Citi 2017 Basic Materials Conference

Nov 28, 2017

Slides

All right, everyone. Thanks again. We're going to be moving on to our next presentation this afternoon. And with us, very pleased to have Westlake. So we have Albert Chao and Steve Bender. Albert, obviously, the President and Chief Executive Officer and Steve, the CFO, who I'm sure many of you know. Steve is going to be giving the presentation today, and then we're going to have Albert around for Q and A. So with that, let me turn the floor over to Westlake. Thank you all very much. There we go. So let me start by a general orientation of Westlake. Westlake is a leading integrated plastics materials company, concentrated in the elephants and the vinyls business, as you can see. And the four points that you see in our mission statement are very important to us, and you'll hear more about them as I walk through them today. We pursue profitable growth and as a result, grow our businesses for the benefit of all of our shareholders. We're focused on the businesses that we understand, and we do businesses globally in areas where we can gain a competitive edge. And we always act in a financial and disciplined opportunistic manner. We're focused, as you can see, in the olefins and vinyls businesses. And our olefins business represent about 47% of our overall EBITDA. Our main product is polyethylene. Polyethylene is the largest plastic used around the world. It's an ideal choice for countless number of nondurable products and largely used in flexible food packaging. Our vinyls business makes PVC, caustic soda, chlorine and chlorinated products. PVC is a very economic plastic because half of the raw materials is made from relatively cheap non hydrocarbon based chlorine. Its unique set of properties make it the plastic choice that's ideal for consumer durable products. Caustic, of course, is used in a wide variety of industries from refining all the way through general industries used even in the manufacturing of soap and other materials. In late August of last year, Westlake completed its transaction with Axial and acquired Axial. We're very excited about this transaction for a number of reasons. We strongly believe the industrial and strategic logic of this transaction is quite compelling. The combined company is a leader in North American olefins and vinyls business now. We're the largest North American producer of low density polyethylene and the second largest North American producer of PVC, we're number three globally and the largest third largest chlor alkali producer in North America and, of course, number three globally. And just as importantly, this transaction is consistent with our history of vertical integration, which captures the margin across the chain and throughout the business cycle. The acquisition greatly expands our manufacturing footprint and positions us for future growth. In addition to the $100,000,000 of cost reduction synergies that we've talked about, we believe we'll achieve another $100,000,000 of synergies related to the transaction. Certainly, this year, we've indicated we'd achieve $120,000,000 of those synergies and have those in pocket this year, with the remaining portion of $80,000,000 in 2018. On this chart, you can see that Axial is just one of the many transactions and acquisitions that we've undertaken in over thirty years. We've undertaken a variety of ways to grow the business. It illustrates that we've grown our capacities over a large number of years. You can see starting with our inception in September 1986 through to the 2017 acquisition of Axial and the expansion that we also completed in Calvert City for ethylene last year. Note that we've achieved this growth both through organic growth as well as through acquisition. And we've mapped out some larger transactions, as you can see here on the graph, to illustrate some of those areas of growth. The green portions of the bars you can see are in the olefin section and the yellow portions of the bars represent our vinyl segment. At Westlake, we're looking not for just ways to grow the business, but really looking for ways to grow the business strategically, always with value in mind, bottom line value, not top line growth is always very important to us. So cash flow value creation is where our focus remains. On this slide, I examine in much greater detail the diversity of our end products and the combined company that we make and also the capacities of productions and perhaps more importantly, how the two product lines combine into one larger chain that values and creates that value that I just spoke of. Westlake is currently fully integrated in our olefins chain. As you can see, the green boxes from ethylene all the way up to polyethylene and styrene. And certainly, I've noted here in the dotted box the joint venture we have with Lotte as we undertake the construction of an ethylene plant in the Lake Charles, where we have a 10% interest today for GBP $220,000,000 and an option to also grow that up to 40% more for GBP 1,100,000,000.0. As I mentioned, we're currently fully integrated in our olefins chain in ethylene, all the way out to polyethylene and styrene and not fully integrated in ethylene in the vinyls chain, and that's where this opportunity to go in further into ethylene provides an opportunity. The Axial assets primarily added production in chlorine, PVC and in the gold bars, you see your building products as well as in the chlorinated products areas. We already had a strong olefins position and a strong PVC position along with our building products presence, but the combined product area added significant capacity both in caustic, chlorine, PVC and, of