Deutsche Bank 8th Annual Global Industrials and Materials Summit

Jun 7, 2017

Slides

Good afternoon. My name is Dave Begley, Deutsche Bank's U. S. Chemicals' Equity Research team. I'm very pleased to have our next company presenting, Westlake Chemical. With us today is President and CEO, Albert Chao and CFO, Steve Bender. Back in 1985, Albert assisted his father and his brother in founding Westlake Chemical. He became President in 1996 and CEO in 02/2004. Steve joined Westlake in 2005 and was named CFO in 2007 with us. We'll now make a few brief comments and some slides. We'll go into the Q and A portion of the presentation. With that, Albert, the floor is yours. Thank you. Good afternoon, ladies and gentlemen and thank you for spending time with us here today. Westlake is a leading global integrated materials company focused in the olefins and vinyls business. You can see on the box here that net sales for LTA in the first quarter this year is RMB6 billion. At the August, we merged with one of our industry vinyl business company called Axial and so the pro form a based on last year's revenue that for next twelve months we'll have about $8,000,000,000 of revenue. Mentioned that we are focused in olefins and vinyls business. By olefins, we mean ethylene polyethylene, we also have a small position in styrene and ethylene also is a major destock for our vinyls business. As you may know, 50% of PVC vinyl is ethylene. So ethylene crossover is both olefins and vinyls business. In the polyethylene business, which takes a pound of ethylene to make a pound of polyethylene, we are the largest LVP manufacturer in The Americas, both North And South America. So we are leading position in this business and we are focused on the packaging business side of the polyethylene business, both for food and non food packaging. As you may know that if Amazon ever takes over the whole retail business, everything Amazon ships in boxes and if you open the box, everything is packed in plastic bubbles for stability rather than the peanut you see and all that is polyethylene inside the box outside the box paper and paper is a large user of caustic and chlorine for bleaching and softening the fibers. So we are in both Internet business and as well as the materials business and we are focused on the consumer non durable side with our packaging business in polyethylene. In the vinyl side that comes with producing chlorine, producing ethylene that's used for PVC. We also sell the byproduct of chlorine manufacturing that's caustic. So today we are the third largest PVC and chlor alkali manufacturer in the world. I'll talk a little bit more about it later on. So we focus the largest part of PVC, the usage is for construction, whether infrastructure for water and sewer pipeline or for housing, building, it's conduit or electricity, sidings, non deal at the feasibility type. As housing market recovers in The U. S. And infrastructure construction goes out in The U. S. And overseas will be beneficiaries of their site. So we are focused on the consumer durable side of the business. What's important also we said in our vision statement is that we are focused on profitable growth. We are not really focused on revenue, even I talk about revenue, the revenue shows the ability to grow the business and to capture margins, but we are focused on bottom line growth that's most important to us. And two, we are focused on business we understand mainly all these in the vinyls business. And three, do business globally. We are the largest manufacturer of specialty PVC in the world and that's based on acquisition we started in 2014 in Germany, the Bill of Business we bought and then the combination of Vaca Vinyl business and Hooks Vinyl business. So they are really the founder of the PVC business back in 1930s and after many generations, they spun all the business into private equity and we bought them private equity. Today, we're the largest facility PVC manufacturer in the world and we also position in China, in India and Taiwan, so likewise in Canada. So we are very global in our vinyls business and what's most importantly also we act in a financially disciplined and optimistic manner. We are incentivized by EDA, economic value added. So we've been using the system by St. Stuart for over twenty five years. So and let's pay the dividend going forward. As I mentioned, we acquired the Axle business in the August. So they are very much in the chlor alkali PVC business and combined together, I mentioned we are number three in PVC globally, we are number two actually in The U. And we are number three globally in chlor alkali and mentioned we are still the number one LDP manufacturer in North America. And just having position number one, number three is not that great, what's important we are fully integrated in the olefin service, we are almost integrated in vinyls business on the chlorine side, actually we are low in chlorine, which means we have potential to further downstream integrate, but we are short in ethylene. As I mentioned to you, it takes zero five pound of ethylene to make one pound of PVC. So, we do have a joint venture with multi corporation Korea that's building a new ethylene plant right in Lake