanted to drill in a little bit about ethylene and your position there with, particularly with the Lotte cracker. Is that one that could either see opportunities to expand, to add more furnaces and increase the capacity? Or is it more likely that you would increase your ownership in it?

Yes. And as background for the group that may not know as much detail, we're still assured as Westlake about 1 billion pounds of ethylene. So we do still have a short position in ethylene, and that's at today's current production rate. So as we continue to grow, that potentially increases as well. We did mention on the fourth quarter earnings call that we were increasing our ownership in the Lotte JV cracker up to our full 50%. Currently, it's roughly 47%. So we're just incrementally taking it up to what the full 50%, which is contractually what we're allowed to do as part of the JV arrangement. So most likely, that's kind of the ownership level going forward at 50-50 level between us and Lotte or JV partner. But being a new greenfield cracker, it is built with additional debottlenecking capacity upfront. You typically -- as you know, kind of overbuild the refrigeration and cold side, so you can in effect, just add for and look to add capacity going forward. And so I think we, along with low table certainly, look at opportunity going forward and a decent likelihood that, that may be economic in the future to do.

I have a couple of sustainability questions, but anybody here want to jump in with a question.

So I had a meeting with your large counterpart in the U.S. market for chlor-alkali and Epoxies. And the question was brought to them about softening Epoxy markets and price moving lower, and they're saying, look, we don't care what the market does. We're not going to cut price. We will essentially just pull tonnage out of the market. And defend our stake until prices recover. And so when demand recovers, we will supply the marginal amount of Epoxy, but we'll do it at the price that we want. Can you take the same strategy? Because theoretically, the 2 of you enabling this volume over -- value over volume strategy would yield a larger market impact than just 1 player doing it?

Yes. It's a good question. And obviously, we want to do what's going to maximize value in the long term for that business. And I think our business with what Hexion brings is in a good leadership position in having a lot of the specialty applications in Epoxy that do have some added value as well that gets specced in. Hexion kind of competes both in some of the more upstream areas of epoxy as well as some of these more specialized areas. I think it's still a competitive market, though. You still have a lot of Asian competitors, and we do think they're behaving more rationally. So again, we foresee pricing holding up well. We're just not necessarily banking on the current level of profitability continuing. Obviously, it would be great if it does.

And then maybe one quick one for you. Are your ethylene crackers all exclusively ethane-based, and thus being able to run some renewable naphtha through there is not likely?

So we do have some flexibility within our crackers. Not to kind of go into too much granularity, but we have the ability to run naphtha or propane in some of our crackers, not all, but some. So there is flexibility there. The issue historically is ethane has in our view, consistently been the most favored feedstock from a cost perspective. And even when say, on the screen, it looks like it may not be at the very short time periods where some of those positions flip, you're still then typically running a lot more coproducts that then cut your ethylene production because of the large coproduct offtake, and so we found pretty much consistently it makes sense to run ethane albeit we have the flexibility to crack different feeds. The question on being able to run potentially more sustainable feeds through there is an interesting one. And certainly, we always look at how to advance our sustainability-oriented products, in Europe, we are making PVC now with a bio-based ethylene feedstock. It's one we're purchasing. We're not cracking it ourselves. We are purchasing it and then utilizing our own chlor-alkali production that has green energy associated with the ECU for it. So I think it highlights that certainly, we are looking for those types of opportunities. We haven't say necessarily found that in the U.S. for running different feeds into it. But certainly, we're interested in finding ways to increase our slate of sustainable products, particularly when it makes economic sense to do so.

Okay. We are out of time. Thank you, Jeff. Please join me in thanking Jeff for his comments here.

Thank you, everyone.