Westlake Corporation (WLK) Q3 2013 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Westlake Chemical Corporation's Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, November 7, 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, and good morning, everyone, and welcome to the Westlake Chemical Corporation Third Quarter 2013 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 third quarter and a current perspective on our 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 we will then open the call up 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. This morning, Westlake issued a press release with details of our third quarter 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 4 hours after completion of this call until 3:00 p.m. Eastern Time on November 14, 2013. 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 45573736. Please note that information reported on this call speaks only as of today, November 7, 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, and it can be accessed at our web age 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 third quarter earnings call. This morning our third quarter 2013 press release reported record quarterly net income of $170 million, or $2.54 per diluted share, on sales of $1 billion. This record quarterly -- this record quarter nearly doubles the net income that we reported in the third quarter of 2012, driven by continued strong results in the Olefins segment and improved results in Vinyls. Both our segments continue to benefit from the low-cost feedstock environment that is a result of the abundant supply of natural gas liquids. I think prices decreased in third quarter as ethane remains in an oversupply situation due to increased shale drilling, which contributed to strong integrated margins across both of our Olefins and Vinyls segments. We believe that this ethane feedstock cost advantage over heavier feedstock base ethylene will continue as significant capacity in fractionation and pipeline infrastructure with additional supplies of ethane in the market faster than the North American chemical industry can consume it. The Olefins segment results continues to benefit from strong margins, driven by low-priced natural gas liquids raw material and continued good demand for polyethylene. Our results also reflect the benefits from the additional ethylene capacity that we brought online early this year at our Lake Charles, Louisiana facility, as well as the improvement in our integrated cost position that allows us to capture a greater portion of the ethylene value chain. Improving results in our Vinyls segment was driven by the improvements in integrated Vinyls margins. And now I'd like to turn over to Steve for a more detailed look of the financial and operating results for the third quarter and the year-to-date.