Charles next to our plant and we own 10% today and we have option to acquire up to 50% of that three years after the plant starts up and the estimate plant starting up is the first half of twenty nineteen. So within two years, we were able to reduce our purchase. We are the second largest ethylene buyers in The U. Today. So if people are concerned about ethylene price coming down with the new expansions, on the vinyl side, we're very happy about it. On the olefin side, we don't sell ethylene, so we don't care, we sell polyethylene, that's more important ethylene, polyethylene price and not ethylene price. So in the short term, if ethylene prices go down, we are happy because we are buyers of ethylene. As I mentioned, it really helps our integration strategy and we believe that we are the one of the most cost competitive vinyl producer in the world. We have our own salt zone that we produce the salt brine ourselves and we have over about 900 megawatts of cogen plants around The U. S. Which supplies our power with natural gas is very cheap in U. S. And we have ethylene whether it's on production from ethane crackers, we have three in The U. S, 3,700,000,000 or we repurchased ethylene US today even though the ethylene expansion is not really having fluton yet, US ethylene price is the lowest price in the world. Today's spot price ethylene is in The U. S. Is the mid high 20s, ethylene price in Europe is the mid low 50s, almost double The U. S. Price and we know it because we are there, we are buying ethylene and then Asian ethylene prices in the high 40s. So U. S. Today still have the lowest ethylene price in the world. So we are very cost competitive and as I said earlier that we plan to further downstream integrate to the value added products from flowing down. And we are diversified geographically as we mentioned, we are not only U. S, Canada, in Germany as well as in Asia, in China and India. And goal is to realize the cost down and the synergy that we told The Street. We're looking at a $200,000,000 combined cost down synergy. We're well on its way. We said in the last quarter conference call that we will realize $120,000,000 of cost down synergy this year and we are on schedule to complete the $200,000,000 synergy by sometime next year and our goal is not to stop there. We continue to look for other synergies and those synergies are purely from cost position. We're not looking those number does not include if we operate the plants better that we are doing a lot of work in maintaining the plants and also does not include margin improvements. I'll just highlight that unlike the olefins business, we all know that capacity coming up from the major olefins companies in The U. S. In chlor alkali vinyl business, globally, we don't know any new plants being built in chlorine or PVC around the world, maybe some debottleneck expansion, but no grassroots plants. And as demand for polyethylene and PVC still grows globally, our GDP one to 1.5 times GDP rate and global demand GDP growth at 3% a year for the foreseeable future. You could have 3% to 5% growth in demand for PVC and caustic also demand is growing globally. Caustic typically follows GDP rate. So we have demand growing and actually capacity in caustic is being reduced in Europe because of the mercury cell problems they have by regulation as well as the reduction capacity in The U. S. So I think we're in a very good position going forward in the Vinyl business. This is just a pictorial of the history of Westlake from a capacity point of view, we don't want to list revenue, the revenue include inflation as well. So Westlake, it was founded, I think, David said 1985, the actual sales was started in 1986. So through the last thirty years, our capacity expansion grew both by organic which means building our own plants. We built two of the three ethylene plants up sells, styrene plants, chlor alkali plants and the yellow plants. But most of the growth has been through inorganic acquisitions. So we bought the Village plants in 1990s starting the vinyls business and certainly we bought CertainTeed specialty pipelines, we bought Eastman Chemicals Texas polyethylene business and we've actually bought Axos business. So we are prudent investors in the sense that we acquire plants and we spend a lot of resources and time to improve the operations and doubling, tripling capacity after acquisition. So if you look at the compound annual growth after thirty years being 17.5% per annum for the last thirty years. And again, we are focused on top line growth, we are focused on bottom line growth. Let's talk about the polyethylene. Today, The U. S. Globally is about 200,000,000,000 pounds of capacity. LDP, the dark blue is about 22% of global capacity, if you take the other high density and near low and Westlake about 59% of capacity of LDPE. Why is it important, if you look at the chart on the right that over the last fifteen years, the left hand two bars that LDPE has higher margin than the other linear low or high density. The last five years, those margin differential continues. So the reason why it is higher margin is again because LDP is made under 40,000 PSI, lot of steel goes into making polyethylene, hence the investment