course, into the building products businesses as well. I think you'll note really how well integrated this business set now remains. In the last couple of years, we've engaged in a very disciplined focus in being able to invest in the business and grow the business. We've expanded through organic expansions, growing our businesses in Calvert City through an ethylene expansion as well as building the facilities in Geismar, Louisiana as well as expanding our Petro one asset just last year. Westlake has a very long history of growth, both organically as well as through acquisition. On this chart, what I wanted to do is highlight really that we've got a variety of ways for feedstock flexibility. You can see the pie chart in the upper right shows that almost twothree of the world's ethylene production is from heavy or oil based feedstocks. In contrast, all of our plants have an ability to use ethane as a feedstock, certainly very driven today by that ethane feedstock. The pie chart in the middle shows that the flexibility we have with regard to feedstocks, as you can see, we can go from an all ethane feedstock where we are today to a mix of feedstocks. This flexibility allows us to adapt our feedstocks based on current needs and based on current margins in the marketplace. The pie chart shows in the lower right hand corner that the 16 Western European ethylene industry by feedstock as well. Our Ventolin subsidiary in Europe provides further diversification of our feedstock requirements. The large supply of ethane and NGLs in The U. S. Is available to us via the expanding pipeline network that you see here on the chart in the upper left hand corner. The chart shows a growing infrastructure used to deliver both ethane and NGLs into the Gulf Coast. This is in addition to all the previous capacity that we've seen added over the last couple of years. The additional capacity from the Northeast in the Marcellus region will be a significant supplement to the current supply from the Gulf Coast and the Mid Continent. Our Calvert City facility in Western Kentucky is benefiting from the access of ethane and NGLs from the Northeast Marcellus fields. Our Lake Charles facility is connected to the Gulf Coast network of feedstock pipelines and storage facilities, And we're also able to take ethane from the ATEX pipeline that Enterprise operates. Can you turn the page for me? For some reason, it's not turning. There we go. Thank you. So let's take a look at our polyethylene business for just a moment. As you can see, Westlake is focused on a more profitable mix in our downstream polyethylene businesses. Global polyethylene capacity today is currently two zero four billion pounds and is composed of three types of polyethylene, namely LDPE, low density polyethylene, linear low density polyethylene, LLDPE and high density polyethylene HDPE. Referring to the two pie charts that you see on the left, the LDPE represents approximately 22% of the global market, whereas 58 of our current capacity. The right chart shows that over the last fifteen years, LDPE has had the highest margins of all the polyethylene products. Low density polyethylene has averaged about $0.77 per pound more than the linear load polyethylene and $05 per pound more than HDPE during the years February 2016. According to the 2016 IHS estimates, low density polyethylene has about $0.85 per pound more advantage over linear and about $0.65 advantage over HDPE from 2012 to 2016. Thus, our current average margin per pound of PE would be in line with historic industry average. So when you look at the mix of polyethylene around the world and the advantage mix that we have, you can see that our low density polyethylene advantage is quite clear versus the industry. The chart on the left shows that Westlake has the highest percentage of LDPE to total polyethylene in North America. Thus, we have among the highest PE margin per pound of polyethylene sold in North America. Product differentiation will be an important factor as new capacity additions are added in the coming years. Furthermore, LDPE capacity being added is all tubular capacity, which is the more commoditized form of LDPE. Tubular low density polyethylene is engineered for high volume production, targeted at low volume applications with a narrow product mix. Autoclave low density polyethylene is a more specialized form of polyethylene and provides a broader product mix and is better suited for specialty applications such as coating and a wide range of flexible food packaging applications. Thus, autoclave low density polyethylene resins commands a higher price in the global market than tubular resins. Westlake focuses on the more desirable autoclave low density polyethylene, which is 80% of our LDPE capacity compared to the global average of about 35%. With very little new autoclave low density polyethylene capacity being added around the world and growing global demand, this market for specialty polyethylene continues to tighten as we march forward into the future. Here we go. So as we think about the future, let's take a look at the global polyethylene additions to be added. The global polyethylene additions around the world are charted here on this chart, as you can see, from 2017 out to 2021. And the new production capacity will find its way into markets predominantly in Europe and in Asia as these markets represent the best netbacker products for this new production. Global polyethylene demand tends to grow between one and one point five times world GDP growth as illustrated by the orange and purple lines that you see. Forecasted global low density polyethylene capacities will not be on pace to keep track with the global