Westlake Corporation (WLK) Q1 2014 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Westlake Chemical Corporation First Quarter 2014 Earnings Conference Call. During the presentation, all participants will be in listen-only mode. After the speakers’ remarks you will be invited to participate in a question-and-answer session. As a reminder, ladies and gentlemen, this conference is being recorded today, May 5, 2014. I would now like to turn the call over to your host for today, Mr. Dave Hansen, Westlake’s Senior Vice President of Administration. Sir, you may begin.

Thank you very much. Good morning, everyone. And welcome to the Westlake Chemical Corporation first quarter 2014 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 conference call agenda will begin with Albert, who will open with a few comments regarding Westlake's performance in the first quarter and the current perspective on the industry. Steve will then provide a more detailed look at our financial and operating results. And finally, Albert will add 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. As you are probably aware, Westlake issued a press release on April 29, 2014, describing our intention to pursue the creation and initial public offering of an MLP that would own a minority interest in a newly form operating subsidiary that would hold our Lake Charles, Louisiana and our Calvert City, Kentucky ethylene production facility. Also on the 29th of April, we filed a registration statement with a Securities and Exchange Commission, which describes a structure of the proposed MLP, as well as its business and…

Thank you, Dave. Good morning, ladies and gentlemen. And thank you for joining us on our earnings call to discuss our first quarter results. In this morning’s press release, we reported quarterly net income of $158 billion or $1.18 per diluted share on sales of $1 billion. Our first quarter results were listed by record income from operations reported in our Olefins segment, which benefited from the ethylene expansion work that was completed last year at our Lake Charles facility and strong integrated margins in the Olefins segment in spite of higher ethane feedstock prices. The Vinyls segment completed an important milestone by converting our Calvert City ethylene unit from propane to ethane feedstock and expanding its capacity by approximately 180 million pounds. As discussed in our last conference call, the planned downtime associated with the project impacted our Vinyls first quarter results. Our Vinyls segment results were also impacted by the severe winter weather that cause the rise in propane feedstock costs and delayed a start to this year’s construction season. The completion of the expansion and feedstock conversion brought at our Calvert City facility allows us to access Marcellus-based ethane and further improve our integrated margins at a site. While allowing Calvert City Vinyls business to capture the advantageous ethane-based ethylene cost position that our Lake Charles Olefins business has benefited from over the past several year. In conjunction with this project we are completing a project to expand our PVC capacity by approximately $200 million pounds at Calvert City, which will allow us take advantage of the increase ethylene production at the site. The benefit of investments that we have made in Lake Charles, Geismar, Louisiana and Calvert City to capture the ethane natural gas advantage in North America to produce ethylene and chlorine for our downstream businesses will drive our future results. I would now like to turn over to Steve to discuss the financial and operating results for the first quarter.

Thank you, Albert, and good morning, everyone. I will begin by discussing our consolidated financial results followed by a detailed review of our Olefins and Vinyls segment results. Let me start with our consolidated results. In this morning press release, Westlake reported net income for the first quarter of $158 million or $1.18 per diluted share, which is an increase of $35 million over first quarter 2013 net income of $123 million or $0.93 per diluted share. Net sales for the first quarter of 2014 of $1 billion was $163 million higher than sales reported in the first quarter 2013, primarily driven by higher sales volume in our Olefins segment, higher sales prices for most of our major products and added sales contributed by our specialty PVC pipe business that was acquired in May 2013. Westlake’s operating income for the first quarter of 2014 was $248 million, an increase of $54 million compared to $194 million reported in the same period of 2013. Operating income in the first quarter of 2014 primarily benefited from improved Olefins’ integrated margins as higher polyethylene sales prices more than offset the increases in feedstock and energy costs. The increase in first quarter 2014 operating income was partially offset by the lost sales, unabsorbed fixed manufacturing costs and other costs totaling approximately $17 million associated with the planned 19-day maintenance turnaround of our Calvert City production facilities. First quarter 2014 results were also impacted by the extended severe winter weather that drove program prices significantly higher and affected the start of the construction season. Sales revenue of a $1 billion in the first quarter of 2014 increased by $176 million over sales in the fourth quarter of 2013, driven by higher sales prices for our Olefins products, PVC resin and PVC pipe as well as…

