Westlake Corporation (WLK) Q4 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Westlake Chemical Corporation's First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, February 19, 2013. 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 and good morning, everyone, and thank you for joining us for the Westlake Chemical Corporation Fourth Quarter Conference Call. I am 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 fourth 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 for 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, February 26, 2013. 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 42085567. Please note that information reported on this call speaks only as of today, February 19, 2013, 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. This morning, Westlake reported record fourth quarter results with a net income of $95 million or $1.42 per diluted share on sales of $801 million. Our strong fourth quarter performance concluded a record year as Westlake reported full year net income of $386 million for 2012, which was driven by lower feedstock cost, resulting from the abundant supply of natural gas liquids availability from shale gas and oil production in the U.S. In 2012, we had several key accomplishments. We reported record earnings and with our strong cash flows, Westlake was able to pay $286 million in regular and special dividends and we delivered an annual shareholder return of 109%. Each of our business segments continued to significantly improve their performance. Our Olefins segment delivered its best year ever and our Vinyls segment reported its strongest annual earnings since 2006. The growing production of natural gas liquids from shale gas and oil production has caused ethane to become oversupplied as significant capacity additions in gas liquids processing and pipeline infrastructure brought ethane into the market faster than the North American chemical industry can consume it. These lower cost feedstocks have reestablished the North American chemical industry's cost position globally and have prompted resurgence in debottlenecking and other expansion projects to capitalize on this advantageous position. Westlake will capture additional benefits from the abundant supply of natural gas and ethane this year as we expand one of our ethylene crackers in Lake Charles, Louisiana in the first quarter of 2013 and start our new chlor-alkali plant in Geismar, Louisiana in the second half of this year. Now, let me turn it over to Steve for a more detailed look at the financial and operating results for the fourth quarter and the year.

