Morgan Stanley Global Chemicals and Agriculture Conference

Nov 14, 2017

Slides

Hi, everybody. Welcome to the Morgan Stanley Chemicals Conference. My name is Neil Kumar. And today we're going to start off with Westlake. And with us from the company is Albert Chao, President and CEO and Steve Bender, CFO. Thank you both very much for joining. So we're going start off with some comments from the company, and then we'll go into Q and A, and then we'll open it up to the audience for any questions. Thank you, Neil. Good morning, ladies and gentlemen. Thank you for coming today to hear about Westlake. Westlake is a leading materials company focused in the vinyls and olefins business. Vinyls, that's the chlor alkali ethylene down to PVC. And we have also a pretty big building products business. And then olefins is the ethylene and polyethylene chain. And some of you may know that the West this is the thirty first year Western history. We started Olefins business and Olefins was predominant of our business for many years. Until last year, we acquired Ekso Corporation. Today, revenue wise, the Vinyls business chain, including the building products, it's about 75% or three quarters of our revenue. It does not command three quarters of earnings yet, but we are growing the earnings on that side. In the olefins business, we have three ethylene plants and primarily all ethane based, two in Lake Charles, Louisiana and one in Culver City, Kentucky. And we are also the largest LDP manufacturer from capacity point of view in all The Americas. About 60% of our polyethylene is LDPE and 40% is linear low density. So the LDPE, some of you, if you don't have a book, I think a website, but we the Fifth Floor Of Benjamin, and we can give you the booklet if you need it to come to the Fifth Floor and get it. LDPE historically is a specialty polyethylene. It commands higher margin, higher prices than linear low and high density. The reason that is LDPE is made under very high pressure. That was the old way to make polyethylene. And so high pressure, it takes a lot of steel to contain the pressure, hence very capital intensive for investment. Whereas the new low density or high density have made under very quite a low pressure. And as a result, you can build very large plants, low operating cost, hence when linear low was invented by yielding carbide back in the 70s, 80s, much of the capacity of LDPE demand was replaced by linear low, but LDPE has to find its own niche. So today, LDPE is focused on the specialty area and with less capacity build, LDPE commands a higher prices, margins than medium low and high density. So we have advantage position. All of them side, one is from the low cost ethane based feedstock compared to rest of the world, which are primarily naphtha based, which comes from oil. And U. S. With low gas price, we still have very preferred position from low cost ethane, low cost ethylene. And from being one of the largest LDP manufacturer in The U. S. In the world, we have good position and good margin for our LDPE business, PE business. So hence the olefins chain, we have pretty good margins through many years and this is how Westlake started from olefins. On the vinyls business, it's more complicated. To produce a pound of PVC, which is the third largest commodity of polymer used in the world, it takes about half a pound of ethylene and 0.6 pound of chlorine. Chlorine comes from salt and electrolysis through electricity to make chlorine. For every pound of chlorine you make, you make 1.1 pound of caustic. We call it ECU unit or electrochemical unit, which is one short ton, 2,000 pounds of chlorine and 1.1 short ton of caustic to ECU. So every time you produce a pound of chlorine, you got to produce 1.1 pound of caustic and you had to sell both chlorine and caustic. Caustic is a commodity that's used lot of applications from cosmetics to utilization to chemicals. It's a very broad application and it's shipped typically on 50% aqueous solution basis. And it's the growth of demand for caustic typically follows about half to one time GDP. It's a slow growth business. Whereas chlorine, it's a toxic hazardous gas. So its transportation is very expensive and people use it quickly to turn into useful chemical rather than store as gas. So the largest use of chlorine is vinyls PVC. You take chlorine, there are three steps to make PVC. From chlorine, you react with ethylene to make EDC, then you make VCN, then you make PVC. So if you want to invest in the vinyls business, you have to think about where does ethylene come from. So if you invest in ethylene plant, then you have to invest in the chlor alkali plant, then you think about power. It's a very high power consuming business. So where does power come from? You buy power, you make your own power. And then you look at where is the use of cost of chlorine. In our case, it's PVC and then you go PVC, you want to go downstream. So if you want to get an olefins business, if