Westlake Corporation (WLK) Q2 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Westlake Chemical Corporation's Second Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, August 2, 2012. I would now like to turn the call over to today's host, Dave Hansen, Westlake's Senior Vice President of Administration. Sir, you may begin.

Thank you very much. Good morning, everyone, and thank you for joining us for the Westlake Chemical Corporation's Second Quarter Conference Call. I'm joined today by Albert Chao, our President and CEO; Steve Bender, our Senior Vice President and Chief Financial Officer, and other members of our management team. The agenda for today will be as follows: Albert will first make a few comments regarding Westlake's performance in the second quarter and a current perspective on the industry. Steve will then provide you with a more detailed look at our financial and operating results. Albert will have a few concluding comments, and then we will open up the call to questions. Today, management is going to discuss certain topics that will contain forward-looking information that is based on management's beliefs, as well as assumptions made by and information currently available to management. These forward-looking statements suggest predictions or expectations and, thus, are subject to risks or uncertainties. Actual results could differ materially based upon factors including the cyclical nature of the chemical industry; availability, cost and volatility of raw materials, energy and utilities; governmental regulatory actions and political unrest; global economic conditions; industry operating rates; the supply-demand balance for Westlake's products; competitive products and pricing pressures; access to capital markets; technological developments; and other risk factors. Westlake issued earlier this morning a press release with details of our quarterly financial and operating results. This document is available in the Press Release section of our webpage at westlake.com. A replay of today's call will be available beginning 2 hours after completion of this call until 11:59 p.m. Eastern Time on August 9, 2012. The replay may be accessed by dialing the following numbers: domestic callers should dial 1 (888) 286-8010; international callers may access the replay at (617) 801-6888. The access code for both numbers is 23500734. Please note that information reported on this call speaks only as of today, August 2, 2012. And therefore, you are advised that time-sensitive information may no longer be accurate as of the time of any replay. I would finally advise you that this conference call is being broadcast live through an Internet webcast system that can be accessed on our webpage at westlake.com. Now I'd like to turn the call over to Albert Chao. Albert?

Thank you, Dave. Good morning, ladies and gentlemen, and thank you for joining our earnings call. In this morning's earnings release, we reported a record net income of $115.5 million or $1.72 per diluted share for the second quarter. Our Olefins segment also achieved a record level of operating income, and our Vinyls segment delivered its strongest performance since the third quarter of 2008. The favorable dynamics in natural gas liquids continues. We expect the growing production of natural gas liquids from shale gas and oil drilling will cause ethane to become structurally long, as billions of dollars of fractionation and pipeline infrastructure will bring ethane from the well head to market faster than the ability of the chemical industry to consume this production. Ethane and propane feedstock prices declined significantly in the second quarter as the supply of these feedstocks outstripped demand. Westlake is one of the best-positioned producers to leverage this NGL feedstock advantage for the benefits in the second quarter, and we are making further investments to bolster this competitive advantage. The sustained favorable oil-to-gas ratio has provided margin expansion opportunities to ethane-based ethylene producers such as Westlake and continues to encourage an increasing supply of ethane-attractive economics NGL extraction for the oil and gas producers. All of these dynamics are game changers for our industry and provide the foundation for Westlake and other North American light-cracking ethylene producers to be globally competitive for many years to come. Now let me turn over to Steve for a more detailed look at our financial and operating results for the second quarter.