Thank you, Albert, and good morning, everyone. I will begin with a discussion of the consolidated financial results for the fourth quarter and the year, followed by a more detailed discussion of our Olefins and Vinyls segment results. Let me start with our consolidated results. As we reported in this morning's press release, Westlake posted fourth quarter earnings of $95 million or $1.42 per diluted share, a 260% improvement over the $26 million or $0.40 per diluted share in the fourth quarter of 2011. Income from operations was $156 million for the fourth quarter 2012, on sales of $801 million compared to $50 million for the fourth quarter 2011 on sales of $859 million. The substantial increase in operating income was driven by higher integrated olefins and vinyls margins, primarily a result of the significant decrease in feedstock cost, strong ethylene margins and steady demand for polyethylene and PVC. While overall product prices remain unchanged and sales volumes were somewhat lower, the effect was more than offset by the significant decrease in feedstock costs. Market prices for ethane in the fourth quarter of 2012 decreased an average of $0.57 a gallon or 67% compared to prices in the fourth quarter 2011. Comparing the fourth quarter to the third quarter, net income for the fourth quarter 2012 of $95 million increased $8 million compared to the $87 million earned in the third quarter 2012. Earnings from operations in the fourth quarter of 2012 of $156 million on sales of $801 million exceeded operating earnings of $143 million on sales of $821 million in the third quarter of 2012. The improvement in operating earnings was the result of further decrease in the cost of feedstocks in the fourth quarter, as well as increases in the price of polyethylene, PVC resin and caustic. For the year ended December 31, 2012, Westlake delivered a record net income of $386 million compared to net income of $259 million in 2011, a 49% increase in net income. Income from operations for the year 2012 was also a record at $615 million, increasing $168 million over the operating earnings of $447 million for the year of 2011. These record results were largely attributable to elevated ethylene spreads. Market prices for ethane for the year 2012 averaged $0.40 a gallon compared to $0.77 a gallon in 2011, a decrease of 48% for the year. Despite the drop in feedstock costs, there was only a marginal decrease in ethylene prices as a result of strong demand and the industry experienced a number of planned and unplanned outages. Now, let's talk about LIFO versus FIFO accounting. Our utilization of the FIFO method of accounting resulted in an unfavorable impact of approximately $11 million pre-tax or $0.11 a share in the fourth quarter compared to what earnings would have been if we had used the LIFO method. The fourth quarter impact was a result of the continued drop in ethane prices during the quarter. From a FIFO perspective, the benefit of lower-cost feedstocks we've seen in the fourth quarter should be more evident in our results in the first quarter 2013. 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. Our Olefins segment reported operating income of $143 million during the fourth quarter 2012, which was an increase of $67 million from the $76 million reported in the fourth quarter of 2011, largely driven by decreases in ethane feedstock costs. The average price for ethane feedstock in the fourth quarter of 2012 decreased $0.57 a gallon or 67% compared to the fourth quarter of 2011. This large decrease in feedstock costs was not fully reflected in ethylene prices, as average ethylene prices remained elevated during the same time period due to strong demand. The high ethylene prices in the fourth quarter supported polyethylene prices, which declined only slightly in the fourth quarter 2012 compared to the same period in 2011. This increase in integrated olefins margin was the driving force behind our strong year-over-year improvement. Olefins segment earnings from operations of $143 million in the fourth quarter of 2012 were $19 million higher than the operating earnings in the third quarter of 2012. The increase in operating earnings in the fourth quarter was due primarily to a further decrease in the cost of ethane feedstocks, which resulted in an increase in our olefins integrated margins. Due to elevated ethylene prices and good global demand for polyethylene, the industry was able to implement a $0.05 per pound price increase in polyethylene prices in January and has announced an additional $0.04 per pound increase for February. Now let's discuss the Vinyls segment. The Vinyl segment reported its best fourth quarter results in 7 years and ended the year with its best earnings since 2006. The Vinyls segment reported fourth quarter 2012 earnings from operations of $18 million, an increase of $38 million compared to the fourth quarter of 2011. The improvement in earnings was primarily the result of a decrease in propane feedstock cost and an increase in our building products and caustic sales volumes. Average propane feedstock prices decreased $0.56 a gallon or 39% in the fourth quarter of 2012 compared to the fourth quarter of 2011, while PVC prices remained relatively stable due to increases in global demand, resulting in higher integrated vinyls margins. The fourth quarter 2012 operating earnings of $18 million were $6 million lower compared to the third quarter of 2012. The decrease was primarily due to lower sales volumes resulting from seasonal buying patterns for PVC resin and building products. The Vinyls segment full year earnings from operations was $86 million, an increase of $82 million compared to the year 2011. The improvement in vinyls was largely attributable to substantially lower average feedstock and energy costs resulting in higher integrated vinyls margins, higher caustic sales volumes and prices and a significant improvement in the performance of our Building Products division. Looking forward, the industry has announced PVC resin price increases of $0.03 a pound for February and $0.05 a pound for March due to elevated ethylene cost, the onset of the construction season and the continued strong PVC resin export opportunities. Caustic demand remained strong in the fourth quarter as the industry was able to increase prices by an average of $20 per ton over the third quarter. The industry has announced a price increase of $35 a ton to be implemented in the first quarter of 2013. Now turning to the balance sheet and the statement of cash flow during 2012, we generated $624 million in cash from operating activities. We ended the year with cash and investment balances of $915 million and total debt of $764 million. During 2012, we incurred $387 million in capital expenditures as we executed our ethylene expansion plans in Lake Charles and Calvert City, Kentucky and our new chlor-alkali plant in Geismar. Since this is the beginning of the year, I expect some of you will have some modeling questions. The capital expenditures for our expansion plans will lift our 2013 capital spending, with it ranging from $500 million to $550 million and we will fund these expenditures from our cash balances. We expect interest expense to be in the range of $27 million to $30 million and we expect a book tax rate of 35%. In the first quarter of 2013, we will complete the turnaround and expansion of one of our ethylene crackers at the Lake Charles complex. We expect that cracker to be down for approximately 60 days in the first quarter. We also expect the completion of the construction of our new chlor-alkali facility in Geismar in the second half of 2013. The flexibility of our capital structure gives us a variety of options when considering future growth projects and we continually seek out new investment opportunities, both internally and externally. This flexibility allows us to maintain our balanced approach to investing while pursuing projects that will bring value to our shareholders. Now let me turn the call back over to Albert for some closing comments. Albert?