you have cheap feedstock like U. S. Today, like Middle East for many years, you build the biggest ethane plant ethane to ethylene plant you can build and you build the cheapest LD or linear low or high density plant you can build. So the value you get is the ethane, right? So that's the value creation. And you can deal with two plants. Whereas in the vinyls, you got to build a chlorine plant, you got to build maybe a power plant, you got to build a EDC, VCM plant, you got to build a PVC plant. So the investment is much heavy, much heavier, much larger compared olefins plant per ton or per pound of products. And then PVC business is very cyclical, seasonally. So sorry, very seasonal. Winter time, much of PVC, 60% goes construction. So in the time when the weather is bad, you cannot build or the demand goes down. So most people do not make a good return on PVC chain, hence, there is no capacity added. China, who is the largest capacity owner of chlor alkali or vinyls, is because they use coal. They use coal to burn coal for electricity. They use coal to make calcium carbide which replaces ethylene and then you react with chlorine. You have a chlor alkali plant, use the power from coal burning. You react with calcium carbide acetylene to make PVC. It's very capital intensive, also uses a lot of power and uses a lot of coal. It's polluting because burn coal to make power, it's polluting. And then we use calcium carbide to from coal to electrolysis to make settling. That's also very polluting and they produce a lot of sludge. The sludge you had to go to a cement plant and it's carcinogenic, you can combine with cement to dispose of the sludge. So because of the cheap coal that China had, China grew their business. Settling business was the original way nineteen thirty's of producing PVC. As soon as ethylene was discovered and used, then all the carbine plants on the world were gone, replaced by ethylene base. China stick with the carbides because of coal, cheap coal and lack of ethylene. So today with Chinese sensitivity to pollution, the government has cracked down on much of the pollution industries and the coal burning generating power generation carbon PVC has been impacted. And there's been some curtailment of production, both some shutting down the high cost plant as well as reduced production of some of the other plants. Hence, recent year or so, the Chinese production of calcium of caustic from coal based is coming down as well as PVC has reduced production. And hence the margin has improved globally when the Chinese plants are not dumping cheap caustic or cheap PVC into the market. So in summary, the chlor alkali market is very strong. Demand globally is very strong because of global demand. The economy is going well. Capacity is impacted by reduction of pollution in China. Mercury cell, one of the three processes make chlor alkali have been shut down in Europe and takes away 800,000 ton capacity away in Europe. And with the lack of investment because the poor returns globally, we are seeing operating rates going up, hence the margin improving. So and PVC is the same story along with the Chinese carbide business. So we are seeing even though there are discussion of new capacity being entertained of in The U. S. Of new chlor alkali 3,000 tons, the world needs 75,000,000 tons of caustic chlor alkali. So the world, if you go by even 2%, 3% a year, you need quite a large capacity increase just to meet global demand. So somebody announced one plan or so that's not changed the dynamics of the Vinyl business. So we see Vinyl business going forward being quite robust. Great. Thanks for that introduction. So I thought maybe you can just continue with core alkaline vinyls. Can you just maybe talk about where we are in the cycle today and how much longer do you think the strength can last in both core alkaline vinyls? Well, hopefully from what I said earlier that you agree that we are really on the up cycle of the chlor alkali chain. If you see chlor alkali, we had replacement economics return wise. It depends on what you see in terms of the end products you sell. If you can sell chlorine at the highest price, caustic at the higher price, yes, it's replacement economics. But much of the chlorine, as I said, if it goes into EDC, DCM, other products, the price is much lower. And if you sell caustic, again, you sell the highest price caustic here, dollars 700 a ton. And that's not 100%, that's a very small part of it. Some caustic soda much lower prices. So if you use average price of total chain from caustic chlorine down to end products. There is not return replacement economics yet. So from that sense, we are seeing improvements going on for quite a while. At what point do you think you will start to see some more announcements for additional brownfield or greenfield chlor alkali capacity? And where do you think prices will need to go to incentivize that capacity? Well, as I said earlier, there's been if you