Thank you, Albert, and good morning, everyone. I will begin with a discussion of our consolidated financial results, followed by a more detailed discussion of our Olefins and Vinyls segment results. Let me start with our consolidated results. As reported in this morning's press release, Westlake reported record earnings in the second quarter of $115.5 million or $1.72 per diluted share, an improvement of 43% from the $81 million or $1.21 per share reported in the second quarter of 2011. The majority of the significant increase in earnings was the benefit of expanded ethylene margins. Included in our earnings this quarter is a pretax gain of $16 million on the sale of Georgia Gulf stock and expense of $3 million embedded in SG&A related to the Georgia Gulf acquisition activity, resulting in a net gain of $0.13 per diluted share. Westlake's operating income for the second quarter of 2012 was also a record at $171 million on sales of $914 million compared to the operating income of $138 million on sales of $925 million in the second quarter of 2011. The increase in operating margins in the second quarter 2012 over the same period in 2011 was driven largely by the drop in feedstock prices. Also contributing to the improved margins was an improvement in building products margins and higher caustic sales volumes. Relative to the second quarter of 2011, ethane feedstocks on the Gulf Coast averaged $0.37 per gallon or lower in the second quarter of 2012. Sales of $914 million in the second quarter of 2012 were $121 million lower than sales in the first quarter of 2012 of just over $1 billion due to lower sales volumes as a result of the Geismar outage and lower sales prices. Integrated Olefins and Vinyls margins increased in the second quarter compared to the first quarter as the drop in feedstock cost outpaced the decline in product prices. While the second quarter saw lower sales prices for polyethylene and lower sales volumes for PVC resin in building products in the first quarter, margins strengthened in the second quarter due to the decrease in ethylene feedstock cost. The second quarter operating income of $171 million was $25 million higher than the first quarter of 2012, primarily due to these higher integrated Olefins sales margins as a result of lower feedstock costs. For the 6 months ending June 30, 2012, we delivered net income of $203 million, a 23% increase over the $165 million reported in the first 6 months of 2011. Income from operations in the first 6 months of 2012 was $317 million compared to $279 million for the first 6 months of 2011. The increase in income from operations is the result of higher integrated margins in both segments, resulting from a significant drop in feedstock prices. Now let's talk about LIFO versus FIFO accounting. Our use of FIFO accounting had less than $1 million impact on our second quarter earnings. Please bear in mind that this calculation is only an estimate and has not been audited. Now let's review the performance of our 2 segments, starting with the Olefins segment. The Olefins segment reported a record operating income of $156 million during the second quarter of 2012, which was a substantial improvement over both the operating income of $133 million reported in the second quarter of 2011 and the $129 million reported in the first quarter of 2012. The higher operating income in the second quarter of 2012 was a result of higher integrated Olefins margins due to a significant decrease in feedstock cost, which were partially offset by lower sales prices. During the second quarter, ethane prices continued their downward trend that started in the first quarter, declining an average of 28% or $0.16 a gallon. Industry polyethylene prices declined $0.14 a pound during the quarter to reflect lower ethylene cost. However, the industry has announced a polyethylene price increase of $0.05 a pound effective August 1, and some polyethylene producers have announced another $0.05 per pound price increase effective September 1, all due to increasing demand. Now let's discuss the Vinyls segment. The Vinyls segment continued to deliver solid improvements this quarter, reporting record operating income of $23 million in the second quarter of 2012 compared to operating income of $10 million in the second quarter of 2011, the best quarter since the third quarter 2008. The increase in operating income was a result of a significant drop in propane feedstock cost, improved building products margins and higher caustic sales volumes. The Vinyls operating income of $23 million in the second quarter of 2012 was an improvement over operating income reported for the first quarter of 2012, driven largely by lower propane feedstock costs. It is important to note that we delivered these results in spite of the lost production resulting from the Geismar outage in late March. The facility resumed operation in May. For the first 6 months of 2012, the Vinyls segment reported operating income of $44 million compared to $7 million reported in the same period in 2011 as a result of lower feedstock cost and improved building product and caustic margins. The significant improvement in our building products business and the margin expansion we have delivered is a result of changes we have implemented in that business. Industry exports of PVC resin were approximately 4% higher in the first 6 months of 2012 compared to the same period in 2011, while our exports lagged due to the outage in Geismar during the second quarter. Some industry producers have announced price increases on PVC resin of between $0.03 and $0.05 a pound effective September 1. Caustic sales volumes in the second quarter were comparable to sales volumes in the first quarter. And the second quarter caustic producers announced a price increase of $60 per ton, which is expected to be implemented during the third quarter. Now turning to the balance sheet and the statement of cash flows. We generated $323 million in cash from operating activities in the first 6 months of 2012 and spent $141 million in capital expenditures. At the end of the second quarter, our cash balance was $1.1 billion, including restricted cash of $20 million, and our total debt was $765 million. In July, we redeemed $250 million of our 6 5/8% notes and refinanced them with new 10-year notes at 3.6%, cutting $7.6 million in interest cost per year. By way of guidance, I would estimate the third quarter will include a nonoperating charge of approximately $6.8 million in redemption call premiums and the write-off of previous financing cost. Our guidance for this year's capital expenditures continues to be between $400 million and $450 million, including expenditures on the Geismar Chlor-Alkali project and the ethane cracker expansion at Lake Charles. The ethane cracker turnaround and expansion will take place in the fourth quarter of this year and result in the unit being down for approximately 50 days. We will be taking a normal maintenance turnaround on our styrene unit in the third quarter of 2012 and expect the financial impact to be approximately $3 million in the quarter. These expenditures will be funded from our cash reserves. The flexibility of our capital structure gives us a variety of options when considering future growth prospects. This flexibility allows us to maintain our conservative approach to investing, while pursuing projects that bring value to our shareholders. Now I'll turn the call back over to Albert to make some closing comments. Albert?