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's press release, Westlake reported record quarterly net income for the third quarter 2013 of $170 million, or $2.54 per diluted share, an increase of $83 million over the third quarter of 2012 net income of $87 million or $1.30 per diluted share. Net sales for the third quarter 2013 were $1 billion, which were $183 million higher than sales reported in the third quarter of 2012, primarily as a result of higher sales volumes for styrene and higher sales prices for most of our major products. Westlake's operating income for the third quarter 2013 was also a record at $267 million, an increase of $124 million compared to the same period in 2012. The increase in operating income compared to the third quarter of 2012 was driven mainly by improved Olefins and Vinyls integrated product margins due to higher sales prices from most of our major products and lower feedstock costs as compared to the prior-year period. Contributing to the sequential annual improvement is the realization of the additional ethylene capacity from our Lake Charles facility, which allows us to produce ethylene at a lower cost than purchasing it from the market, thus capturing a greater portion of the Olefins integrated margins. Sales revenue of $1 billion from the third quarter 2013 were $65 million higher than sales in the second quarter of 2013, driven by higher sales volumes of polyethylene -- for polyethylene. The third quarter income from operations of $267 million was $32 million higher than in the second quarter 2013, primarily due to lower feedstock costs and higher polyethylene sales volumes. For the 9 months ended September 30, 2013, we reported net income of $439 million, an increase of $149 million over the $290 million reported in the first 9 months of 2012. Sales revenue for the first 9 months of 2013 increased by $38 million compared to the prior-year period, mainly due to a higher sales volumes for styrene and sales contributed by our recently acquired specialty PVC pipe business. These increases were partially offset by lower feedstock, ethylene and ethylene co-products sales volumes. Income from operations was $696 million for the first 9 months of 2013, an increase of $237 million over the prior-year period. And that was mainly attributable to higher Olefins and Vinyls integrated product margins due to a significant decrease in feedstock costs as industry ethane prices decreased 40% and industry propane prices decreased by 10% from the prior-year period. Our utilization of the FIFO method of accounting resulted in a favorable impact of $1.6 million, pretax or $0.02 per share in the third quarter as compared to what earnings would have been if we reported on the LIFO method. Please bear in mind that this calculation is only an estimate and has not been audited. Let's move on to review the results of our 2 segments. Starting with the Olefins segment. The segment reported operating income of $237 million on sales revenue of $679 million during the third quarter 2013, compared to operating income of $124 million on sales of $540 million in the same period of 2012. The increase in operating income was mainly attributable to higher Olefins integrated product margins as compared to the prior-year period, primarily as a result of higher sales prices for most of our major products and lower feedstock costs. Olefins operating income of $237 million in the third quarter 2013 was $49 million higher than the operating income in the second quarter of 2013. The third quarter operating income benefited from higher polyethylene sales volumes and higher integrated Olefins product margins, driven by lower feedstock costs. Partially offsetting this benefit in this quarter was the impact of an unplanned outage at one of our crackers at our Lake Charles facility, which resulted in the unit being down for 14 days. We estimate that the impact of the lost production and associated costs to be approximately $21 million on a pretax basis in the third quarter results. In the first 9 months of 2013, the Olefins segment reported an increase of $176 million in income from operations to $586 million, up from $410 million for the same period in 2012. This increase is mainly attributable to higher Olefins integrated product margins as compared to the prior-year period, driven by lower feedstock costs, which was partially offset by the lost production and expensing of approximately $70 million related to lost production and other costs associated with the turnaround and expansion of one of our Lake Charles ethylene units. Now let's move to the Vinyls segment. The Vinyls segment reported income from operations of $40 million from the third quarter of 2013. This is an increase of 64% as compared to the $24 million reported in the third quarter 2012. The increase in earnings was driven by higher vinyls integrated product margins, largely resulting from higher sales prices and improved operating rates as compared to prior-year period. Vinyls operating income of $40 million in the third quarter 2013 decreased $13 million from the operating income reported in the second quarter of 2013. The decrease in operating income was primarily due to higher propane costs as compared to the second quarter of 2013. For the first 9 months of 2013, the Vinyls segment reported income from operations of $136 million, an increase of $68 million over the $68 million reported in the first 9 months of 2012. This increase was driven by a lower feedstock costs, higher sales volumes for PVC resin and higher operating rates compared to the prior-year period, partially offset by non-recurring costs associated with our specialty PVC pipe acquisition. Now let's turn our attention to the balance sheet and the statement of cash flow. As of September 30, 2013, we had cash and marketable securities balance of $717 million and total debt was unchanged at $764 million. In the third quarter of 2013, we generated $292 million in cash from operating activities. We incurred $200 million in capital expenditures. Throughout 2013, our capital expenditures have been funded from our cash balances and interest associated the funding in these projects is being capitalized. We expect our interest expense for 2013 to be in the range of $19 million to $22 million. Our guidance for 2013 capital expenditures is in the range of $550 million to $600 million. This capital expenditure estimate includes the Lake Charles ethylene expansion that was completed in the first quarter 2013, the construction of our Geismar, Louisiana chlor-alkali plant that is scheduled to start up in the fourth quarter of this year and the procurement of long lead items related to our Calvert City, Kentucky ethylene plant feedstock conversion and expansion project in 2014. We anticipate that startup costs associated with our Geismar chlor-alkali plant are expected to be approximately $5 million in the fourth quarter of 2013. As we look forward, we expect to complete our debottleneck and feedstock conversion in Calvert City in the second quarter 2014, which will impact first quarter and second quarter results. We believe that our current capital structure gives us flexibility to consider variety of capital deployment opportunities as we consider future growth prospects and investment opportunities. This allows us to pursue projects that bring value to our shareholders and to maintain our conservative approach to growth. Now let me turn the call back over to Albert to make some closing comments. Albert?

Thank you, Steve. Westlake's third quarter results are reflective of earnings potential. This is driven by the ongoing low-cost feedstock environment and the ethylene expansion that we completed in Lake Charles in the first quarter of 2013. Looking forward, fundamental factors that contributed to our success remain in place, as though [ph] natural gas liquids production from shale oil and gas drilling continues. Westlake remains well positioned to benefit from the low-cost gas derived ethane versus the more expensive oil derived nasa feedstocks. Continued industry investments in infrastructure to produce, fractionate and deliver these NGLs to the Gulf Coast will help sustain this cost advantage position. We continue to make important progress in our near-term growth initiatives that are part of our broader integration strategy, successfully completed our ethylene expansion project at our Lake Charles facility in the first quarter of this year. We'll start up our chlor-alkali plant in Geismar within the next month. In the second quarter of next year, we expect to complete 180 million pounds ethylene expansion and conversion of our Calvert City ethylene units from propane to ethane. We're evaluating another ethylene expansion at our Lake Charles, Louisiana facility in 2015. These projects will enhance our product integration and improve our profitability to allow us to further capture the low-cost feedstock advantage, reduce our costs and create value across our businesses that will drive earnings growth. Thank you very much for listening to earnings call this morning. Now I'll turn the call back 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 4 hours after we conclude the call. We will provide that number again at the end the call. Operator, we're now prepared to take questions.

