Westlake Corporation (WLK) Earnings Call Transcript & Summary

Welcome, everybody, this morning. Very happy to be up here. Those who don't know me, I'm Duffy Fischer, the U.S. chemicals analyst here at Goldman Sachs. Today, on our fireside chat, we welcome Westlake Chemicals up. Westlake a fantastic American story in my view. We've got Steve Bender, who is the CFO for the company, I think a little over 15 years. Is that right? Probably just did your 15 years in the last year or so -- so founded by the Chao family, Albert Chao, as CEO, just great -- kind of started from nothing built it into a $16 billion revenue company. I think was revenue last year. EBITDA, a little over $4 billion last year. Just to kind of level set this year expectations are for about a quarter, that EBITDA to go away, I think consensus is down around $3 billion. We'll talk about that a little bit. Key businesses for Westlake are chlor-alkali, ethylene into polyethylene and epoxy business and then something that's somewhat new, at least the way they break it out is the Building Products group. The segments are called HIP, which is the Building Products group and then PEM, which is where the chemicals are basically housed. The PEM segment is about 2/3 of the assets, about 2/3 of the sales and a little bit different than a lot of our companies, a little over 3/4 of the revenue is actually in the U.S. So pretty U.S.-focused company. The assets are even a higher percent in the U.S. So again, with that, we're very happy to welcome Steve Bender to chat today. Steve, I think as we start -- when don't we start with the new business. You guys made a pretty sizable acquisition about a year ago, the epoxy business from Hexion. So I guess, one, it's not a business that we're that familiar with because it's a little bit smaller within some of the other companies that have had epoxy historically. Some of it's been private historically. So just walk us through the strategic logic of why Epoxy, what drives Epoxy revenue, what drives Epoxy growth? And how you imagine kind of scoping the footprint of Epoxy now that you have it?

So if you think about how the company has really developed and grown the business over its many years, think about really our focus, and we hear us talk a lot about product integration, looking both at the inputs and the product and all the way through production in places. So as you think about the inputs into the epoxy chain, they are actually some of the same products that we actually produce. So from an input logic perspective, it makes sense. And as we think about the trends from the demand perspective, the Epoxy business we acquired in [ 2022 ]. So we've owned it just a little over a year. It really goes into a wide variety of applications. But when you think about it, it's largely coatings, adhesives, we're one of the largest players in wind energy. So windmills, those blades or epoxy material when you think of lightweighting, think of epoxy materials when you think of the automotive and aircraft, think of epoxy, you think of even some of our big customers or the coatings guys and the reason that paint shines on an automobile is it's blended with epoxy as podium material and protectant. So when you think of the big major trends that we see from a demand picture and you think of the inputs that we already produce that are feedstocks into the epoxy chain -- we felt like the epoxy business was a very good one to consider. We started assessing really the Hexion ownership of Epoxy and recognize these assets have been owned by Hexion for many years and had probably been underinvested in over a long period of time, had gone through a series of owners and recognizing that these are good assets, legacy shell, if you will. So good technology, a good team, but frankly, underinvested. So we looked at a business that we felt we could bring capital to strong demand pictures over the cycle, good inputs that we knew well and can actually feed these plants with. For us, it was then just finding an opportunity. Is there a price that makes sense for both parties. And that's really what drove us to finding an opportunity at a price that made sense. Recognizing this business is a cyclical business. But if you also look at the investments we've made over the course of like the last 20 or so years, we've continued to move more into a performance-oriented portfolio, less commodity oriented and this investment in epoxy is just another illustration of the focus in stronger performance oriented, more custom solutions and products for our customers. And that's really the overall strategy.

Okay. And then if you kind of just went through and did a SWOT analysis, how is your epoxy different from some of the other ones that, again, tangentially, -- we understand the Huntsman business now, some of the Europeans, where are you stronger -- where are you bigger? And just how would you characterize the difference between those?

So I'd say that when you think of our competitors really only a handful of players really in the epoxy business, Asia, China represents about half the overall market. But you're right, Olin and Huntsman and represent the great majority of the other big players. So we look for markets that are also have rational players where there is also an understanding of the desire to make money in. So when you look at where we're positioned against some of our competitors to say, we're the leading producer of epoxy going into wind energy. So we're also the leading player in aviation, not an aerospace but in aviation. We're also one of the leading players in coating applications. So not only did we acquire a business that really is well-positioned geographically with a strong footprint here in North America, strong footprint in Europe and in Asia, China and Korea. But we have a very strong market leadership position in aviation, automotive and wind energy and, of course, coatings and adhesives. So a strong market position from a geographical footprint across those 3 main geographies and as I say linkages into the products that we already produce that are feedstocks into this business, which provides us an ability to build that product integration over time. That was really the thinking and the driver for the economics.

