Westlake Corporation (WLK) Earnings Call Transcript & Summary

So my name is Eric Petrie. I cover Eastman chemicals on the team under PJ. And we're happy to have our next fireside chat with Westlake Chemical. And we have CEO, Albert Chao and Steve Bender was going to be here, too, but he came down with something. So he's a free pass, but we have Jeff Holy in his stead. So Westlake has expanded its portfolio into building chemicals and products with acquisitions. So we look forward to hearing an update from you on the housing and construction end markets. And they also retain a solid cost footprint with the majority of their assets based in the U.S., so they have a feedstock advantage. So Albert, thanks for being here and let's kick it off.

So on your third quarter call, you noted quite a few headwinds with economic challenges, higher energy costs, rising rates, slowing construction end markets. So similar to the other chemical companies that we've had presented today, they've matched demand by lowering their utilization rates. Can we get an update on your end markets as they stand today?

Sure. Vinyl business is our biggest market in terms of integrated from chlorine, ethylene to PVC to downstream building products. The upstream we call PEM. And the downstream, we call HIP business. And we have books on that we want to as on our online business, so the upstream performance, essential material vinyls is both on the performance side, which is the polymer PVC, and then the caustic soda, which is the essential side. And as you know, for every ton of chlorine produced from electrolysis of salt, you produce 1.1 ton of caustic. So it's a [ fair ton ] and become store chlorine. It's hazardous. It's a gas, where you can store caustic. So basically, you produce to the demand for chlorine. And the biggest use for chlorine in the U.S. and around the world, about 50%, 60% of chlorine is used to make PVC. And PVC, as you know, more than 50% goes to the construction. So construction is the most -- more and most volatile business, and with the housing slowdown from the higher mortgage rates and higher housing costs, we see there is a reduced demand for new construction for residential homes with a single-family and multifamily. And as a result, demand for PVC has slowed down and the demand for building products, we call the HIP business, which is housing and infrastructure products and also slowdown. On the other hand, when you reduce production of chlorine, also reduce production of caustic, as I said, it's a [ fair ton. ] Caustic demand has followed GDP. I mean applications much broader. Caustic is used in making soap, consumer products for -- into alumina refining, into pulp and paper, into refinery. So it's very, very broad. It follows GDP, and GDP really has not had that much of a slowdown compared with housing. So demand for caustic soda very strong, yet production has come down, hence, caustic prices gone up. So despite PVC price has slowed down -- PVC demand slow down, prices come down, caustic price is going up because of the shortage of supply of caustic. So in a way, they are balancing each other. So we are the second largest producer of caustic and PVC in the world. Even though PVC demand has slowed down, our total integrated chain margin is still quite high. And as a matter of fact, we are still increasing caustic price. Now still if GDP continue to slow down and if next year -- we will talk about the forthcoming recession, if it truly happens, it will reduce the demand for caustic. And then everything being equal with less demand of caustic, caustic price will come down. And that's why the industry consultants are saying that maybe next year second quarter, while they increase prices, the caustic price will come down. Time will tell. Going back to your question on the housing side that we saw with the housing meltdown in '08, I think in the U.S. new residential construction with a single, multifamily. At '06 was like 2.3 million units a year, and '08 with housing meltdown dropped 400,000. And then over the last -- next -- in the U.S., 14 years, has climbed slowly from 400,000 back to 1.5 million units and 1.5 million is the 50-year average of U.S. new home construction, multifamily and single-family combined. So we just got back to the 50-year average. And the demand -- the population has grown a lot in a 50-year average. The demand is very strong. So even though we are seeing because of the high cost of housing and high mortgage rate has slowed down the demand for housing, homebuilders come out with smaller square footage solid homes to satisfy the lower price for builders. And we'll see whether the federal government or anybody will do anything regarding the mortgage rates to make it more possible.

Very good color. And then could you talk a little bit about operating rates and it might differ between chlorovinyls, epoxy, polyethylene? But tell us where they stand today, particularly in Europe. And what's your thoughts on destocking. It seems like most managements are kicking the goalpost into first quarter, second quarter even of next year.

