Looking to Westlake (WLK) for Clues

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Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

February 20th, 2017

Looking to Westlake (WLK) for Clues

  • WLK has become an increasingly interesting stock for us as the company has a number of things all moving in the right direction today:
    • The Axiall deal gives increased leverage to what appears to be an improving PVC and Caustic market globally.
    • The deal also brings synergy opportunities which we believe the company will grasp quickly and will likely outperform versus what has been suggested.
    • We are already believers in a stronger ethylene market, but WLK also has styrene capacity and that market appears to be tightening quickly.
    • The stock is very inexpensive if WLK can return the Axiall assets back to the returns that the company has overall – could do better in a stronger PVC and Caustic market.
  • While WLK’s earnings report is important for WLK and for WLK holders, the late timing of the report means that WLK has a better view of how Q1 is progressing than prior reporters.
    • Important because WLK is in so many businesses that impact others and there will likely be read throughs for many companies:
      • Ethylene and polyethylene – DOW and LYB
      • Styrene – TSE and LYB
      • PVC/Caustic – OLN, DOW (Europe) and Akzo
  • There are some concerns that investors will want more clarity on:
    • The increase in capex needed to fix some of the problems acquired with the Axiall assets.
    • Ethylene costs for 2017 given that WLK is now the largest buyer of ethylene in the US – will WLK buy ethylene assets – long rumored.
  • Regardless – WLK looks inexpensive in our models as we would expect WLK to earn close to $7.00 on a normalized basis by 2018, while consensus is expecting less than $4.20. Normalized value for the company with its expanded asset base is close to $100 per share.

Exhibit 1

Source: Capital IQ and SSR Analysis

Details

As a late reporter, WLK can be a fountain of information for the commodity chemical group, with mid-quarter data on pricing, margins and demand. The company is:

  • A large buyer of ethane and propane
  • A medium sized producer of ethylene and polyethylene
  • A styrene producer – so a buyer of benzene
  • One of the largest PVC producers in the West – US and Europe
  • A large chlor-alkali producer and seller of caustic
  • With the Axiall acquisition the company adds
    • A larger ethylene merchant position – WLK is the largest buyer of ethylene in the US today
    • An ability to cut costs as a consequence of the transaction – benefits that should start to show up the fourth quarter results, but for which the 2017 run rate is more important

As we have been generally more bullish on ethylene for a while now, WLK has been on our radar, but without the same leverage as LYB. When we saw the commodity cutbacks in China, WLK moved towards the top of the list given the pricing gains in Caustic and PVC, which may be sustained through 2017 and beyond.

To be clear, we are interested in WLK itself today as the recovering caustic and PVC market is a very big deal, post the acquisition. Also, styrene has real strength today – boosted by a recent US announcement of a US major shutdown extension. WLK has the potential to be one of the better stocks in the group today, but it does have a couple of hurdles yet to cross:

  1. Some of the assets acquired with Axiall are in poor shape and WLK will need to spend money to fix them – expect a significant ramp up in capex this year which will eat into free cash flow.
  2. WLK is the largest buyer of ethylene in the US, in what we think is a tight to tightening ethylene market. There are some ethylene assets that WLK could acquire – and we expect one of those deals to take place, but the situation is complicated by the agreement that Axiall did with Lotte Chemical to build in the US – giving WLK half of the ethylene it needs by 2019 (although the timing of this facility is less clear than it was).

But in addition, WLK should give us mid-quarter data that will give clues as to the performance of LYB, TSE, OLN, DOW, PSX and in Europe Akzo. Polyethylene is the key data point that we are looking for – the market appears to have bounced back from some Q4 2017 weakness as new capacity was added in North America, but we would like to see continuing strength as this would give us more confidence that further capacity additions in 2017 can be absorbed quickly.

WLK itself will likely trade based on the balance of how much the PVC and caustic markets are improving and how much down time and expense WLK has in 2017 to fix some of the issues at Lake Charles, LA. Strong commentary on caustic will boost OLN.

We are effectively “all in” on commodities right now, metals, paper and chemicals. Exhibit 2 shows discount from normal value for the commodity companies we maintain detailed models on. WLK shows as one of the most interesting valuations.

Exhibit 2

Source: Capital IQ and SSR Analysis

©2017, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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