demands that we see. And as you can see that we have a continued capacity of additions that really aren't going to keep up with that global demand. So as you think about the global footprint that Westlake today has, you can see that we have continued to grow our business through acquisitions. On this slide, we look at where we're growing. Pre acquisition, Westlake had a global PVC presence with facilities in North America, Europe and Asia. Post the acquisition of Axial, we've expanded our presence in North America and Asia to complement our expansions in Europe and the 2014 acquisition of Ventolin. Our global presence offers many advantages. Our North American operations are currently benefiting from integrated low cost production. We have global we have a global presence, and our European facility, Vinylit, is a global leading player in the form of specialty PVC resins. We also have a vinyls facility in China that we refer to as Wazu. This facility makes it one of the highest quality PVC films and resins in China serving major domestic and export customers. The Axial acquisition added more capacity in North America, greater diversification in Asia and a greater expanse of our products around the world. On this chart, you can see in the upper left hand corner, the integration of our Vinyls segment after the acquisition. While most vinyl producers are integrated into chlor alkali, they're not integrated into ethylene. Importantly, the majority of the margin in the vinyls chain is in ethylene and chlor alkali. In order to illustrate the value being integrated, I've divided the historical margins in vinyls into chlor alkali, ethylene and PVC, as you can see in the upper right hand pie. As you can see over the last cycle, this is from 2005 to 2015, most of the value in the vinyls chain is in the core alkali and ethylene slice of the pie, claiming about 91% of that margin, with only about 9% of the margin in the PVC resin manufacturing process. The pie chart that you see in the lower right hand corner shows the typical industry margins look like from 2010 to 2016. As you can see, the majority of the margin over this period in ethylene represents a large portion and again in chlor alkali as well as in ethylene and certainly up from 47, up from 39. But still, the importance here is that the PVC slice of the pie represents only a small portion of the overall EBITDA margin chain. Through upstream integration in chlor alkali using shale gas based power and the ethylene using shale based ethane and NGLs makes Westlake one of the lowest cost producers of vinyls globally. On this chart, you can see that as the combined entity now, Westlake is a leader in North American core alkali and PVC markets. The combination creates the number three North American core alkali producer and the number two PVC producer in North America. In the long term, the acquisition will continue to provide greater scale and synergies to Westlake's existing businesses, a better position the company for additional competition around the world throughout the chain, offer better ability to serve customers and capitalize on future investment opportunities and creates a combined business with broader geographical footprint, which includes Westlake's Ventolin business in Europe, which is, as mentioned, a global leading player in the specialty PVC resins business. This chart at the top of the page illustrates the relative specialty PVC production capacities of Westlake in relation to other PVC producers around the world. Westlake is the largest global producer in the specialty PVC market, which brings better margins than the commodity PVC. The specialty PVC takes lots of forms and has lots of uses. It takes an opportunity for us to really expand into a segment of business that we don't typically participate here in the North American business. It goes into flooring, wall coverings, artificial leathers and wide range of other applications, automotive and hospital applications. It's just a sampling of some of the specialty applications that our Ventolin business provides. Global PVC demand has continued to increase from over 30,000,000 tons to over 40,000,000 tons over the last ten years and is projected by industry consultants to reach almost 50,000,000 tons by 2021, driven by construction and infrastructure requirements in the emerging markets around the world. The low cost of natural gas to produce power for the production of chlorine and low cost of ethane to produce ethylene provides North American PVC producers the advantage to continue to export to emerging markets and to satisfy this growing demand. And as you can see today with the orange wine that we continue to as an industry continue to see exports between 3040% of North American production. So let me spend a minute and turn to a discussion of our focus and our disciplined culture about how we manage the balance sheet and some of the returns in the business. A key element of our philosophy is a prudent reinvestment of capital and a realization of an efficient return on this investment. In just a few minutes, I'll review some of the metrics that we use. The chart above shows that we've prudently invested in the business through expansions, new facilities and acquisitions. I've listed a few of the examples of our recent history and near term projects and to illustrate the commitment to grow both organically as well as strategic acquisitions. The chart that you see at the top of this page shows the debt to total cap ratio over the last ten years. You can see that Westlake has consistently been less leveraged than our peer group. Yet during the same time period, we've continued to deploy billions of