Okay. From our point of view is that destocking is pretty much -- I won't say over, but people's -- prices start coming down polyethylene and PVC and -- other than caustic, since probably May, June, July, I think we hit probably industry high depending on the products in May, June, July. And polyethylene has dropped probably, what, $0.15, $0.17 during the last 4, 5 months, PVC dropped $0.40 a pound in the last 4 months and expect it to drop a little more. So all our customers, people are very smart. They see the writing on the wall, price coming down. That's what [ it holds ] or less. And they are using the inventory which they build up, whether because of hurricane concerns or the business so good they order ahead. So in the last few months, people have been destocking. And I think pretty much destocking is over. What is happening now is people don't have a good feel what the new level of demand would be and how much stock they should keep. So if you watch some of the industry analysts, they say -- they see outstandings going up -- maybe that's true, not because inventory is going up, inventory is down, but the sales down more than the rate of inventory coming down. So if it was less -- lower inventory volumes, the days sales outstanding; they have gone up. But it doesn't mean that people are cutting inventory. So you talk about inventory operating rates, as I said earlier, people look at chlorine based on chlorine demand and the biggest use of chlorine in PVC. And PVC, because of the slowdown in construction in the U.S., they had to export. In export, we had a lot of problems with logistics. The docks were full, warehouse were full, the ship that coming in and China also are dumping because of the lockdown, [indiscernible] dumping their capacity PVC overseas, price is low. So I think the industry operating rate more like in the 80% range. So people have significant scale down for PVC. And as a result, chlor-alkali plants also scaled out. And polyethylene, the scale down to reduce inventory. But I think the last month, right, they have increased production a bit to -- so inventory seemed to have gone up a little more. And actually, polyethylene price has stopped dropping. And I think October, November, December -- October, we just finished prices flat. November is flat to December, [ table things spread ] also and actually January people talk about $0.05 a pound increase in polyethylene in the U.S., partially because the feedstock for ethylene and natural gas price going up [ into time. ] So it's more of a defensive for the cost going up rather than increase margins.

Good. And then moving from the shorter term, more to the longer-term outlook, how do you view ECU and PVC fundamentals, where do you see reinvestment economics? I mean caustic soda prices, chlorine prices are moving higher, PVC at $1 per pound roughly. So how do you see reinvestment economics?

First of all, if you look at those prices, our list price, they're not real price. The actual price is much lower than that. Do you want to answer this or should I answer this question?

All right, okay to go ahead but...

We were having above investment economics during the May, April time, we had all-time high. You kind of look at chlor-alkali economics by itself. You got to look at integrated because if you go to chlor-alkali plant, who we're going to sell the chlorine too. So if you look at the whole chain, we had above the investment economics, not today. Today, ethylene spot price, we have 0 margin. Chlorine, you have very good margin. PVC, if you transfer chlorine at high price, very low margin. If we export, we have 0 negative margin, actually subsidizing chlorine. We had a negative chlorine to justify exporting PVC. But you made up on the caustic side that not exceed that -- the negative margin. So today's price does not allow a margin return on PVC to the whole chain.

Okay. Good. And then turning to feedstock costs. Our keynote lunch speaker, [ Ed Morris ] was saying, we expect NGL barrels supply growth of 400,000 to 500,000 barrels per day. So how do you see ethane prices, which is what you cracked and maximize the...

It's good. [indiscernible] Good news. Basically, and also with a forward look, ethane price today is $0.40-odd a gallon. And then next year is looking at the mid-30s -- low to mid-30s. So people are projecting lower price for ethane and propane. As you know, there is -- there are export terminals for ethane, people are building more. But until more ethane terminals are built, there's a limited amount of place to use the ethane, whereas propane is much easier to build the terminals and export. So propane price can still be high because they're able to export and compete with oil, whereas ethane, if you don't have a terminal and receiving in both sense, then ethane price should drop, which is good news for us.

And then maybe taking a broader step back, looking at cost curves, how do you compete with energy crisis in Europe, you have a specialty PVC Vinnolit over there. So could you talk a little bit about your cost position?

Okay. Sure.