read in the trade journals, they discuss company looking at permitting for new chlor alkali plants in The U. S. So people are studying it and from time of studying it to completing the plant can take three, four, five years. And I think the investment cost is quite high. We finished our low scale chlor alkali plant with 350,000 short tons, started in 2013. I think we started the project in 2009 and finished 2013. And it's a very expensive investment. I think Oxy also came out with a similar plant about the same time, smaller, 200,000 ton. And Dow, Bitsui joint venture, they came out maybe a few months earlier. And one of the contractor which built the plan lost a lot of money because they did a fixed cost plan, a fixed turnkey for the plant. So chloroplast plants are very expensive to build and you want to build it where the cheap power and then do you buy power or do you cogen? And through the actual acquisition, we have about 900 megawatts of gas based cogen capacity that came along with it. So we're able to enjoy the low cost gas based power. We do buy power, Louisiana Energy and those cost is much higher. So if the investment, you had to go build your own power plant, again investment goes up. It's an expensive investment to go to chlorhyside business. When you think about PVC, are there any notable differences between the end market drivers for commodity PVC versus specialty PVC and building products? Yes, there's two types of PVC. One is suspension, one is called emulsion or paste. Suspension is about 90% of global PVC produces suspension. And among the suspension grades, there's minor differences, maybe $01 $0.50 difference in price, not a whole lot. The emulsion PVC is about 10%, and that's a very called specialty. And we because our acquisition of VinoVet four years ago, we are the world's largest specialty PVC manufacturer. And those investments are much higher than the suspension PVC. And the demand for those specialty products are growth slower. I think the suspension PVC growth maybe 1.5 times GDP, the emulsion PVC growth of one time GDP on the average. Can you just talk about how you're thinking about your net short ethylene position today? Are you looking at anything beyond Lotte and what would make you more constructive on adding ethylene capacity? In The U. S, even though we have three ethylene plants because of the Axial acquisition and Axial has zero ethylene plant, we're about GBP 1,800,000,000.0 short. With the Axial joint venture sorry, with the joint venture with Lotte, it's GBP 2,200,000,000.0 or 1,000,000 metric ton plant. So we have 10% of that, so reduced by GBP $220,000,000. We have the option to acquire another 40% up to 50% of the plant, three years after plant startup and the plant startup is SMTP 2019. So we can go to GBP 1,100,000,000.0. Even with that, we are still GBP $78,000,000 short. So we are looking at we debottleneck the last three years by £800,000,000 with our three ethylene plant. So we could look at further debottlenecking our plants or do acquisitions and we are looking at all the above. Okay. And then when you think about the ethylene and PE cycle, how do you expect it to evolve into 2018 and how does your LDP outlook compare to your HTP outlook? Well, said earlier, we only produce LDP at a year low. Our gas phase plant can make HDPE, but we decided to focus on linear low because our customers are mainly in the packaging business. And in the packaging industry, LD and linear low are the two popular policies in PE. With high density, the applications goes very broad into pipe, into milk jugs, into injection molded products. And we are focused in our PE business in the packaging, which is the higher growth, higher margin side of the business. As you mentioned, there's 30%, 40% of ethylene capacity built in U. S. And commensurate amount of PE plant polyethylene plant built in U. S. Majority of the annual load is LE and high density as well. So in our book, I think Page nine shows that if global GDP grows between, I think, OECD estimates about 3% for the next five years. We're looking at one to 1.5 times GDP growth. That's the historical growth pattern for polyethylene consumption, demand growth. Then over the next four or five years, it will absorb all the global capacity increases. I mentioned that 30%, 40% not in The U. S, there's no capacity added in Europe, no capacity added in Latin America. Only Middle East and Asia has the Middle East polyethylene capacity added. And Asia and China is mainly methanol olefins is expensive cost ethylene. So even though we have 3040% capacity added in The U. S. And TE, we believe that global demand growth will absorb all the global demand global supply in polyethylene next few years. Okay. And then maybe a question for you, Steve. In terms of your balance sheet, it's less than 2x leverage right now. How do you think about additional I mean, you mentioned some maybe debottlenecking opportunities. How do you just generally