Thank you, Steve. Westlake had an excellent 2012 and I'm optimistic that abundant supply of ethane from North American shale gas and oil production will continue to give our business a significant cost advantage over global naphtha-based ethylene producers. The billions of dollars in capital being invested in North America to produce, fractionate and transport the natural gas liquids production from the shale gas and oil properties has fundamentally shifted the cost structure of the North American chemical industry and showed that the shale gas advantage should benefit North America light ethylene crackers such as Westlake's for years to come. We have continued our pursuit of near-term growth initiatives to leverage the shale gas benefits we see. The financial benefits of our expansion plans will begin materializing in the first quarter of 2013 with expansion of one of our ethylene units in Lake Charles and in the second half of 2013, with the start up of our new chlor-alkali unit at Geismar. Additionally, in the third quarter of 2012, we announced a series of growth plans for our Calvert City facility. These include expansion of our Calvert City ethylene unit by 40% from 450 million pounds to 630 million pounds a year. The conversion of that unit from propane to ethane feedstock and expansion of our PVC facility in Calvert City by 200 million pounds a year. In 2014, we will see the financial contributions from the completion of these expansion plans in Calvert City in ethylene and PVC. We are targeting 2015 to complete another ethylene expansion in Lake Charles. All these investments expand our product integration while leveraging our existing asset base to deliver near-term benefits and demonstrate our belief that the shale gas advantage will benefit us for years to come. Thank you very much. Now, let me turn the call over to Dave Hansen.

Thank you, Albert. Ladies and gentlemen, 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 to you at the end of the call. Operator, we're now prepared to take questions.

[Operator Instructions] Your first question comes from the line of Brian Maguire.

First question was in the press release, there was a comment about a trading activity in the fourth quarter resulting in unrealized losses, $10.8 million. I just wanted to clarify whether that was included in the $143 million of operating profit in the Olefins segment in the quarter or the $1.42 of earnings or is this an expense that kind of relates more to future gains and losses?

No. It's included in those operating results, Brian.

Okay. And was that just related to hedging out some feedstock or some finished products at a higher or lower price than what was realized in the quarter?

Yes. We have normal trading activity and this is just part of that.

Okay. And then second question was, I know you have the big turnaround and capacity expansion in the first quarter of the ethylene unit in Lake Charles and I also noticed your olefin volume was down around 11% in the fourth quarter. I'm just trying to get a sense of how much of that volume decline was due to trying to build inventory of ethylene in advance of the turnaround and how much of an impact the turnaround had on the fourth quarter earnings?

There was a little bit of that activity as we built inventory for that planned quarter. That's going on right now, Brian.

And is that -- you commented on 60 days so I guess we're getting towards the end of that, I understand it happened in the second week -- start of the second week of January. Any change to the 240 million pounds or so of additional capacity? The size of the expansion, do you think you'll be able to get the full amount of it or is it still too early to tell?

We'll know when the unit is up and running but that range is still, I think, a reasonable estimate.

Your next question comes from the line of Don Carson.

Steve, I just wanted to follow up on the Lake Charles turnaround. So what volume impact will have this -- will that have this quarter? Did you build enough inventory to see through the loss of a couple of hundred million pounds or did you have to go it and buy spot or do swaps or anything like that? Maybe just walk us through how -- what the first quarter impact will be?

Yes, Don. We had planned obviously, for the turnaround here and so certainly, we had built inventories to be able to see us through the period. Certainly, there'll be lost pounds obviously, while the unit is down. It's a couple of hundred million pounds.

Okay. And then what is the impact, I know you had a BCM force majeure recently. What impact will that have in the quarter?

It will be de minimis.

Right, okay. And then you talked about a Geismar start up in the second half. Do you have an exact timeframe now and sort of what impact that will have on your merchant purchases of chlorine in the second half of the year?

Don, we'll get to the exact timing and start up of that as we get into -- later in the year and so we'll talk about that as we get more specifics with the start up of that unit.

Your next question comes from the line of Frank Mitsch.

You're ending the year, obviously, with a very nice cash balance. Obviously, you're using a lot of that on some of the internal projects that you have but I was just curious about your interest in M&A and perhaps pursuing some of the crackers that are reportedly for sale out there or folks looking for partners to start up. Obviously, thinking about Eastman who you have a relationship with on the ethylene side for your polyethylene unit. What are your thoughts about doing things of an M&A nature as opposed to doing what you're currently doing organically?

Frank, as you know, we always look at projects both internally and externally and as you can imagine, as an industry participant, we assess those things on a regular basis. But I can't make any comments about anything we might be evaluating currently.

So we should not be surprised if you do something of a strategic nature outside of your own internal programs?