machineries are much more expensive than medium low high density, which are made very low pressure. And when people have low feedstock costs like Middle East has, like U. S. Has today, they want to build the biggest cheapest ethylene plant which is ethane cracker, they want to build the biggest cheapest investment cost, which is high density and then get the profits back from what from the cheap ethane, not from making polyethylene. So, LDP becomes more expensive to build, people didn't spend the time and they think the cheap linear low high density will take market share away from applications where crossover. So, they did, linear low took some of the packaging, the liner bags and lower cost market away from LDPs. LDP has found niche markets where its property is more special, hence the margin is better and less supply. On the Miro side, I mentioned that globally we are the number three PVC manufacturer in the world, but number two in The U. S. And the clockwise we are number three globally. And mentioned that little bit that we bought in 2014 is combination of the vinyl business of Hooks and the Vaca and we are the largest specialty PVC manufacturer in the world. They are all based in Europe, five plants in Germany and one plant in England and because of specialty nature, they enjoy a higher margin than the commodity suspension grade and globally about 10% of the PVC are specialty PVC and we the leader on that. And not only that, Duolit also is the world leader in technology for making vinyls from PVC, VCM and the emulsion PVC, which they are very large at as well as suspension. So we are able to use technology to help out Axial and Westlake's wireless business. So it's a double win for us. With that, I'll hand over to Steve to give you a summary of our activities last few years. Thank you, Robert. One of the important elements that you've seen from some of the charts and the comments that Abbott made is really making strategic investments at the right time and obviously at the right price. We're very focused in driving value at the bottom line, not growing the top line, but growing the bottom line, the EBITDA business is really the focus that we're in. So as you think about making the right investments to get the right ROI, I wanted to highlight a few of these that you've seen us make over the last few years. You can see we've made strategic investments to expand and integrate the chain across the space. You can see we've invested most recently in the large acquisition last year with Axial that brought significant volume to our vinyls business, grew substantially. We've also expanded the two Lake Charles ethylene plants that really help us integrate the business and bring a significant amount of upstream capacity, ethylene in this case, into our business. You can see we've also made a variety of investments. Most recently, Albert highlighted the Vinylate investment we made in 2014, one of the largest player in flexible specialty PVC. You can see we've also added PVC capacity in our businesses as well. In this most recent year in 2017, we expanded our facilities in Calvert City, adding 100,000,000 pounds of ethylene in the business. You can see over a period of time, the focus has been growing the integration of our chemical chain, in this case, value for the bottom line. And that's really been our focus, driving EBITDA. So in the current year, as we continue to invest, we're investing this year to bring reliability and predictability to those businesses we acquired of Axial. As we continue to focus, you can see that we focused at improving the overall bought and the overall value of the business that we bought. With that, what I'll do is I'll turn it back over to Dave and let you spend the rest of the time for questions. Thank you, Steve. Thank you, Albert. Albert and Steve, you've invested, I think, about $6,000,000,000 in chlor alkali between Axial and OYO investments. You highlighted the reasons why good growth, no new supply. How long does this positive backdrop persist for chlor alkali? That's a good question. Can you hear me? Okay. Hello? Yes. Sorry. That's a good question. As you know that PVC business, I thought PVC first, we were the industry doing quite well, exporting only 10% of our production all the way to 2007 when the housing construction new starts was averaging about 2,300,000 units both single family homes, multi family homes and with housing meltdown since 02/2008, in 2008 housing dropped 80% to only 400,000 units new starts. As a result, which is a big housing market is a big user of BDC, our industry had export 30 of the 35% of its production and that's because of the low cost position The U. S. Enjoys with shale based ethylene and petrochemical feedstock. We're able to do that at a lower price margin than otherwise. Chloroacolide last cycle did not peak in 2007 and 02/06, it peaked in 2010. As a result, before it peaked, company like Dow joint venture with Mitsui to putting 80,000 tons of new chlor alkali plant. We had 350,000 tons of new chlor alkali capacity starting in 2013 and obviously put 200,000 tons. So hence the chlor alkali market also became oversupplied. And as said earlier, chlor alkali business growth, GDP growth and