Thank you, Steve. I believe Westlake's strong second quarter performance illustrates the earnings power of the company. Westlake is very well positioned to deliver value, both in the near term as well as over the long term. First, through our favorable feedstock position, an advantage that will be with us for years to come. Second, through our pursuit of initiatives that expand our bottom line and take advantage of the low-cost feedstocks that shale gas and oil drilling are providing. These initiatives include expansion of our ethylene plant at Lake Charles in Louisiana, the first of which will deliver benefits in the fourth quarter of this year. We will follow up that expansion project with expansion of the other Lake Charles ethane cracker in 2015. We are also finalizing our study of the conversion of the Calvert City, Kentucky, ethylene unit from propane to ethane, as well as the expansion of that cracker. Third, turning to our Chlor-Alkali project. We've made substantial progress on our new facility at our Geismar plant and expect it to be operational in the second half of 2013. The project also capitalizes on the globally competitive cost of natural gas used for electricity and key cost element in production of Chlor-Alkali. When these 4 major projects are complete, Westlake will be one of the most fully integrated and lowest-cost vinyls producers globally. We're working on all fronts, beginning with our strong feedstock position and leverages this advantage through the investments we are making to further our competitive position. We will continue to look for avenues to grow our business and bring value to our shareholders. We have ample ability to fund our growth, and we have the patience and discipline to invest when the risk reward trade-off is favorable. Thank you very much. Now let me turn the call over to Dave Hansen.

Thank you, Albert. Before we begin taking questions, I would like to remind you that a replay of this teleconference will be available starting 2 hours after we conclude the call. We will provide that number again at the end of the call. Operator, we'll now take some questions.

[Operator Instructions] And our first question comes from the line of David Begleiter with Deutsche Bank.

Albert, can you comment on the prospects in your view for the PE price increases that go through in both August and September?

Yes. We believe the prices had faltered in June. And as the oil price globally has increased and the inventory sentiment and demand for polys has also start to increase and people start to build inventory back that we believe that there's a strong possibility of the price increases to be implemented.

But can you comment on PE volumes? In the last couple weeks, it seems some of the restocking has slowed a little bit.

Well, what we see is that inventory levels in both producers and consumers are either low range of the normal levels. So we believe that inventory demand, the poly demand would increase compared with the lows of the April and May time period.

And Steve, are you able to comment on what your operating rates were in Lake Charles for both ethylene and polyethylene in Q2?

Yes, we are running as best we can. Certainly the margin's there, so everybody's running as fast we can.

Our next question comes from the line of Brian Maguire with Goldman Sachs.

Albert, you generated a lot of cash in the second quarter, and you kind of are in a high-class situation of having a lot of cash on your balance sheet. Gross cash is about $17 a share, and your net cash is about $365 million, yet, you pay about $50 million a year in net interest expense. So that's a big penalty you're paying for having a very conservative balance sheet. And I was just wondering, going forward, you've got a pretty good outlook for the industry, it seems like you're going to continue to generate a lot of cash to meet all your internal growth needs. So I was wondering if you were -- you and the board were considering more aggressive return of this cash to shareholders, either in the form of a higher regular dividend or a special dividend going forward.

Certainly. We do have, as I mentioned in the call, a substantial number of capital investments that we're making. Some of them we already announced the size, in terms of our first ethylene cracker expansion in Lake Charles and polyethylene plant. We are working on our second ethylene plant expansion in Lake Charles, as well as expansion and conversion from propane to ethane for our Calvert City plant. And all these are pretty large size capital expenditures. So this is where the use of our cash will be in the near term. As far as dividend is concerned, we certainly review with our board every quarter, and we will be reviewing again in the upcoming quarterly board meeting.

Okay, great. And I was hoping you might comment on the inter-quarter trends for volumes of PE and PVC. For example, was May higher than April? And how did June compare to May? And then kind of what have you been seeing in July so far?

Certainly. There was certainly -- with the price drop in oil and in gas demand for our products not only the U.S. and globally had slowed down in April, May period. But since oil price has hit the bottom and is not moving up in June, July, we see people who start replenishing the inventory level. And demand generally is pretty healthy, especially in the U.S. And with the competitive cost position with U.S. olefins and integrated vinyl producers, I think we also have a very good position to supply the export market.

Okay, great. One last one, if I might. I know each of your crackers in Lake Charles had a fairly small operational hiccup in the quarter, one in May and one in June. Just wondering if there was any financial impact on the second quarter numbers or any expected impact on the third quarter earnings from those small outages.