dollars of capital into the business and profitably grow the business. We didn't overextend ourselves as some did during the same time period. Even now, after the acquisition, we still have certainly an average debt to cap ratio better than our peer set. And as you may know, we've recently issued $750,000,000 of debt as a means to continue to delever and extend the maturities of our debt. There are implications here for investors that you should really note. We have the ample ability to fund future growth, and we have the patience and the discipline to invest in the risk reward trade off is very favorable. In the chart at the bottom, you can see that we continue to remain strong investment grade ratings, and we intend to stay investment grade on an ongoing basis. Our disciplined approach to spending and the competitive factors we spoke to earlier ranked Westlake among the top of our peer group in returns. The left part of the bar chart shows we're putting those assets to work with effectively than our peer group and generating returns above our peer set. The middle bar on the chart shows we're achieving these margins with less capital employed, and the bars on the right show our average EBITDA margin is better than our peers. I attribute that really to our superior bottom line results and our operating philosophy and execution specifically, our focused growth in expanding our chain integration, the advantaged feedstock and, of course, our product mix. Let me spend just a few minutes and talk about the Master Limited partnership that we formed in 2014. This year, in January, the IRS issued their final regulations, which reaffirmed our private letter ruling we received in 2014 that income derived from processing NGLs and ethylene is considered qualifying income. This has provided much greater clarity really into the long term growth of the Master Limited Partnership. This slide reflects the rather interesting structure that we have here. I know it's maybe a little bit of an eye chart. But at the time of the IPO, when we created the OpCo and the Master Limited Partnership, the 10% of the OpCo was dropped down into the partnership. In September of this year, we dropped an additional 5%. So between the September 2017 dropdown, the one completed in 2015 and the IPO, today, we have 18% of the operating company contributed into the partnership. The cash used from that transaction as we issued new units was channeled up to Westlake Chemical and allows us to continue to further deploy that capital into the business. As you can see, this dropdown is just one of the four levers that you see in the upper left hand corner, which is periodic dropdowns of OpCo, the ability to have organic growth as we've undertaken over the last several years, expansions in Calvert City and our PetroOne asset most recently, acquisition opportunities and of course, the Votee joint venture investment might be considered one of the optimum acquisition opportunities for OpCo as well as well as expanding the margin that we today currently have, a $0.10 margin, but certainly could expand it over time. The structure of the MLP insulates the partnership from fluctuations in feedstock prices, whereas 95% of the partnership's income is derived from an ethylene contract that is sold to Westlake Chemical, so it insulates the partnership from all commodity risk, leaving only 5% exposed to commodity variabilities. The takeaway here is the partnership is extremely stable, backed by an off take arrangement with an investment grade parent, Westlake, and is well positioned to continue to grow, as you can see, with 82% of the operating companies still yet to be dropped down. So very well positioned for the partnership to continue to grow and very well positioned to use this partnership to fund Westlake's continued growth. So the significant investments we've made and will continue to make have continued to expand our business and enhance our margins. You can see these items that we've built upon from the previous investments over the last several years have continued to grow our earnings. The recent acquisition of Axial, the Petro one expansion in 2016, the acquisition of Vinylit in Europe in 2014, a variety of other expansions have continued to propel our earnings as we march forward and continue to look for ways to grow real value at the bottom line. These are just a few of the important integration steps that we've taken to propel our EBITDA. With that, I'll pause and take questions. I'll invite Albert up here, who I know is struggling a little bit with his voice today to take questions from the audience. I guess according to the is there any restrictions that rating agencies have given you in terms of how much of the assets you can drop into OpCo and still maintain the ratings? As we think about that, we recognize that the consolidation of the partnership into the parent is there. And so certainly, we'll continue, as I mentioned earlier, make sure that as we go forward with the partnership that we maintain investment grade metrics. We recognize it's a balancing act always with the partnership as a subsidiary, but our focus is always at the parent to maintain strong investment grade financial metrics. On our discussions with the agencies, and I think I see one of them actually in the audience today, I would say that certainly the kind of metrics that we work with and communicate with, whether it be Moody's or S and P or Fitch, is really to make sure that there's always a balancing act. We recognize as we march forward, there is no limitation in terms of how much of OpCo can be contributed into the partnership, none whatsoever. And it would be my expectation that