Yes. And I think that's a good segue from Albert's comments on NGLs because it highlights that the cost advantage we have here in North America, we see us being very durable versus our global competitors, whether in Europe and paying a much higher price for electricity from higher gas costs, obviously, a much higher oil price globally or Chinese competitors, which have a higher cost base from coal-based production. So I think here in North America, we're certainly very well positioned to export our products globally at a significant cost advantage. And then when you look at the businesses we do have globally, Vinnolit is a good example because there, we may not have that cost advantage we have in North America, but we have the more technological specification of specialty PVC there, where we can compete more on a specialized product basis. That Vinnolit-PVC on average, we get somewhere between $0.25, $0.30 of additional price over commodity-based PVC. And so that puts us in a position to be able to compete better despite what isn't a cost advantage like we have here in North America.

Great. And then turning to ethylene, polyethylene supply/demand. Where did producer and converter inventory levels stand in your view, are they growing and above normal? At normal? Or how would you quantify that?

Certainly, I think destocking is going on almost over. And I think inventory at the converter level, definitely is normal. I don't know -- the old normal or new normal. The producers are probably above normal. Producers are partly just be careful because the demand domestically is only so much. If you lower the price, you're not going to get more sales, everybody are big boys, Exxon, Chevron, Dow, Lyondell, new Westlake, and we're not going to roll a trade there. So if you want to sell more polyethylene, only way is export. We export, you talk about 30 to 90 days extra inventory. So you had to put -- sometimes the warehouse not ready to pack your products because everybody want to export, right? Because as I said that's the escape route. When you don't want to throw your x capacity to domestic market rule in the market, you export. All the export terminals are packed. So railcar, you've got to wait until ready to unload and load we put in the bag, and then wait for boat. If the boat [indiscernible] congestions and shipping is not right. So you're talking about 30 to 90 days inventory for export. Domestic, we put a railcar and ship it to a customer, 90 days -- 30 days, it's over. So inventory number may look higher for polyethylene or PVC is not truly that they want to have inventory nothing that's sitting for export, which takes more inventory...

Okay. And then I think part of the reason why we're seeing lower polyethylene prices is due to high single-digit capacity growth on the polyethylene side in North America, but your mix is a little different in terms of your sales in polyethylene grades. So why don't you give a little taste of that, if you can explain it?

Yes, sure.

Yes. And that is a very differentiating factor with us. Most of our polyethylene production is low density polyethylene, and the majority of that is autoclave low density, which is the most specialized form of polyethylene. And there's 2 real keys to that differentiation. One is that we get a higher price for that more specialty-based polyethylene. But second, and very much to your question, that if you look at where the growth in polyethylene capacity is coming from, it's in the more commoditized grades that is outside of our primary focus in polyethylene. And so we feel like we're very well positioned not just with that higher specialty margin, but also that you don't see that additional capacity growth really going after our primary product of that autoclave low-density polyethylene.

Turning to epoxy, which is a business that you purchased from Hexion. How much are earnings down due to competitive pressures that you're facing from higher exports from China, they've significantly increased their LER exports? And then how much exposure do you have to wind energy?

Okay. First of all, wind energy -- we like exposure to wind energy. We are the world's largest supplier of special epoxy resins for the wind turbine blades, our epoxy formulated can make windmill blades over 100 meters long, single blade. And as you know, the longer the blade is more efficient to windows. So we [indiscernible] can do that. So great, and the epoxy -- the windmill business is very strong in the U.S. despite the European economic issues, still very good in Europe. It's poor in China because of lockdown. They need more windows for discount make them and ship them because of the lockdown situation. Epoxy business, I think last year and early this year doing very well. Prices are very high, demand very strong. But since the middle of the year, things start to slow down. And U.S. is still very good, demand. Very good prices. Europe is good prices, but demand is weakening because of recession. And China is just terrible prices and terrible demand because of lockdown. And China, yes, they have epoxy plants or LER, liquid epoxy resin, which are the more commodity grades. And for Westlake, we have both commodity LERs and specialty resins or related, we call it EPS, epoxy specialized products. And those products are commanding very high margin and prices over the commodity grades. So China is exporting LERs mainly to Europe and reducing the European price where they can. But they're not able to supply the specialty -- epoxy specialty grades that we make.