Yes, Brian, there certainly was. When you think about the outages that we had, both at the Petro 2 and Petro 1 units, there was an impact in the second quarter. About $15 million in the second quarter, and I expect in the third quarter we'll see a number in that same area as well in the third quarter.

Our next question comes from the line of Frank Mitsch with Wells Fargo Securities.

Paying off $16 million in a short period of time is something to -- that a lot of folks on the line would love to achieve. I just wanted to confirm, are you fully out of Georgia Gulf stock at this point?

Yes, we are. And thank you, Frank, for that nice comment.

Great. And so you mentioned that this is the first -- the best quarter miles in several years. I was curious as to a couple of things. One, how much of the benefit of the $22 million that you reported was due, you think, to the propane cracker that you have there? And then secondly, I guess there was a lot of talk in terms of building products off a pull-forward from Q2 into Q1 due to the weather. Did you see any of that impacting your business as well?

Frank, it's Steve. As it relates to the propane pricing, that was probably the biggest driver of the vinyls in the second quarter with much meaningfully lower propane. And certainly from a volume point of view, we did see, as we commented throughout the quarter, that pull-through from 2Q back into the first quarter. So that certainly did impact volumes.

Okay, great. And how would you characterize the operating rates in your building products pipe business as it stands today versus where it was, let's say, a year ago?

They're still low.

Our next question comes from the line of Don Carson with Susquehanna Financial.

Steve, just can you comment on how much the Geismar VCM outage cost you in the quarter? And I was surprised the FIFO adjustment was so small because given the sharp drop in both ethane and propane from Q1 to Q2, I thought you would have had a bigger FIFO impact.

Yes, Don, the impact of the outage was just really a couple million dollars. As it relates to the FIFO, LIFO, that really is an accounting mechanism that we use for finished goods. And so on a -- with the drop in feedstocks, especially late in the quarter, the effect of that will really carry over into Q3. So we'll wait and see how the rest of the quarter weighs out in terms of feedstocks. But that drop late in the quarter is not on a FIFO basis. Our finished goods are on a FIFO basis. So the effect of that would really flow into Q3.

Okay. And then going forward into the second half, how big of an impact will this 50-day outage at Lake Charles have? And are you building inventory now to account for that? And then one final question on polyethylene. Again, there's this -- question is to how much of this is restocking versus improved final demand. What does your forward order book look like as you get out into the latter part of this month and into September? Is that still relatively robust?

In terms of the outage, we are continuing to build and plan for that turnaround, and so we are beginning to build ethylene. In terms of as Albert commented on the order book for polyethylene, the price increases, I think, speak for themselves. As Albert commented, we're seeing good demand at this level. And I think those price increases in August, September reflect that good firming demand that we're seeing in polyethylene.

Our next question comes from the line of J. Zekauskas with JPMorgan. Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division: You plan to expand your Calvert City cracker. How much could you expand it by?

That's what we are studying right now. Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division: Right. But order of magnitude, in -- is this a couple of hundred million pounds, or is it much more than that? I realized that for feasibility, you try to examine your costs and what's a good investment for the company, but could you be more precise?

Certainly. Well, we are doing the study right now, so we can't be precise. But we will be adding a huge amount of capacity. This is a plant was relatively small when it first started and debottlenecked several times. And we are studying right now is how much more can we debottleneck, but we believe there will be some additional pounds. And hopefully, we'll be able to discuss that in the future quarters. Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division: Okay. Separately, does the combination of Georgia Gulf and PPG in the chlor-alkali area change anything at Westlake? In the sense that do you think that this combination is positive or negative or neutral for industry PVC and chlor-alkali dynamics?

Well, we can't comment on the merits of the deal. But the merger of 2 -- they were the same 2 companies mitigating [ph] more capacity. And that what we regret is that Georgia Gulf will not add any new chlor-alkali capacity as a result, so that should be positive for the industry Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division: Okay. And if I could ask a final naive question. Whenever I look at your Vinyls income, I always think that it could be accounted for either by the profitability of the propane cracker or it could be accounted for by sales of caustic soda. I'm always surprised that it's not higher. Do you think the same way, or you're not?

Well, I think you hit a very good point is that the propane cracker has been losing money for quite a while, when we have propane price following mostly oil price. And so in last 2 years, propane was -- oil was very high and propane was very expensive. But now with propane price coming down and with our ability to convert to ethane, we think that in the future, we will have quite a good positive impact on our bottom line for our Vinyls business. Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division: And then lastly, do you buy your propane essentially at spot? Or have you bought your propane at some contractual rate?