all of OpCo will be contributed. The issue is really how we deploy the capital back up to Westlake and grow the business. And our focus really is to make sure that we continue to have the set of earnings and balance sheet metrics that allow us to maintain that rating criteria. Also Westlake assets that are not in OpCo, those cannot be contributed to the OpCo assets? In fact, we have all the ethylene assets contributed in. And certainly, as we continue to look for ways to grow the National Owner Partnership, we'll look for any asset that is qualifying under the IRS code to think about growing the business over time. Also that we control the GP of MLP. Yes. What Albert is saying is that we control the general partner. And so even if we contribute all of the operating assets into the partnership, we still control the general partner, which controls the entire structure. So it doesn't create a limitation for us to be able to control the crackers even if we contributed 100% of the operating company into the partnership because we'll always control the general partner. Can you guys provide us an update on post hurricanes as the polyethylene situation normalized? And what are inventory levels now? And where do you think pricing is going at least in 4Q? And so PJ, what we've seen really is, if you look at some the consultants that are out there, you see that they're we've seen about zero one zero dollars come into the market really as a result of a variety of drivers. I wouldn't attribute all of that necessarily to the Hurricane Harvey. I contribute some of that really as a result of seeing strength in demand in our markets. Now if you look at what some of the consultants such as IHS are suggesting between now and sometime in the early spring, we may give up some of that additional value that we picked up. But I would say that because of the outages that we saw from some of our peer set as a result of the hurricane, inventories have been relatively tight. Some of our customers were expecting lower prices as we entered the season, expecting new production to start later this year, which in fact has not all occurred. So they lower their inventory levels just as the hurricane disrupted production from some of our peer set. So as a consequence, inventories haven't fully built up across the industry per se. And this is really why we saw an opportunity to really service some of our competitors' customers because we were not impacted by the storm and able to also meet our own customer demands as well. And also, you are net short ethylene by about GBP 2,000,000,000. What are the plans to close that? I know you have Lotte joint venture coming in 2019 and that could close some of the gap. Any thoughts on acquisitions, particularly next year if industry were to enter, even if a mild downturn, maybe valuations come down and you could scoop up some assets? So as we think about the Lotte joint ventures, today, it's as you noted, under construction is expected to be completed by 2019. We have 10% working interest in the facility, but we have an option that would allow us to step up as high as 50% ownership of that cracker. That would allow us to bring on between today, $220,000,000 and an incremental £880,000,000 for a total of 1.1 We'd still certainly be short ethylene nevertheless, pounds 700 to £800,000,000. So there are plenty of opportunities to find ways to fill that as long as the investment thesis is appropriate. And that's the kind of analysis that we'll look at for this election of this option that we have with Lotte. We're very focused at bottom line value. And so to the extent the returns are appropriate, we can think about electing that option or pursuing other opportunities to go into ethylene. It's function of what the returns require. Are you actively looking for other opportunities? We all ethylene is core to everything that we make. And so of course, everything that is an ethylene space, we look at. I've got two questions. First question is the PVC market's pretty tight for Care of China. Could you give share us your views on the outlook for PVC? And how you think is this the new normal? Or will we see a normalization over time of PVC pricing? And then I'll come back to that. Well, we certainly as we enter the season currently, we typically, the fall season is a slowing period seasonally for PVC. But certainly, as you noted, there really hasn't been any PVC capacity additions here in The U. S. For a number of years. And certainly with the regulatory changes we've seen in Europe as well as in China, whether it be the reduction of mercury based chlorine production, shutting chlor alkali and chlorine sites down and a knock on effect of reducing production of PVC in Europe. We've also seen some regulatory effects in China that have had an effect of reducing capacity adds. In fact, there have been policies set out by central government in China that limit or restrict new capacity adds in many of the major metropolitan centers in China that could be a constraint on additional capacity. So we continue to see, I think, a good runway for capacity a good runway for the industry with limited capacity adds here in The Americas, in fact, the entire Northern Hemisphere. And a second question is, obviously, AkzoNobel is spinning out its specialty chemicals business, which where do you see consolidation in caustic soda, in particular, kind of going? And what role do you want to play within that industry? When you think about the consolidation that's already occurred in this space, whether it be in Europe or in The Americas, certainly we participated in some of that. But again, I go back to my commentary that we're a value based