And then when you went back and did your due diligence, I think this business was about $1.5 billion in revenue roughly when you got it.

That was actually the segment as reported by Hexion, which included some businesses that we did not...

Okay.

The [ Versatics ] business did with this transaction. So our -- the sales number was well below that 1.5.

Okay. Cyclically, over -- like a full cycle, how much does this move up, if you think just like margins, is this 10-ish percent, what would like an average cycle historically look like for the Epoxy business, how much volatility?

So I'd say where we see the drivers today is really -- the epoxy business is still recovering really from the onset and recovery of COVID. So we saw China really shut for a rather extended period of time, as all of you know. And the China beginning to reopen, it's reopening slowly but clearly reopening. And during that period when the markets were largely shut, it took a lot of their production of epoxy and exported it into the European marketing. And that really flooded the European markets and with the advent of the invasion in Ukraine, energy prices in Europe rose -- and so as a consequence, that became a huge headwind for many of the industries, not only epoxy, but many of the industries in Europe. Now that we've seen energy prices come way down off their strong peaks in Europe, China beginning to open a lot of that production and sales activity came from Asia has started to pull back. So we've been at today's energy prices, our Epoxy business can very well compete in markets domestically in Europe. So we think we're very well-positioned. As I mentioned, this business had been underinvested in for a number of years because of the ownership initially by private equity than later as an independent company, but nevertheless, clearly underinvested. So there's great opportunity to really improve the performance of the business invest for work on strategic partnerships with others to really improve the reliability, profitability of the business and what I call product integration, which is really the hallmark of how Westlake has really run its business being integrated from end to end. And so I see opportunities to continue to improve the profitability of this business, both near-term as well as the long-term.

Okay. And then if we look at the numbers, let's say, in Q1, is that representative of kind of the base integration kind of already happening, the upstream connectivity, the rightsizing of the headcount, that kind of stuff. Is that like a good run rate? Obviously, the business itself is struggling from an industry standpoint. But from the Westlake integration standpoint, are you mostly done with that first round?

So we've announced that we'll be achieving between $55 million and $105 million of synergies over the course of '23. And this is what I would consider cost reduction. This is not revenue synergy, which is not so sticky, but I'm really talking about cost reduction, which tends to be a lot stickier. So we mentioned in our first quarter results that we already have pocketed 1/4 of that, and I fully expect it will be on the run rate to achieve the high end of that $105 million range by the end of this year. And so portions of that really come from the Epoxy business. Portions of that also come from some of the acquisitions we made in '21, largely concentrated in our building products business. But I see significant synergies across all those acquisitions. And that's just the '23 synergies, not the total synergies, it's just 23 synergies. You recognize that we expect between, as I said, [ $55 million to $105 million ] and I expect we'll be on the very high end of that achieving those synergies in '23. I think between '21, '22 and '23, very compelling synergies and we think about acquiring businesses, it's always recognizing we're going to do so with a very big focus on cost reduction. While we chase revenue synergies, of course, the reality is our real focus is on cost reduction synergies because those are much stickier.

Right. Okay. And then longer-term around the Epoxy business, what's the prognosis for being able to bolt other things on? Is it an industry the way you'd look at least in Europe and the U.S., it's mostly consolidated so you can't really do much more consolidation. So it might be like a downstream play? And what about other geographies, Asia, at some point? Or is that just too competitive? But what's the 3- to 5- to 7-year view of what you can actually tack on to...

No, there's -- I think there's still plenty of opportunity to further integrate the businesses, both in Asia, Europe and in the United States. So I feel very energized actually, I'd say, the [ CSD ] either expand on the footprints we have organically and to make some acquisitions, whether they're in solutions or other smaller businesses that bring great technology. One of the hallmarks here in Westlake is -- and this came with our Epoxy business is R&D centers. We have 9 R&D centers within the whole Westlake, certainly in solutions, especially in Epoxy and some of our other performance materials, working on product development, handing well with our customers is really critical to the stickiness of that customer and frankly, improvement in EBITDA margin. And so when we think about the Epoxy business, the R&D centers that came with this business are really critical. And we have some really long-term relationships with customers that we expect to see further product development and frankly, margin improvement in the business.

Okay. Maybe move away from epoxy, -- another area that I would say investors aren't as familiar with -- within the Westlake family is kind of the Building Products segment today. And I think when you look at that segment, that's the one that we get asked most how do you model this? What's the right way? In the other segment, we still know a lot of the tonnes and the pounds and come up with some margin estimates and get most of the way there. But the building products is the one that seems to stump people, at least gives people the most cause for concern that they don't understand what the drivers are. So when you look at that, how would you model it going forward if you were on our side? What are the main drivers? Is it just a revenue and a margin model? Or can you actually get in and kind of think about different products and try to track different products?