look at capital allocation from here? Well, when you think of the use of capital that we've been deploying over the last couple of years, it's really been very consistent looking at and especially very active this year. We've looked at really deploying capital into the plants to make sure they run reliably and improve operability and performance and production. We also look at opportunities to find if there are opportunities to debottleneck. And so while there's nothing that we've announced yet, we'll continue to look at those opportunities. And of course, we'll look at deleveraging opportunities as well. We've paid off over $700,000,000 this year, and we'll continue to look to delever next year as well. And of course, at the same time, we'll look for ways in which we can return capital back to shareholders. And so as you think about the waterfall, it's maintaining the plants and running them reliably, looking for opportunities to put capital to work that give us really good returning opportunities, delevering and then of course returning capital back to shareholders as opportunities provide. And then in terms of the synergies with Axial, it looks like you're on track to capture the $200,000,000 Is there any possibility of upside to this number? Of course. The answer is we've announced that we'll pursue and I think we'll have in pocket $120,000,000 of those synergies and cost reductions this year with a target of achieving the $200,000,000 by 2018. But certainly, we won't stop there. The numbers that we talked about of 120,000,000 and $200,000,000 are really cost related to cost reductions and cost reduction related synergies. And so there are other opportunities. And as Albert talked about, improving the reliability of the assets, looking for opportunities to see pricing power in the marketplace and with improving reliability, improve production as well. Those are all synergies as well. We've just not publicly quantified them, but certainly, we're pursuing cost reduction opportunities and other synergy opportunities. The $200,000,000 we talked about achieving by 2018 is just those that we've quantified in the marketplace, but we certainly won't stop there. Great. Maybe we can turn it over now to the audience to see if any questions. Please, Mark. Great, thank you. If you could maybe talk a little bit more about the supply rationalization you're seeing in China. Is that structural or is it just more seasonal right now as it relates to winter months? And how do you expect that to ebb and flow looking into 2018 and beyond? That's a good question. I think both structural and seasonal. Structural in the sense that China has finally realized the importance of issue of pollution both on air, water and soil and governments really want to do something with it. We had a plan in China for twenty odd years and for many, many years, no government agent ever came to visit us. They come twice a month. So they are very conscious of pollution and applying even stricter standards than some of The U. S. Standards we are looking at. So that's good. I think good for the Chinese people. But they also talk about seasonality, this two plus 26 applies to reduce PM twenty five two point five. So the particular matter, 2.5 microns, which are the ones that are very serious in causing lung problems in China. And the government really want to reduce that and the goal to reduce 30% this winter from, I think, now until May of twenty eighteen, we'll reduce that 30%. Only we can do it is by reduced production, reduced pollution. I don't think any technology can be applied that quickly to reduce this pollution. We are seeing curtailment of production in steel, cement, alumina, smelting and all that and coal as well as PVC. So there's some of that going on. And question is, is that only for winter or that goes into other times of the year. But I think the big picture is government want to do something and they want to reduce pollution. So either companies have to invest a lot more money to improve operations or shut down high polluting plants. Well, there's some discussions about 10% of those PVC plants are in the two and twenty six regions, which is two major cities, Tianjin, Beijing and 26 secondary cities. That's all in Northern Hemisphere. But I think the pollution, not just in Northern Hemisphere, it's all China. So I think these are the I don't know, they are the test markets if you will and whether they will spread to other cities or not. Any other questions? I can ask one here. So in terms of your building products segment, you mentioned buyers being interested in the past. How do you assess the strategic fit of that business today? Sure. The building products, Westlake, before we acquired Axle, we were already the second largest PVC pipe manufacturer in North America with Axo acquisition. We are still number two, I think JM's been number one, but we are close second with large position, second largest also in Canada. And Axo, as