Thank you, Steve. We are pleased to report a strong start to 2014, with these first quarter results. Driven by growth in Olefins sales volumes and margins, our Olefins segment delivered record income from operations, while Vinyls segment successfully completed an expansion and ethane conversion project at our Calvert City ethylene plant that will improve the cost position of our Vinyls business and drive future results. The important milestone, combined with our achievements in 2013, where we expanded our ethylene capacity and completed our product integration with the start up of our new Geismar chlor-alkali facility, led the foundation for improved operating results. We have further growth opportunities, including the completion in the second quarter of our PVC expansion project at Calvert City, which will expand our PVC capacity by approximately 200 million pounds. Additionally, we are currently planning another ethylene expansion at our Lake Charles facility, which will further expand our vertical integration by adding approximately 250 million pounds of ethylene capacity in late 2015 or early 2016. All these investments reflect our strategy to integrate our product chain to allow us to further benefit from low cost ethane feedstock as well as improve our cost position, which will drive our near-term and future results. Thank you very much for listening to earnings call this morning. Now I will turn the call back over to Dave Hansen.

Thank you, Albert. Ladies and gentlemen, before we begin taking questions, I'd like to remind you that a replay of this teleconference will be available starting 4 hours after we conclude the call. We will provide that number again at the end of the call. Operator, we'll now take questions.

(Operator Instructions) Your first question comes from the line of Brian Maguire with Goldman Sachs. Please proceed.

Hey, good morning, guys.

Good morning, Brian.

Good morning, Brian.

First, just congratulations to Steve and Albert on the recent MLP IPO filing, I know you guys have been looking at that for a long time. And it sounds like it came to a good decision, it sounds like it will be a very value accretive to the shareholders. So, just my thoughts on that, congratulations. But on that note, I was hoping you might provide some guidance on what kind of tax considerations there might be as it pertains to Westlake, what kind of a tax impact this might have for you if the transaction goes through, and would there be a kind of one-time check you write to the IRS for transferring the assets? Any kind of guidance you could give there would be great?

Brian, as we mentioned, there is not much I can say as it relates to the MLP at this stage, but I would say, as you know, we spent a lot of time studying this transaction post-transaction. And certainly, we want to move forward to make sure that it’s beneficial to not only the Westlake shareholders but any potential future Chemical Partners unitholders. So I would say it’s just been an area of detailed study, but I can’t really say a whole lot more.

Okay, great. And then the results in the quarter from Olefins are very strong, I thought sequentially moving up quite a bit, $25 million or so, despite the higher feedstock cost. So wondering was there any benefit or material benefit from the differential between Texas and Louisiana spot prices in the quarter and were you able to take advantage of that, selling a little bit more volume into the Louisianan spot market?

The impact were quite small but were net buyer of ethylene.

Okay, great. And then Steve thanks for quantifying the impact to the second quarter from Calvert City turnaround and some of the inventory issues. I think Petro 1 also had a little bit of a hiccup this month as well. Just anything we should be thinking about for the impact of the Olefins segment from that?

It will be a small impact.

Okay, great. Thanks a lot.

You are welcome.

Your next question comes from the line of Hassan Ahmed with Alembic Global. Please proceed.

Good morning.

Good morning.

In the past, Albert, you’ve been fairly vocal about ethane being quite long in the near to medium term in the U.S. With this recent announcement from enterprise, does that change your views at least as far as the medium term goes?

No, we believe that ethane will be long for the foreseeable future. And the fact that enterprise is building this terminal, it will further reinforce the fact that excess ethane that U.S. needs to find a home for it.

Fair enough. And now you have your sort of Geismar chlor-alkali facility up and running, you said there were some for lack of a better we are putting it hiccups in Q1. But in the Q4 call, you talked about how you felt that chlor-alkali pricing may have potentially bottomed out, is that what you continue to see as we sit here today?

We have industry announced price increase and I think for the first quarter and price increase was partially implemented. Going forward, depending really on the global demand and U.S. demand for chlor-alkali and chlorine, so time will tell how demand will offset by increased capacity in the industry.

Very good. Thank you, Albert.

You are welcome.

Your next question comes from the line of Don Carson with Susquehanna. Please proceed.

Yes. Steve, I was wondering if you could quantify how much you spent on your crackers over the last three years if you total up the money spent at Calvert and then first expansion in Lake Charles. And maybe just remind us, how much you’d be spending next year on the expansion of Petro 2?

The expansion of Petro 1 next year in 2015, late 2015 or 2016 will be adding about 250 million pounds of capacity. And we estimate that it will be the capital cost to be in the neighborhood of $250 million to $350 million of capital. In terms of the capital that we spent in Kentucky and in Lake Charles on Petro 2, we press released that and that’s been, I think a very transparent number.