Good. I think that's a good overview of PEM. So we'll switch to your HIP segment, your housing and infrastructure products segment. So this is where we get into some of the Street consensus of U.S. housing starts down 20%. We have repair and remodel, which is holding up, growing about 3% CAGR over time. So what's your outlook on sales next year? And pricing with lower PVC, how do you reset pricing into next year?

You try...

Sure. So this year, we've guided to $4.5 billion to $5 billion of revenue for that HIP segment. We obviously just resegmented that business at the beginning of this year to highlight really the size of that business to Westlake with both the growth we've had in that business over time as well as a couple of the recent acquisitions, Boral, LASCO, Dimex. If we look into next year, and I think highlighting the R&R piece is important because about half that business that goes into housing for Westlake is on the R&R side where we're still seeing good strength and that typical, much more stable demand profile. And then while we are seeing obviously housing starts come off, we're seeing that come off but still what is a decent level really historically speaking, if you think about where it's been over the last decade or so. So overall, we're probably looking at a revenue profile that doesn't look much different than 2022 does.

And I think, Albert, on your last call, even though you said weak PVC demand, large pipe was strong, helped by infrastructure bill. So why don't you give us a little flavor into that? And then how much of your sales do go into pipes and fittings within the broader HIP segment?

Well, the pipe and fitting business is a very important component. We have 3 businesses in the HIP. We have pipe and fittings. We have a Royal [ products, ] which is all around the house. And then we have a compound business, PVC compound. And all of these, we have the [indiscernible] the HIP business was housing infrastructure. The Royal business is all housing and infrastructure, whereas the pipe and the compound goes infrastructure. The pipe will make large standard pipe for wall and sewer and then the compound goes to wire and cable coating, a lot of goes into electrification side. So -- but the HIP -- and then HIP, I think the housing is about 80%, 90%. The infrastructure is smaller. With the Infrastructure Reform Act that was the passed a year -- 2 years ago. We are starting to see slowly money coming from these municipalities and state government. So we expect next year to see more of that. I think the Congress allocated about $40 billion to $45 billion for improving the water and sewer infrastructure issues. So we're the second largest pipe-maker in the U.S. and focus on large diameter also. The fitting business is very important. Even though the fitting volume-wise is small, fitting business is one of the highest margin business we have. And we are, again, like probably #1 in the tube fitting in the U.S. and complements our pipe business. So we are growing that through LASCO acquisition that we're even getting bigger in the fitting business. So pipe and fitting business is a very important component of the HIP business. And as Jeff mentioned that there's still a lot of growth potential. So depending on the demand and recession, we think that HIP business potential growth volume is still pretty strong.

And a comment on pricing. Can you hold on to pricing if underlying PVC is declining in housing?

Yes. I think generally speaking, historically HIP business pricing, they don't change like resin price. Resin price change every month, right? We often go down. Whereas HIP usually once or twice a year, they have a price reset. Now having said it, the last 2 years was very volatile, increases in resin, we're able to pass through price increases more often than once or twice a year, but not every month. So as the price comes down, from a resin point of view, your -- the HIP prices are less -- follows much slower than resin price. So we're able to hold the margin a bit longer, but eventually has to slow down.

Okay. Switching to kind of ESG and IRA. How are you looking in terms of hydrogen and electrification of crackers? How do you view those 2?

You want to do that, do it?

I can start off, maybe you can...

Okay then, sure.

That's good. I think certainly, we're studying the opportunities that the IRA bill could generate. We actually make a good amount of hydrogen today within our existing operations. Question is looking at some of the incremental investment necessary to really monetize it hydrogen externally versus using it internally and similar with other IRA items like carbon capture, I think there's certainly some potential opportunity there, but it's about studying those opportunities for what's going to generate appropriate returns on those potential opportunities. But certainly, we're very mindful about looking to move the business in more sustainable ways and any opportunities that the bill could create.

Okay. I think at this point, I'll open the floor to the audience, see if they have any questions.