some of you remember, they were Georgia Golf and acquired Royal Products, Royal Technologies back in the '19 I think 2005 or 2006 area. And so they are very large in the PVC siding, trims and molding business. So if you look at our building products, it's revenues already exceed $1,000,000,000 So it's a large operation. And before we acquired Axo, Axo was in the process of selling that business. I think they got based about $700,000,000 Is that right, Steve? That's right. Something in that magnitude. So we have to stop the sale process and while we're acquiring them. So after we acquired them, we had a much closer look and we are very pleased with the business. So certainly, we can sell the business if we need to, but it's a big consumer of PVC resin as well as I think we are still, as I said, number two in pipe. We're number one in specialty pipe. We acquired a certain teeth business about five years ago, and we are the largest specialty pipe business PVC pipe in The U. S. Agriculture and mining and many other applications. But we are number three in siding PVC siding, which is second largest use of PVC in The U. S. The first is pipe, second largest PVC market is sidings and also chip, I think we're number one in trims and moldings. And we are in decking, sort of windows. So we have a broad portfolio in the building products. And this is some of the area we can grow further, not only strengthening our position, but also we can broaden our products including if we interested in non vinyl building product business. So we acquired not only good portfolio of products, but also good management team. So we're looking forward to further grow that business adding value. If you could maybe just expand a little bit on that in the building product segment, like what are you seeing in today's market environment? How does that compare versus where we were earlier in this year and versus expectations? Sure. As you may know that 02/1927 period, suddenly we had the bubble, housing bubble, but we had 2,300,000,000 residential units being built at the time period. And with the housing crisis meltdown two thousand eight, it dropped to 400,000, 80% drop in demand for housing units. And today, we climbed back to about 1,100,000, 1,200,000 units, still less than half of the 2,300,000. As I understand, the last fifty years, U. S. Average home building is 1,500,000 units for fifty years average. So many as you know that many young people are living with their parents or rentals and but the demand is still their population has grown in the last fifty years. So we believe that over the next two, three years, I think maybe three years, we'll get back to the 1,500,000 units. Now I don't know what the tax reform will have in how much impact would it has on housing demand, but if they were to live somewhere, and I think the parents just want the kids to live with them forever. So whether they have rental units or house each house, you know, have four sides and they use more material whether it's PVC or wood than apartment which at best of two sides. So it will light wall housing build single family homes rather than apartment, but apartment also is a good consumer of materials and plastic products. So as we see that growth come back, U. S. You have to ask us, U. S. Today export 30% of PVC produced. So as we see housing and before the housing crisis, only 10% of U. S. PVC was exported. So as we see housing come back, demand demand in U. S. Is to increase, export will reduce and it will also further support the pricing for PVC on a global basis. On the back here. Could you talk about scope for incremental opportunities at Axial, both just from I mean, you've talked about just capacity creep opportunities, so potentially investing in brownfield expansions, but also I think historically you talked about their lower level of utilization versus their targets and that opportunity to just get to, I think, more like your operating rates and just other scope for synergies? Yes. I think as you've seen the improvement in operability all throughout the course of this year as we've invested in the maintenance capital in the business. And we'll continue to look for opportunities to grow that. We've got still room to grow because these assets are not still running at as high an operating rate as we would like. And so before we think about putting additional capital in to grow additional plant, what we'd like to do is continue to grow operating rates and spread that fixed cost over those pounds. And so what we'd like to do is really see an improvement in operating rates still and get more economies of scale out of the existing plant before we look to deploy additional capital. We're always doing that, but certainly what we'd like first to do is get the best economies out of the assets that we have. All right. There's no more questions. I think we'll end it right there. But thank you both very much. Thank you. Thank you very much. I appreciate it.