On those expenditures, how much would that have collectively raised your tax basis in those assets?

Well, certainly, we had benefit of accelerating tax depreciation over the last couple of years. And so while we’ve had those capital dollars spend, we’ve also been able to reap the benefit of bonus depreciation over the last couple of years. Last year was the last year of the 50% bonus depreciation. So we’ve been able to benefit in 2012 and ‘13 from those dollar spent.

And then secondly on Geismar expansion, you mentioned I made a very modest contribution in Q1 but you are looking at meaningful contribution going forward. What -- can you size the delta between small and meaningful?

Well, what I would say is during the first quarter of 2014, we’re in a process of ramping in the operating rates up for that unit. And so today, with that unit at, what I would call commercial operating rates, it will make its normal contribution based on the margins that you see in the market place and all -- that’s all I was trying to guide was that we didn’t have it at full operating rates from the first quarter as we ramped it from a start-up to its rates today.

Okay. And then finally, just a follow-up on caustic pricing, Albert, you know the industry’s got this $50 initiative out there. It doesn’t seem like much came through in Q1. What’s the good rule of thumb for how much you might realize this quarter say half of that price increase if it is successful?

Don, we believe that approximately half of that announced price inclusive -- implemented.

Thank you.

You’re welcome.

Your next question comes from the line of Alex Yefremov with Bank of America Merrill Lynch. Please proceed.

Good morning everyone. Just wanted to -- could you provide early indicators of demand for our PVC resin and also fabricated products in the domestic market. Do you see meaningful pickup? Was warmer weather arriving in the U.S.?

Yes, we see that demand is recovering from the cold winter we had. As you know, PVC prices increased in the first quarter substantially and/or some inventory building by the fabricators. So it will adjust out through the second quarter that we believe with upcoming warm weather and improving economy of demand for PVC will increase in the second quarter.

Related to that, what is your outlook for PVC prices, do you think that current domestic PVC prices are sustainable given the gap between domestic and export prices?

Time will tell, I think the demand increase will see whether it will be balanced by the increased capacity coming on stream.

Probably more of a short-term question, do you see an impact on PVC and chlor-alkali industries in the near term from dollars outage in Louisiana?

Well, it depends, it’s all about the ethylene situation. Depending on how long the outage would be. And this -- ethylene production capacity come on stream from the turnarounds.

Okay. Thank you.

You’re welcome.

The next question comes from the line of John Roberts, UBS. Please proceed.

Morning.

Good morning, John.

Could you give us an update on your interest in acquisitions and current M&A environment?

We continue to look at ways of deploying capital and lots of different fashions. As you know we looked at and we talked about this morning, expanding our ethylene footprint in Lake Charles by expanding that cracker in late ‘15, early ‘16. We’ll also continue to look for opportunities to deploy capital and opportunities that present themselves that have good returns above our risk-adjusted cost of capital. So we’ll look at ways to deploy capital both internally and externally.

Then as a follow-up, neither your cost of capacity is placed in the market. Is your mix of customers similar to the overall market mix or are there any significant differences between the average competitive mix in customers?

Well, certainly we have a different footprint because we have a business up there in Western Kentucky. And so I can speak to the customer mix of all my competitors. I would say that we have good coverage of the customers both in Midwest as well as in the Gulf Coast.

Thank you.

And frankly across both coast as well.

The next question comes from the line of Frank Mitsch with Wells Fargo Securities. Please proceed.

Good morning, gentlemen. You mentioned that the Geismar plant was -- the new Geismar plant was operating at the planned operating risk. Can you indicate is that at the industry average or were you -- or are you planning to operate that plant towards its nameplate capacity?

Well, it’s operating closer to the industry average and we plan to increase production as demand increases.

Okay. Great. And then you mentioned that the Calvert City plant is complete. How is that running today?

Running smoothly. As I mentioned, we’d completed the debottleneck in the feedstock switch from propane to ethane and were pleased with that activity.

Great. And then lastly, on building products, how did that trend pricing volumes in Q1 and how did that fare in April relative to Q1, that is, I mean, are we seeing a material bounce back in that sector?

Yes, we see demand recovery and as you know, the PVC price increased during the first quarter. So the building products also reflected price increases, reflecting the cost -- volatile increases.

Thank you so much.

You’re welcome. You welcome.