during the from 2013 onwards GDP growth was slow in The U. S. So it took quite a while until now. Finally The U. S. Operating rate clockwise running at mid to high 80% and in our industry we need about 90% over to have real pricing power. Even then we are having the industry is having price announcement every quarter of this year so far. So we are able to enjoy pricing margin improvement. So what's happening now unlike the polyolefin business, you have all the major six-seven-one, adding new ethylene plants and polyethylene capacities as we speak. In the vinyl business, as I said earlier, there are no new announced plants in the world for both chlor alkali or for PVC. So as demand for PVC growth and caustic growth and GDP rate, it's better than year, whether it's a year, two or three years, will be over 90% in The U. S. Especially and that will really help the margin to improve. So we talk about mid cycle average earnings, we're not in the bundled business to the mid cycle yet. So we're climbing out of the trough and we are on the upswing side of the trough, whereas in the polyolefins, I think we are in the down cycle and the question is how long the cycle will be and how deep will be. There is different comments I'll make out of it. Very good. Just also on capacity closures in both Europe and potentially China, what are you seeing, what are you hearing, what's your expectation? Yes, as mentioned earlier, Europe has a regulation to shutdown mercury cell plants chlor alkali plants. There are three process to make chlor alkali. Mercury is the oldest highest cost, then the diaphragm which primarily in The U. S. And then membrane for lowest energy cost in the newer technology and that's what the rest of world is using membrane and U. S. Also has membrane capacity. And the military process is being outlawed in Europe at end of this year. As a result, some nuclear cell plants are planned to shut down end of this year or some of them converted to membrane at investment cost. And those people can justify investment or the government is paying for it, they will do it. If not, they will shut it down. So industry consultant estimate between 850,000 tons to 1,000,000 metric tons of capacity, we're taking out of the mercury cell in Europe. Whereas in China, China has a different element. Much of the vinyl business is coal based. They use coal to make calcium carbide which reacts in water to make acetylene, which is the 1950s technology in the world that PVC was made through acetylene and hydrochloric acid HCL and not with ethylene and chlorine. It's a highly polluting, high energy intensive. But on the other hand, because of China's abundance in coal and the lack of enforcement on environmental issues, those coal based carbide plants proliferated. And today, China is much more conscious of environmental problems because of the citizen demanding it. And hence that during the last winter, some of the coal plants coal based PVC plant and coal based power plants are forced to rather lower rates or shutdown as a result capacity brought down, prices coming up and global polymer prices went up during the winter months. Very good. And Albert, on Axial, the potential seems quite large, just the cost potential, but really maybe more than the reliability and predictability to get a higher operating rates. How do you frame out the potential upside from Axial over the next two, three years post your investments to really improve this business? Yes, we talked about the $200,000,000 cost down and that's ongoing within our target. We should achieve it within two years after acquisition. And then we've seen that we talked with one on one that ongoing maintenance we're working, we are bringing earlier the maintenance turnaround cycles to fix on a problem those plants have and hopefully when those are done, we will able to improve the operability of those plants which means we'll increase the output. And thirdly is the market, as the market tightens, demand increases and solar plant shutdown, the margins are improving. So we are seeing three prongs of improvement in operations, lower cost, higher output and higher margin. So when Georgia Golf bought PDG's assets in the beginning of twenty thirteen, they talk about the combined vinyl business, chemical business having $850,000,000 cycle average EBITDA earnings and cycle bottom of $550,000,000 EBITDA. Unfortunately, they did not take into account all the overcapacity in the chlor alkali business. So in 2015, the adjusted EBITDA was $320,000,000 way below the $550,000,000 talked about. But I think if cost down is the three pronged approach works, it's foreseeable that the EBITDA could go to cycle average. And as said earlier, we are not near cycle average earnings yet. So, the potential to improve the operations. Sounds good. Maybe just lastly on core alkali caustic now that you are a player in that field, what's your view on caustic over near and medium term? I think it's very positive as I mentioned that we'll be able to industry is able to increase price every quarter and not without getting the full amount, but we're getting part of the amount and export prices improved. Usually export caustic is the worst market for that and actually