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

A question for you, Albert, on the impact from the Evangeline pipeline being down and you've seen the stock price of ethylene in Louisiana and the chalked off system rise up to $0.65 pound and Texas was down in the 40s for a while, picked back up into the 50s. But as I remember, I think you have a little bit long ethylene and Louisiana a little bit short in Texas. So is there an opportunity there to benefit from that and maybe sell some of your ethylene volumes in Louisiana rather than turn them into polymers? Is that something that you had the opportunity to take advantage of in the fourth quarter?

Yes. We certainly try to optimize our earnings potential across both our Geismar and Lake Charles facility in terms of ethylene and other products.

Okay. And then for the startup of the chlor-alkali unit in Geismar, I think, Steve, you commented that that will be about a $5 million impact from some downtime due to tie in there. Just curious for the benefit for 2014, how quickly should we expect that unit to ramp up? And as you think about trying to place the caustic volumes into the merchant market there, what kind of a mix between domestic and international do you think you'll have? And what sort of a net back you think you'll get on that versus what some of the consultants like IHS are publishing for caustic prices?

Brian we'll bring that unit up over the quarter as we startup and certainly be operating that unit as we go forward in '14. It's hard to know exactly what the conditions for a netback will be in 2014. So we'll wait until we hit into '14 to see what those results look like.

Okay great just one last one, if I could. I know you guys are periodically just hedging on propane, specially around the winter months. So just as we think about the impact from higher propane on the fourth quarter, any guidance or sense on how much of that you might have had hedged at lower prices already?

Nothing that is material.

The next question is from the line of Hassan Ahmed from Alembic Global.

Obviously, you guys continue to benefit from cheap ethane and of this year carrying out the propane to ethane conversion in Calvert City next year. Just wanted to sort of hear your views about how you see certain sort of co-products span out in the near to medium term, propylene, butadiene in terms of pricing and of course, supply demand.

Certainly, propylene price is still pretty strong and butadiene price has been rather low but recovered somewhat. And looking forward, we still believe that ethane will be advantaged materially over propane. The conversion at Calvert City from propane to ethane will reap good benefits for Westlake.

I guess let me ask you this slightly differently. Obviously, the marginal producers out in call it in Europe and Asia are sitting there, not really making very healthy margins. So what I'm trying to just understand is that if at all the cycle does take off, will that in your mind, recovery be induced by much higher than where we are today core product values for will be an absolute rise in ethylene prices?

We believe there will be demand recovers globally from improved economies around the world we believe product prices will improve across the board and that would help the high cost plans to make reasonable return on their investments.

And just a slight follow-up. Styrene seem to be a decent contributor in the quarter and I would imagine that -- so if you could just tell me how much of a contribution roughly styrene was in the quarter? And as a follow-up to that, just wanted to figure out how Certain Teed's run rate EBITDA is looking now that it's under your umbrella?

Hassan, the contribution from styrene was positive but not significant. And certainly, the continued delivery of returns in our specialty PVC business continue to perform as expected.

So but is it higher than sort of the levels that we're spending at over the last couple of quarters, recently higher?

We acquired this in May. And so there were some transaction-related costs in that quarter. And so those are behind us. And so we're now on the performance level as expected at this stage.

The next question comes from the line of Frank Mitsch from Wells Fargo securities.

Sabina Chatterjee here for Frank this morning. So just a question on the balance sheet, still really strong and obviously you're investing heavily on internal growth projects, but what are your thoughts on M&A here to further enhance your capacity?

Well, Sabina, as we continue to look at these investments that we have organically, that is a continued focus. But certainly as we have very consistently we look at the point of capital first at some of these projects that we have underway today and we certainly will look at opportunities both internal and external. And so we certainly look for opportunities that are valued to further the integration and expansion of our product offerings.

Okay. And then do you have any update regarding the Eastman situation?

No. And frankly, I think we've have had this issue certainly brought in front of us and frankly there isn't anything further to advise at this stage.

Okay. And then if I could ask a question just on PVC dynamics there, what were your operating rates in Q3 and maybe how you see volumes and rates evolving over the next year? I guess that depends on your way of construction as well.

Yes. I think the PVC operating rates heavily has improved over last year and we're both heading into a seasonally weaker period of the year. Looking forward to next year with integration improvement from a new chlor-alkali plant and ethylene expansion that would help further improve our margins in our Vinyls business.

The next question comes from the line of Edwin Rodriguez [ph] from UBS.

Just a quick question on PVC a follow-up again prices have been soft. Do you see any prospects for higher prices in the next year? I mean, once the uncertainty about all the capacity coming in. What do you see prices going in?

I think global demand has grown this year. And we expect, as the economy improves next year globally, that demand will further increase and will help certainly price side margin improvements. Around the world, very little PVC capacity is being added other than U.S. and China, so I think the rest of the world demand something to increase and will benefit the U.S. PVC producers.