Good afternoon, Albert, Eric and Jeff as well. Just -- could you talk a little bit about your thoughts on China, obviously, about a lot of volatility and the hope of reopening and so on and so forth. But do you have a high-level view on how you think things might emerge there?

Yes. China is a $64 billion question. It's very dear and important to our business. In most commodity business, whether in oil, in cement, steel, petrochemicals, it's very, very important. They are the world's largest consumer, and probably producer in many of those products. And as we all know, China did lockdown for a good part of the last 2 years whereas the rest of the world, we're able to open up with the vaccination and get life back to normal. China has not been normal for 2 years, and I think people are fed up. And so President Xi -- even though he said he want 0 COVID. What's happening now just is not -- is scientifically impossible. Once he opened up, he allowed -- I think a month, 2 months ago, allow people to move in and out of China. That has brought variance of COVID to China, and now you have the highest infection rate. So the only way salvation is vaccination and they have to wake up. So -- and the demonstration of what I read and hear is all over China. It's not like Tiananmen Square was only 1 place in Beijing and only students. This time, it's everybody and all over China. So President Xi has to wake up and say, we want to do something different. This is my view, and it will be good to watch next few weeks maybe, maybe next few months or next few weeks. They can't plan down -- you cannot plan down whole China in terms of putting everybody in prison, neither prison is big enough. And people have -- the economy is terrible. And we have friends over there. The government people, they still paid by the government. But if you're an individual business, whether you are shop owner, everything else, they used up all the savings. There's no helicopter money, they used the PPP U.S. bailout. And they can't live anymore, so -- When that happens, it explodes, revolution will come. So I think it's good that China will open up. Hopefully, the leadership will rise. And when it opens up, we're talking with the group this morning, it will be bad for the [indiscernible] and energy consumption and driving. But for -- at least for the commodity business, it will be much better than what it's doing now.

I've got one more question on China. And I know you're very knowledgeable on China. What are the levels of inventories of plastics in China? Are they extremely low? Because they haven't used any plastics for packaging and...

Yes. I don't think inventory is very low. It takes cash to hold inventory. And if you have no demand, you want to turn your inventory to cash. And China being exporting a lot of PVC that they have excess capacity, and they sold a lot for the last 4, 5 months, and drive the price down. And then we are seeing slowdown. They're producing less, they're slowing down, exporting the price that's leveled off. So we are seeing signs of capitulating so which brings inventory destocking probably overall year old.

And in your R&R business, repair and remodel business, if existing home sales are down 20%, 30%, do you expect that to hold up? Or do you think that will go with the existing home sales?

It's about new home construction, so...

No. Not new home, but existing home sales. You buying my home and saying price is c***, everything...

I understand. If you sell your home, your low-cost mortgage will be done. So people -- I think 80% of the mortgages are under 3% or something in the U.S., right? The refinance over the last how many years. So nobody wants to sell the home and had to pay a high mortgage rate for new home. So what people do, they just remodel and spend money. So I think what Jeff was saying that -- an R&R probably will be pretty good and sustain our HIP business for next year because of R&R.

Right. So for the housing side, as we're mentioning, it's about half of the overall sales profile. And as well, if you think about both, as Albert mentioned, a lot of people who have "cheap mortgages", and so they look to just stay in their own home instead of entering into new construction, probably going to be more likely to look to then upgrade their existing space and spend on R&R. And the average age of the house in the United States is about 40 years right now. So a lot of those houses are fairly well aged at this point and needing more significant upgrades, whether it's the roof, the siding. And so that should also help stimulate some decent continued spend on the R&R side, even in the face of potentially lower new construction and new home sales.

And you made, I guess, 2 or 3 acquisitions, maybe more in housing infrastructure side. Maybe you could say, in the last few years, and now the market is down. How are they performing? What would you say on your scorecard? How would you rank them?