Frank, as I've said, I can't make any comments about things that we assess. And obviously, if we have something to announce, we'll do so.

Great. Here we are, halfway through first quarter, can you comment on what's going on in the caustic market? We're hearing mixed reports in terms of the success of the $35 per ton price increase on the table there. What are you seeing volumetrically? There was a lower operating rates for the industry overall in January, obviously some of that was on plant outages. But what can you -- can you characterize what you're seeing in the caustic markets right now?

At the caustic market, I think, it's stable. I don't think that the demand, the economic pickup has not been that material. So I think it's going sideways and there's a price increase on the table we'll see whether we can get in the first quarter.

Your next question comes from the line of Kevin McCarthy.

I think in the past, you've commented that you are studying an MLP structure and I'm wondering whether or not Westlake has reached any conclusion as to whether an MLP might be feasible for either new or existing assets and whether it's still an ongoing subject of consideration?

Kevin, we are continuing to evaluate this. It is an involved analysis, it takes some time and our analysis continues. We've reached no conclusions one way or the other, at this stage.

Okay. And then the second, I want to follow-up on the subject of polyethylene resin pricing? A few of the trade journals had reported that at least one competitor, NOVA, had deferred the $0.04 proposed increase for February into March. Have you observed that and have any others made similar moves or you're still kind of fighting for the plus $0.04 in February?

Yes. I think as far as we know, NOVA is the only company who's done that. We are in the middle of February. The business is good and we are proceeding with our price increase.

Okay, very good. And then finally, Albert, I'd be interested to hear any thoughts you might have on the propane market as I guess, been the better part of a year now, where we've been above the 5-year average band for inventories, what is your view regarding the sustainability of key propane when you look at the amount coming out of the ground, inventories, feed switching, et cetera, any thoughts along those lines?

Sure. Today, if you read the IHS Chemical's outlook for February and March, propane is the third feedstock for ethylene by about $0.01 a pound over ethane, mainly because of the high propylene prices. And as you know, approximately 40% to 50% of natural gas liquids ethane, the balance is propane and butane, as more and more ethane is produced, so is more and more propane and butane being produced. So until the export terminals with the warm winter and until the export terminals can export the excess propane, propane prices in the U.S. will be attractively priced for the chemical industry.

Your next question comes from the line of Hassan Ahmed.

First question on the vinyls side of things. You just mentioned that you expected, at least in the very near term, caustic pricing to be going -- I mean there is a price increase on the table, but you talked about sideways pricing. My question was a couple of quarters out, as more chlor-alkali capacity comes online, do you still expect the market to be relatively balanced?

That's a good question. Certainly, as you said that our plants and a few other plants coming online in the second half of this year and depending on the demand in the market and depending on what other companies do with their other higher cost caustic plants, we don't know what the balance of production and the demand will be and we expect that if there's excess of production over demand, then there will be some price pressures over caustic.

But would you expect, I guess, the market to be rational or the participants in the market?

Well, certainly, we hope so.

Okay, fair enough. Now changing gears a bit on the olefin side of things. Obviously, on the U.S. side, there seems to be a rather large delta between contract and spot ethylene pricing. Now as I look in the Asian spot side of things and this is, as it relates to ethylene, there seems to be a nice pickup or uptick in the price of spot ethylene. Call it almost $200 a ton over the last couple of months, which to me, was a bit surprising, particularly ahead of Chinese New Year. I mean, is this really a function of underlying demand sort of having picked up a fair bit or is there something else going on?

Well, I think the rent oil price moving up in the last month or 2 has indicated a pickup in demand, mainly as we read from Asian and Chinese demand increase. I think the manufacturing sector in China has improved over last year's downturn.

And you are seeing the ripple effect of that in the ethylene, polyethylene side of things?

We believe so, yes.

Your next question comes from the line of Jeff Zekauskas. Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division: So these days, the price of ethane or the delivered price of ethane relative to the price of methane is lower. Do you see this as a new normal or do you see this as an exceptional period of time over the next -- that is, is the ethane price from your point of view in the mid-20s unusual or do you think it's normal going forward?