Your next question comes from the line of James Sheehan with SunTrust. Please proceed.

Good morning. Looking at the polyethylene markets, you see inventories creeping up a little bit now. Polyethylene prices have been very strong recently. Do you think that the prices can hold where they are?

Well, time will tell. We have -- it’s a season, the second quarter and third quarter usually are the strong demand season for polyethylene. So time will tell how strong the demand will be.

Okay. And just a strategic question if I may on the MLP. I notice in the S-1 documents that Westlake plans to lend money for the cracker expansion. Why did you choose to do it that way amongst all the alternatives?

Jim, well, I know that you would love to have lots of questions on this. I can’t really speak a lot of the detailed elements of this. But once we get past the SEC comments and registration statement’s effective, I’ll be able to be a lot more responsive to those questions and many more that I know that you have. But unfortunately, I just can’t get into the details until the registration statement’s effective.

Okay. And then on -- last question on Dow’s plans to have -- to divest its chlor-alkali business, what impact do you think that process may have on your business?

We don’t think it will have much impact on our business.

All right. Thanks a lot Albert.

You’re welcome.

(Operator Instructions) Your next question comes from the line of Jeff Zekauskas with JPMorgan. Please proceed.

Hi, good morning.

Good morning, Jeff.

It seems that in the first quarter there was more pressure on ethylene prices than there was on polyethylene prices. Why do you think that is? And do you think that the weakness in ethylene prices has any bearing on polyethylene prices in the second quarter?

Well, as you know, there were some unplanned outages in the ethylene industry and especially also with the Evangeline pipeline not in operation. So ethylene was very short on the river area. And Evangeline, when the Evangeline pipeline comes in operation sometime in this month and after turnaround there will be more ethylene available to the industry. But having said that, polyethylene global prices follow really global oil price and I think oil price has been very strong globally. So we anticipate that polyethylene prices globally would stay pretty stable at this level.

Well, as you say, we shall see. Can you give us an idea of what you might to with your -- how do you see your free cash flow after you complete your next polyethylene expansion? In that -- is it possible for you to enlarge your footprint, or is that the last step? And if it is the last step, then how do you see use of cash flows after that time?

Jeff, as we continue to look for internal or organic opportunities, we’ll continue to look at and assess whether it’d be invested in the ethylene or other areas of our business. And certainly, we’ll continue to look as well outside of our business. So as we look at growth opportunity first organically because they’re completely within our control. The best and most quickest payback projects are the ones that we’re working on right now and then we’ll look at opportunities outside of that and those could be inorganic. But we’ll continue to look at those opportunities and assess which one have the best and quickest returns to this.

Okay. Great. Thank you so much.

You welcome.

We have a follow-up question from Alex Yefremov with Bank of America Merrill Lynch. Please proceed.

Steve, could you break out the FIFO, the $25 million FIFO benefit between the segments? And also do you have an idea of how FIFO could turnout in the second quarter?

Alex, we don’t typically breakout the FIFO between Olefins and Vinyls, but I would say, given the concentration of our business of Olefins and Vinyls you would expect that the preponderance of that would be on the Olefin side of the business.

And how about 10-Q outlook, if you have one.

Well, we’ll see where prices go over the next month and a half or two, but prices for feedstock have trended down and so they continue on that trajectory. We’ll certainly benefit from having a lower or certainly have a detriment in FIFO as a consequence.

Thanks a lot.

You’re welcome.

Your next question comes from the line of PJ Juvekar with Citigroup. Please proceed.

Yes. Hi. Good morning.

Good morning, PJ.

Yeah. Albert, so your decision…

Good morning.

… to do MLP now, how should we read into that about your view of the ethylene cycle?

Well, as we’ve said in the past few minutes that we believe the ethylene business will be quite strong going forward and we have favorable ethane feedstock position going forward as well.

Okay. And Steve, you said you would look at inorganic opportunities, which chains are you more interested in doing these deals? Is it ethylene side or chlorine side?

PJ, we look at both. There isn’t a preference per say at looking at one or the other. If we look at, it’s a businesses -- both businesses are businesses that we well understand. And as you know, they all -- are all tied from feedstock all the way through in the polyethylene or in the PVC. So we’ll pursue opportunities in both.

Thank you.

You welcome.

At this time, the Q&A session has now ended. Are there any closing remarks?

Well, we’d like to thank you again for participating in today’s call. We hope that you will join us again for our next conference call to discuss our second quarter 2014 results. Have a great day.