It is a different business, and we do give revenue guidance and margin guidance and continue to do that every quarter as we march forward. I think a huge driver of the Building Products business is brand, not some common in the chemicals business because in the chemicals business is all formulation-driven, of course. But I think in the Building Products business, it is a different kind of animal. Branding is critical in terms of the stickiness with your customers and the selection processes. We actually work very closely with the influencers in this business vis-a-vis architects and frankly, being able to have those influencers, select your brand, which allows you to become very sticky with our customers. When you think of our customer [indiscernible] or the nationwide homebuilders. And while we don't deliver the last mile, so we sell to the distributors who then deliver the last mile -- but we're selling to a lot of these nationwide homebuilders. And because they are nationwide as is our Building Products business, we have the ability to really deliver the products and the branding that they're looking for. They have the ability to be able to do this in a very timely manner to meet their construction schedules. The ability to stand behind the warranty that's really important to a new home. Half of our business is repair and remodeling, half our business is in construction. And so when you think about the slowdown we've seen in new construction, we've actually seen good traction really in repair and remodeling because consumers are going to either continue and invest in the home they are living in if they don't invest in a new home. So the mix of 50-50 between repair and remodeling and new build has been a huge advantage in our Building Products business. And again, I'd say the branding is very important to the consumer. So whether they're selecting a home or selecting products to do repair and remodeling their home, that branding is critical. So definitely back to the question of how to model this, I'd say, look at the guidance we're providing, which is revenue and margin guidance. This business is very scalable. We delivered a 20% EBITDA margin in the first quarter. And when you think about some of the challenges in the construction markets, I think it's very telling that this business is much more scalable than the heavier industries such as chemicals, because you can adjust your line operations, you can run 3 shifts instead of 4, and run 6 extruders instead of 12 extruders -- you can do this not only within the product lines, but across the country. So you have a very scalable business that can adapt very quickly to changes in supply and demand. And so while our products are on the range from Windows to roofing to siding, trim and shutters and decorative stone, it is hard to look at a consultant who publishes volumes or prices. So I would say that most of the building products competitors all report revenue and margin guidance. And so we're in line with those and I would say, look to the guidance that we provide.

Okay. And so when you look at the half that goes to new home build, I would assume a big marketing event you would have is targeted, say, at the purchasing manager for like a KB Home, is that who you're trying to get pull through from even though you may not deliver directly to KB, is that who your sales point is?

So when you think of the D.R. Horton and the KB Homes, Lennar and Pulte and such, those are the customers ultimately that are distributors who are our customers are selling on to that builder. And we service, of course, to regional builders as well, but mostly the nationwide branded builders. And certainly, each one of those -- each one of those companies also have a marketing or a sales procurement point of contact across regions. So we have a wide variety of touch points because what may be in terms of hotter markets, say, in the Northwest or the Northeast or the Midwest or the Southeast of the Southwest vary. And because we have a nationwide footprint and can accommodate changes in dynamics of market trends. It allows us to be very nimble to be able to meet the needs of a KB Home or a Pulte, Lennar or D.R. Horton. And I would say the conversations we've had with all those niche wine homebuilders remain very optimistic in terms of their outlook. They recognize that construction levels that we saw in '20 -- like the second half of '20, '21 and '22 were incredibly strong. You've seen that they obviously have a lower their expectations. But in our conversations with people like D.R. Horton and Lennar, they recognize that if you let their tradecraft go and slow down your business, you don't actually have a construction business. So what they've really decided to do is really come forth with incentives. We know we've underbuilt in this country for probably 15 years since the great recession. In the meantime, the population continues to -- continue to strongly grow. And there is a significant shortage of housing stock in this country. And so the builders recognize that. And so what they're really doing is providing incentives, sales incentives of all sorts -- many of these builders also have financing arms that were providing points -- [ discounted points ]. And as we work, these builders, I recognize there will be some probably price compression. This is why we've guided to high teens rather than the 20% we delivered last year on average. So we recognize there probably will be some margin compression. That's why we've got into the high teens in terms of EBITDA margin. But we continue to recognize that the market continues to be well undersupplied. So we are very optimistic and very bullish about this market, medium to long-term.

Okay. So that's where the brand comes in on the new home side. When you think about the brand on the repair and remodel, is it the contractor you're trying to get the brand recognition to? Or is it -- do you think you can actually drive it to a homeowner that would ask for your product?