Well, going back many years, ethane price was more or less gas price plus a fractionation cost of $0.04 to $0.06 a gallon. And [indiscernible] price [indiscernible] when demand was high and ethane really was slow. But today, with shale oil and gas production that so much gas liquid is coming out. As I said earlier, there's not enough demand from the petrochemical side to absorb all the ethane. So the price has dropped closer to natural gas prices. But I guess going forward, depending on what natural gas prices will do, then it will have a large impact on the ethane price. Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division: Okay. In terms of your Geismar chlor-alkali expansion, would you expect operating rates, I don't know, to average above 60% in the third quarter of this year?

Geismar? Which plant are you talking about? Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division: Your new chlor-alkali...

We said we'll start on second half of this year. And as Steve said, we will give you more updates later on in the year when we have more visibility.

Your next question comes from the line of Gregg Goodnight.

You've mentioned several times about the plentiful ethane, the EIA reported over 36 million barrels of inventory at the end of November, which surprised people that it actually went up. My question to you is, do you have your own house view on what ethane inventories are likely to do this year? I know we're starting off with a lot of shutdowns including your own. Do you think inventories are going to remain high throughout the year?

Currently, we believe that ethane rejection right now into natural gas. And this year, in the U.S., there's about close to 1 million barrels of fractionation capacity coming online and all of that, about approximately 400,000 barrels a day of ethane. And this is fractionation capacity now, which means there will be more additional ethane that will be coming into the marketplace. I don't think this 400,000 barrels a day of increased demand or close to that number even, of that demand from petrochemical from ethylene capacity additions. So we believe there'll be additional supply and that exceeds the demand increase.

Okay. Second question. Your olefins volumes were down 11% year-over-year. What piece of that was attributed to the high spot price of ethylene and your decision, say, to back out rates and say perhaps, to styrene or some other areas?

Well, with high ethylene prices, it impacts the ability to export polyethylene, PVC or styrene.

Absolutely. So, did you make a decision to limit exports in say, polyethylene due to your purchase position on ethylene?

Yes.

And was that about equal in magnitude, say for instance, for your pre-inventorying ahead of your shutdown?

Yes. I think we looked at how much we have to -- we can put inventory and how much we have to buy, how much we have to curtail production.

[Operator Instructions] Your next question comes from the line of Brian Maguire.

Just a follow-up. I want to get your quick thoughts on your stock repurchase program at this point. It was, I guess, a pretty modest use of cash in 2012, maybe $10 million, $11 million of repurchase activity and I think you still have an authorization there. Just wondering how you think about it at this point. I know you did the special dividend and maybe just how you think about the different forms of returning cash to shareholders at this point?

Brian, as you know, we are going to have an elevated capital spending program in 2013 and of course, we'll continue to move forward on those major projects. So as we look at ways to grow the business organically or inorganically, if we can find ways to deploy it at over our risk-adjusted cost of capital, we'll do so. And if we can't find those kinds of projects and can't find a way to bring those -- that value to the company and the shareholders near-term, then we'll return it back in either that form of the special as we did in December or in that share repurchase.

Great. And just one last one on the CapEx. I know it's ticking up this year with the growth spending and maybe there's a little bit abnormal growth spending in '14 with the Calvert City plant but what would be the kind of the expected level, maybe a steady-state CapEx for the business after the current slate of growth spending is all completed?

I tend to think of once we've got a more steady stream level kind of maintenance capital running to 67 -- $60 million to $70 million of maintenance and then some nongrowth but discretionary capital, another $30 million or so, so in the neighborhood of $100 million to $110 million a year included some of that discretionary capital, but non-major project growth-oriented.

Your next question comes from the line of Richard O'Reilly.

Of Revere [ph] Associates. Besides the first quarter turnaround, are there any other schedule for the year? Because that's always a wildcard in your quarter-to-quarter performance.

No. There are no other scheduled or planned turnarounds other than the one that we're taking currently.

When would be the next big one then, in the future, of normal turnarounds?

That will be for the second ethylene plant in 2015.

Okay, ladies and gentlemen, I believe that, that will end our question-and-answer session at this time. We're pleased that you have been able to join us today for our call and we hope that you will join us again for our next conference call to discuss our first quarter results in 2013. Thank you very much.

Thank you for your participation in today's Westlake Chemical Corporation's Fourth Quarter Earnings Conference Call. As a reminder, this call will be available for replay beginning 2 hours after the call has ended and may be accessed until 11:59 p.m. Eastern time on Tuesday, February 26, 2013. The replay can be accessed by calling 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 42085567. Have a great week.