Okay. And also just on ethylene, polyethylene, we're right you had the $0.5 price increase in polyethylene but contract prices for ethylene have been up and down, I mean, do you see polyethylene prices following ethylene up and down?

I think polyethylene prices follows more of the global demand for polyethylene to know the U.S. exports around 20% of its production today. So the global price has a pretty large impact on U.S. prices I think it's less that you have ethylene price has a less effect on polyethylene prices.

The next question comes from the line of Alex Yefremov from Bank of America Merrill Lynch.

One of your competitors reported 10% volume gain in fabricated products in the third quarter and better margins. Do you see signs of an uptick in demand in this product line in Europe business? And maybe could you talk about your sentiment or your customer's sentiment going into the building season in 2014?

Yes. certainly with the hot recovery of the housing market, the fabricated home-building products segment has improved but the improvement is rather gradual as the housing demand has also been gradual. We expect that 2014 with improving economy, the housing markets will improve further and so will our building products segment.

And then maybe a follow-up, Albert, on your comment regarding -- I think you said you're still evaluating a further expansion of your ethylene cracker at Lake Charles in 2015. Are you committed to this expansion at this point or is this sort of -- I guess could you update us on the status of your thinking on this expansion?

Certainly. We are doing work on that and to say that you're still evaluating the expansion which would be timed to our turnaround of the other ethylene plant in Lake Charles.

And a final question, if I may, just a follow-up on M&A. Dow has announced, as we all know, that they may potentially be selling some chlor-alkali in related downstream assets. Is this something that sort of on your radar screen? Is it something you could be potentially interested in?

Since we're part of the industry and these assets are in that space, as Alex, we look at a lot of things in this space. And certainly we look at all things that are relevant to us in this industry.

Dave, there are currently no further questions in the queue. [Operator Instructions] And we have a further question from the line of Brian Maguire from Goldman Sachs.

Just 1 last one if I could at the end here. Albert, I think earlier in the year you set an expectation that you might have a decision about changing the corporate structure to an MLP or trying to work that into the corporate structure somehow by the end of the year. And then we still have about 2 months left in the year but just was curious if you had any update there or any updated thinking on that front?

Brian, as I've said consistently, we continue to evaluate and study this. And as you well know, it has many moving parts and we're continuing to evaluate and study this concept.

The next question again comes from the line of Alex Yefremov from Bank of America Merrill Lynch.

I just had a follow-up on the Calvert City project next year. Feedstock flexibility, could you give us some sense maybe if you don't have an exact number of the cost associated with this turnaround, how could, for example, I compare to the turnaround costs that you had at Lake Charles this year?

As we get closer into that turnaround will give better guidance in terms of what those costs are, but at this stage I'd like to reserve until we get a little closer to those costs for the turnaround itself. The overall project, we've given some indication of the cost of not only the expansion and debottleneck and the PVC to be between $210 million and $240 million. That's the expansion and the PVC but not specifically the debottleneck.

Maybe at this point, Steve, another way to ask this question, do you have an idea of how long the site will have to be down to do this upgrade?

It will be a shorter period than the 74-day outage that we took in the first quarter of this year for the Lake Charles facility. The work is not that extensive, but we'll give better guidance as we get closer but it will be shorter than the 74-day period.

The next question comes from the line of Robert Reitzes from BroadArch Capital.

I may have come on just a little bit late. I just wanted to -- what did you say, Albert or Steve, about the caustic in terms of pricing? Do you guys feel that it's a supply-demand imbalance? Or do you feel that maybe caustic is a little out of bounds, just curious what your views are on that, your subjective views?

Certainly. Into the fourth quarter we see that caustic demand and pricing have softened somewhat on a global basis, and that's usually the case in this time of the year.

The next question comes from the line of Mike Shack from [indiscernible].

Could you guys comment how long is the lead time on PVC pipe that you would ship out to builders, so builders are going to be ramping up in March? When do you see those orders coming in and how long does it take you to fill them?

Well, I think typically we'll deliver from inventory so that the time lag is a matter of few weeks.

And as you deliver within a few weeks, does it only take you -- I mean, if you're anticipating a pickup next year, how are you planning on building inventories? Will inventories be above last year going into year-end?

It's usually winter time people build inventory and ready for the spring building season.

And would you anticipate that your inventories in PVC pipe will be higher than last year?

It will be probably similar.

Ladies and gentlemen, at this time the Q&A session has now ended. Are there any closing remarks?

Thank you again ladies and gentlemen, for participating today's call. We hope you will join us again for our next conference call to discuss our full year 2013. We hope you have a wonderful day. Thank you.