earlier this year export price caustic almost parity with domestic spot price. So global demand, as said earlier, there's no new capacity added chlor alkali globally anywhere. So as global demand increases, aluminum plants coming back and pulp and paper consumption is increasing and for container packaging, caustic demand is increasing and all of GDP growth. So, GDP is growing globally at 3% rate, caustic demand will increase. Very good. And Albert, on building products, which is now I believe over $1,000,000,000 of sales, why is that an attractive business for you longer term? Well, yes, I think, David, what it provides us is an ability to have a full integration of the chain. When you think about that business, it takes, at today's operating rates, probably over 1,000,000,000 of resin. So when you think about where the large investment we have in the business is, it is really upstream. But to run that value business downstream, we want to have that full integration. It actually provides good stability of earnings. That Building Products business is a very stable business. It provides very stable earnings and provides us a really great platform to take that resin into that Building Products business and provide stability. So when I think of the value chain everywhere all the way from the beginning of the process to the end of the process, it provides us an opportunity to catch the margin from one end of the spectrum to the other. And importantly, it's a lot more stable earnings stream than some of the other commodity ends of the business further upstream. And on Vinylid, how is that specialty business benefiting your U. S. Operations now or will it going forward? That Vinylid business is a very important business. Let's say, it's the global largest player that we have in specialty PVC space. Today, it is about 10% of The U. S. Market, but it provides us an opportunity to really have very high margins in that specialty business, as you would guess. And so certainly, as a global leading player, it is deeply into the technology. We have a huge R and D facility there in Europe that allows us to really work with our customers to co develop products to really continue to expand its offerings. Very good. Albeck, switching to ethylene, I'll go through this pretty quickly. Your view on The U. S. Ethylene cycle, where we are today, what will be the depth and duration of this downturn we're likely going to see over the next twelve to eighteen months? Yes, as you know that new plants are being built, U. S. Today exports 20% of the polyethylene that we produce today. So, with all the additional capacity added on, we're not going to absorb by The U. S. That internal demand growth. So all the players are planning to export those products. They have terminals set up, baggage packaging set up and also exploring using terminals outside of Houston. Houston is the historical export area for petrochemical polymers and now they're going to New Orleans, to Charlotte, to Dallas and other ports able to export. So they're avoiding congestion and furthermore that all these capacity coming up from existing players, the Exxon, the Dow, the Lyondell, CPChem, Nova, Formosa, they are all polyethylene and the addition is a fraction of the existing capacity. So I presume that these majors who are very knowledgeable, very good business people, will shouldn't shoot their own foot. But having said, I've seen them before. So but people are saying that there will be so much capacity, the sky is falling. But I think it goes back to the fundamentals. U. S. Ethylene today based on ethane still have over $0.10 a pound cost advantage of the naphtha crackers overseas and even with the low oil price we have today, the oil price improves those cost advantage will increase. And usually export price are lower, netback price FOB in U. S. Cost are lower than domestic price. And earlier this year because the demand for polyethylene increased a lot in Asia, actually export price increased over U. S. Price. And as a result, we're able to get $08 a pound price increase over two months, February and March. And even though we are giving back $03 in May, we did enjoy those price increases, which means that the high cost producers in Asia and Europe and their price really sets the floor, not The U. S. Competition capacity as the floor. And if price policy gets too low here, we just export. And so now we are cost competitive with the world we can compete. So there is a floor how much margin the price will drop in The U. S. Which and some people are estimating by 2021 globally will be short of polyethylene capacity again and there will be new demands. And as you may have heard Exxon SABIC talk about putting over $10,000,000,000 of a new plant near Corpus Christi and Shell is planning to start its own project in Marcellus in West Virginia or Pennsylvania and Total joint venture with Nova to put a new plant in Houston. Now these are world class companies and they are in anywhere they are in Asia, are Middle East, are in The U. S. They believe The U. S. Is the best place for the ethane cracker. I'm sure they are looking at projects not for next two years or next five years, for next twenty years and this is the best place