investor in our businesses. And to the extent there are opportunities that make sense, always we're interested, but to the extent that there are opportunities that don't make sense, we don't so specific to Accent a Bell. Certainly, we're aware of what's in the press. We'll watch with interest, but certainly our focus is really in creating value at the bottom line. Bigger is not always better our view as bottom line value is where we're focused. Thank you very much. You're welcome. So maybe going back to the mercury based capacity conversions in West Europe. To your understanding, how far into that whole conversion process in that region are we? I know there was some going on this year and maybe some will continue to shut down and then take some time to convert to clean technology and then restart. So how far into that are we? And also how typically, when a plant shuts down, can you talk to us about how long that shutdown typically lasts and how long they may be offline for? Go ahead. You want to come over here and all of it. I know you're struggling with your voice. Excuse me. I think people are estimating 800,000 tons. Okay. I'll do it. There's about 800,000 tons of capacity that was expected to come out as a result of this European mandate to shut mercury based production capacity. We think we're well through a lot of that. There is still some additional capacity yet to shut probably in the month of December. And so we see another 300,000 or so tons to come out still. They'll run right up, I would expect, right to the end of the year and shut. There are some that are finishing their conversion to membrane, but I've already built that into my analysis when I think of the numbers. And so certainly, we think that with that shutdown and we've seen some knockoff effect impacting the PVC and other derivatives businesses as well. Maybe a follow-up on China. So the we're hearing about a lot of pressure on coal based capacity and including some of the PVC producers. To your based on what you're seeing on the ground, is that making do you see that impact happening? Like is it actually showing up in the market? Or and how much and how low have these plants dropped utilization to if they're just dropping utilization or if they're coming offline completely? Many of the integrated coal based producers using that approach are really more inland. And so this is really more around the two and twenty six areas that are really being impacted. And so my point is that certainly it has had some impact, but certainly the bigger impact to the coal based has really been and those that are integrated are back to the mine mouth. Certainly, we've also seen some that are more coastal based certainly have more direct adverse impact to their businesses. And certainly, we have seen that effect. And so certainly, that's also had an impact. We've also seen those using more of an MTO approach also, which also have had some impact as well. Another question over here. I have two questions for you, Steve. LDP I'm sorry, don't know this, but LDPE is the most profitable, but it's the one with the least focus of additional capacity. Why is that? Because it's higher cost? Well, it is a higher investment cost, but it also has when you think of the opportunities that producers were looking at to capture, they were really capturing the ethane to ethylene margin and then monetizing that by creating the most commoditized form of polyethylene and exporting that into the marketplace. So the very high pressures of low density polyethylene are higher investment cost. And when you look at the number of grades that are necessary to produce into that market, especially in the autoclave high clarity form, for over 100 grades of autoclave low density polyethylene. So to the extent they chose to go into low density polyethylene, they chose to take a tubular route, which only has a handful of grades associated with it, Again, allowing them to then export just to those handful of grades into the export market, whereas if they'd gone into the more specialized higher margins business of autoclave, there would have been hundreds of over 100 grades. And as a consequence, much more challenging particular grade you're going to make on which particular day to export to a particular market. So their strategy was really to commoditize the polyethylene they produced. So they produced high density, linear low density and the tubular or commodity grade of low density. And that's why you didn't see anybody in this market or almost globally really add autoclave capacity. There will be some coming, but certainly that market is much more specialized given the wide number of grades and the customization that's really necessary for its applications. Okay. And the other question I had, I don't know if you disclose this or care to, but is the family's ownership of Westlake Chemical Partners similar to its ownership of Westlake Chemical? No, it's the family does not have the same concentration of ownership. The family certainly does invest in the partnership as well as the CFO does. There was a question in the back here. There's been a lot of focus on PBC crackdowns. And then I guess very recently, there was some announced HDPE closures in China, which is kind of like a little bit more new to the conversation set. So I was wondering if you could comment a little bit on the I'm going to butcher the pronunciation, but Changji province or something, HDPE curtailments and whether you've noticed that. It seems to trigger some inflection in Chinese pricing, whether that's playing out a little bit. I have to admit, I'm not that familiar with that topic that you're mentioning. Okay. Got it. Thanks.