We buy at market prices. Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division: At market prices.

[indiscernible] and bring it by pipeline to Calvert City, Kentucky.

Our next question comes from the line of Gregg Goodnight with UBS.

Albert and Steve, your Lake Charles, your second expansion, I'm curious as to why that timing is 2015. It would seem like in these market conditions and all the expansions that have been announced, it would be wise to do that as soon as possible. What is the logic for 2015?

Gregg, as I commented earlier in the Q&A, that unit was down for a short period of time in the second quarter. And while it was down, we did some maintenance on it, and that allows us to move it into 2015.

Why not 2014 or even 2013, maybe?

Well, we're working on our turnaround for the first unit this year. And while the margins could relate to run the plant as slow or as fast as possible.

Okay. The second question. You mentioned that your operating rates on fabricated PVC were lower. Are you seeing any pickup in either of your window or door profile business or your large diameter pipe business coincident with this slight increase in housing starts that we're seeing?

Yes. We do not see a material improvement in the pipe size, but we see some benefits in terms of the -- for the windows and the fence business, because they're used both for replacement. And for new housing and also, a bigger proportion now of the new housing multifamily units, which also uses more PVC windows.

On a year-over-year basis, could you give us a rough idea of what volumes would be up in your window and door profile business?

It's better but not materially better.

Your next question comes from the line of Kevin McCarthy with Bank of America Merrill Lynch.

This is Alex Yefremov for Kevin. A question on NGLs markets. Do you see a potential impact over the -- in the short term over the next 6 months maybe, related to increased ethane rejection and also potential cuts in NGL production levels overall? Do you see potentially an upwards pressure in the price of ethane and propane?

Well, the forward market for ethane and propane are pretty flat for the rest of the year and into in next year. Even at today at $0.35 for ethane, it's like $5.25 million btu still substantially higher than the $3 gas price. So there's still very positive return benefits to the producers to sell at these prices.

Okay. And then, you mentioned some changes you made to your fabricated products business. Could you just maybe elaborate what kind of changes were those?

We improved our cost position and rationalized some of the plants and also take some part of mix that's more profitable.

Okay. And a final question, if I may. Is there an explicit financial impact in the fourth quarter related to your Lake Charles turnaround and expansion that we should pencil in?

Sure. The impact is we're going to be out for a 50-day period as we go through that, both the turnaround and debottleneck. And so you need to take into consideration the outage for that 50-day period.

[Operator Instructions] Our next question comes from the line of Hassan Ahmed with Alembic Global.

Albert and Steve, a bit of a more macro question. Obviously, feedstock costs, particularly the crude oil-based ones gyrated all over the place through the course of the quarter. What sort of trends have you been seeing out in Asia, in particular? Call it on the Chinese side of things, in terms of the operating rates out there, the demand trends out there on the ethylene and polyethylene side of things. And are there, at all, any export opportunities for you guys to take advantage of?

Certainly. Because of most of Asia are naphtha-based, their feedstock cost has been influenced by oil, with the recent increase of oil price, ethylene prices moved up. And today, they are about $1,150 a ton, which is about $0.52 a pound equivalent in the U.S. We understand that polyethylene prices has not moved up yet, and we believe that polyethylene prices in Asia will be going up higher to meet the higher ethylene cost.

Fair enough. And in terms of just the exportability side of things. Do you think there's opportunity for Westlake and other producers out here to maybe pop up their volumes by exporting more product out there?

Yes, yes, absolutely. I think U.S. polyethylene producers export about approximately 20% of its production. And because of the competitive nature of the U.S. ethane-based ethylene producers, these prices are attractive for export markets.

Our next question is a follow-up question from the line of Brian Maguire with Goldman Sachs.

Yes, Steve, I'm just wondering if there -- I see that Eastman is going to have a turnaround in one of its crackers in Longview in the fourth quarter, and I know you source some of your ethylene from there. Just wondering if that have any expected financial impact on the fourth quarter or first quarter of '13 results?

Brian, we -- as I mentioned earlier, we have already begun the inventory for the plant turnaround, and it shouldn't have an impact to us.

We have no further audio questions. I will now turn the call back over to Dan -- Dave Hansen for any closing remarks.

Well, thank you very much. We appreciate you participating in our call today. We hope you'll be able to join us again for our next conference call to discuss our third quarter 2012 results. Thank you, and have a wonderful day.

Thank you for your participation on today's conference. This concludes the presentation. Everyone may now disconnect, and have a great day.