I think in the world to put a new project. So from an industry player, again, we don't unlike you ladies and gentlemen, looking for the quarter to quarter performance as industry producer, we're looking at five decades of performance. So, we're a very long term risk adjusted investor. So, we believe that the long term future for olefins polyethylene still very good in U. S, maybe hiccup along the way. Very good. And I want to touch on partners, Westlake Chemical Partners had a bit of a stabilized position until the IRS ruling. Are we back in business with Westlake Chemical Partners, which we expect further dropdowns and how does LATE play potentially in this in that business? Yes, we clearly are. We're forming that partnership as we did in 2014. We had a variety of levers, four key levers to be able to grow the earnings of the partnership. Today, we only have 13% of the operating company in the partnership, which leaves 87% yet to drop in, so significant opportunity to really continue to drop in capacity. I don't think people have focused on how large an inventory of dropdown capacity we have. We also have an opportunity to expand and add assets into that partnership, and you mentioned Lotte. Today, we have a 10% interest in that ethylene business with an opportunity through an option to expand it up to 50, up to three years post completion, which should be in 2019. So we can also take that ethylene investment, drop it into our operating company and then drop it into the partnership as well as other ethylene opportunities down the road. We can certainly expand those ethylene businesses. And so we've been in the process of expanding ethylene capacity over the last several years, and that cracker of Lokey's could also be expanded. So that's the third lever. Then, of course, the fourth lever is taking that margin that we've constructed for the partnership to have a zero one zero dollars per pound margin in that business, and certainly, that can be increased over time. So those four levers are very important, and you would expect that with the dropdown capacity that we have, we'd certainly be thinking of doing a dropdown somewhat sooner than later because we as you mentioned, the IRS has now given us a green light to move forward. So the partnership is, if you will, back in business. Okay. I don't want add that I don't know whether you all are able to buy MLPs or not, but Westlake, we are Westlake partners, we are yielding 6% on distributions, higher than some of the high yield fixed income chemical guys and we're growing the distribution by low double digit rate every year going forward. And it may not be tech sensitive, 80% of the tech sheltered. So if you hold high yield fixed income much cheaper, better return to own MLP than even high yield fixed income, because it's growing. Any questions in the audience for Albert or Steve? I'll keep on going. One other option or acquisitions perhaps, obviously, there's a cracker sold recently, there are more crackers to sell today. How do you look at and analyze the attractiveness of acquired assets in the ethylene side? Yes. Well, the acquisition team is always looking at opportunities. You mentioned the Williams transaction that occurred with Nova. And certainly, as we think about ethylene, ethylene is core to everything that we make. It goes into our polyethylene and styrene and PVC businesses. But as I mentioned earlier in my comments, we're very focused on the return at the end of the day. So everything that we look at has got to have that risk adjusted return. So when we think of putting investments into ethylene or investments in the any other chain of our business, it has to be at the right time in the cycle and at the right value proposition to give us the return profile that we're looking for. So we assess all those opportunities, but I'm always focused on ROI or an ROA focus. And my last question, Albert, is on ethane. How do you foresee ethane trading relative to fuel value going forward? It seems given recent discoveries in Permian, there's a lot more liquids available going forward, maybe not the premium people thought could exist a year ago. Certainly, there's a lot more production oil and gas and hence the associated gas, which is very rich in NGLs are coming up. Today, I think ethane trades about $0.25 a gallon and projection by HS by the end of the year, they go to $0.30 and whether in a year or two years when older plants come up, go as high as $0.4 But I think we just heard the presentation enterprise, they all foresee that by 2021 with all the new expansions in oil and gas production that ethane will be long again, hence the new wave of expansion of our new ethylene plants has been discussed. So even at $0.30 between $0.25 you're talking about $06 a pound price increase and at $0.40 ethylene is still at $0.16 $0.17 a pound cash cost, still much lower than naphtha cracking and as we expect that oil I don't know you guys feel about oil price that would stay at $40 $45 range for the indefinite future. I think people are believing that five years from now, oil will be a lot higher than where we are today. Very good with that. We're out of time. Thank you very much, Albert and Steve. Thank you as well.