I think it's expected. We were a much smaller player in the housing side, even though we were #2 in PVC pipe for a long time, I think over 20 years in the U.S. We were not [indiscernible] only housing we got into was after acquisition of Axiall, which we have a Royal business in 2016. Then we got into housing. And we've been watching housing a lot because pipe is housing, but it's more infrastructure, every house needs to have water and sewer into the house, outside the house and [indiscernible] But the Axiall business was first time into the house. And we really like the business. It's a HIP business. It's much less capital intensive. It's very brand conscious. And we're able to buy Axiall, the royal business and then the borrow business. They have very good brand name, well-recognized, great management team, knowledgeable, and great platform, and I think in our book on Page 14 or 12. It shows we are #1, 2, 3 in the business we're in. And the HIP business is really a U.S. business. And you don't have U.S. -- you don't have international exports to the U.S. because it's very regional. People want delivery very fast to the scale they want. So it's a U.S. business, we don't export much other than South America a little bit. No imports. So if you're #1, 2, 3, and had a brand recognition, you got it made. It's like you have IBS ownership or Apple [indiscernible] buy an Apple or something. So the job now for us is get our cost down. So investing in robotics to reduce the labor content. We're introducing more ESG-friendly products and a lower-cost installation. And also like in pipe, we introduced this specialty-oriented PVC pipe. It's 40% lower in weight, actually stronger and lighter. So people can carry in store much faster, cheaper. We are selling at the same price. So it's all -- all these cost savings go to bottom line. So we are looking at a lot of new product developments. And also borrowers' business, they underinvested, they only underpaid so they have all high turnover staff, and we're able to improve that, and -- like adding one more shift. So all of a sudden, we can double our output. So I think we know what we got into. They're not the greatest assets, but it's a great platform for to grow, and we have a lot of plans to further get value out of it and grow the platform as the economy improves. And the demographic shows that demand for housing should really grow a lot for the next 10 years because of the housing formation age, 34 to 45 years are just coming up for the next 10 years, at least.

I think we have time for one more question.

Maybe I can sneak in 2. You mentioned you thought the HIP profile would look similar next year to this year. I mean if you have -- housing starts down 20%, and that's half of your business, what are the key drivers that kind of keep you in a similar mode as the current revenue streams? And then just quickly on working capital, can you cut your use down by a couple of hundred million? Can you use $400 million in the first 9 months this year, can you get it down to, say, $200 million? And does your CapEx roll down a bit next year as you work through projects. That's my last question.

Yes. Maybe on the housing piece. So if you think about that R&R mix. So on the housing side, it's about 50-50. So have that R&R component that's likely to grow into '23 to offset some of the weakness that we'll likely see in new construction. And then dimension as well that housing side is roughly 3/4 of the segment. We still have that infrastructure side, which is another quarter. And as Albert mentioned, we're starting to see some strength there as some of the spending from the infrastructure bill continues to bleed through in the municipalities. So I think both the infrastructure side and the municipality side should help support some of the softness for like we see on the new construction side.

And working capital?

Oh! And then yes, certainly, as you start to see potentially some of the costs come off or pricing, we should see some strength unwind in working capital. Likely in Q4, we'll see some strength on that with the seasonality in the business and strong cash flow, and likely as well into '23 if we're looking at a lower cost environment as you should see if you just look at kind of where some of the curves are currently at, that should also benefit us from a working capital perspective into next year.

[indiscernible]

Yes. We have maintenance CapEx. We call it nondiscretionary, keep the plant running safely, environmental compliance. And then we have discretionary capital, and that is a return -- ROI return with a cost reduction, energy savings, capacity expansion, all that. And we've been watching carefully how much discretionary capital we want to spend not knowing how the economy will go next year. So we have a lot of great, great projects. We are putting on the hold for the moment and watching the market, but we are not -- we don't shortchange nondiscretionary maintenance, safety environment that continues.

Great. Thank you.

Thank you very much. Appreciate it. Thank you all. And this is the last meeting, I think, inter-meeting for the investment group. So I wish you Merry Christmas, Happy New Year, a bit early in November. But in Houston, we already have all the lights on and things -- if you come to Houston, you'll see all the fantastic lights and houses and things before Thanksgiving. So anyway...

Thank you.

Thank you very much.

Thank you very much.

Thanks, PJ.