Well, hello. Thanks for joining us after the break here. We're going to continue on in the world of petrochemicals. Again, for any of you who I haven't met, I'm Bob Koort. I run the chemical equity research effort here. Ryan Berney's on the other end of the stage, who works with me as well, particularly on a lot of the commodity-oriented stuff. We're very pleased to have some fellow Houstonites, I guess we're called, from Westlake Chemical. We've got Albert Chao, who's the President and Chief Executive Officer of Westlake, and Steve Bender, who is the Senior Vice President, Chief Financial Officer, and Treasurer. As for most of the presentations today, we're going to lead off with questions. I like the full room here. I'm hoping that Ryan and I will only have to ask a few.
I was wondering if you guys might start off, if there is anyone not quite familiar with Westlake, to just give us a brief overview of exactly what you do, where you earn your money. Maybe talk some about your integration.
Should I use the slides?
Do you have slides to use? Sure.
Thank you. Good morning, ladies and gentlemen. Thank you for being here today. In case you're not familiar with Westlake, you can look at this slide here. Westlake is a leading integrated plastics raw materials company. We are focused in the two businesses, namely the olefins and vinyls businesses. The olefins business encompasses ethylene and its derivatives, polyethylene, we also have a styrene position. The vinyl business encompasses raw materials, ethylene, chlorine, we make PVC, as well as fabricated products, building products, in terms of PVC pipes, windows, vents, et cetera. You can see from the box our LTM first quarter of this year's results. Of the four points, our mission statement is very important to us. We want to pursue profitable growth and, as a result, create value for our shareholders. Number one goal, our job is to create value for shareholders.
We are focused on business we understand, namely olefins and vinyls business. This is our 30th year anniversary since our founding in 1986. Over the span of time, we have grown the business to today's size. Also, we do business globally, where we gain an edge. In the vinyl business, we are in Europe. We are the largest specialty PVC manufacturer in the world with the acquisition two years ago of Vinnolit, our subsidiary, which was former Hoechst and Wacker, two old line German chemical companies' vinyl business. We also have a vinyl plant in China, outside Shanghai. We are one of the most global vinyl business in the world. Also very importantly, we act in a financially disciplined and opportunistic manner. Just for people who understand polyethylene. Polyethylene is the largest commodity polymer used in the world.
We are focused on the LDPE side, which is more specialty polyethylene, we are focused mainly on the packaging side of the business. A lot of our product goes to food packaging. The vinyl side is PVC, so it's a polyvinyl chloride polymer. PVC is the most widely used polymer in construction, it not only goes into water and sewer pipe. It's the best. You can see from the Flint, Michigan issue. They used a steel pipe, which rust and corrode. PVC, they have dug up pipe in the ground buried for 50, 60 years, it's as good as brand new. PVC is the best product for water and sewer pipe, as well as for products like window frames. A lot of windows today in the world are made of PVC for best heat insulation. Some insulation, you don't need to paint them.
For sidings in the U.S. and bunch of other construction materials. Does that answer your question, Bob?
Yes, it did.
Okay.
Do you have other slides you'd like to show, Albert?
As I mentioned earlier, this slide here, we've been in business for 30 years, this is a chart that shows the capacity growth. It's not sales, because with inflation, sales will be much larger. Capacity growth of our businesses. The green part shows capacity in our olefins business, the yellow part shows capacity in our vinyls business. For the last 30 years, from 1986 to 2016, the compounded annual growth rate of capacity increase is 14.8%. We grew by both acquiring assets. The first green part, I think 1986, we acquired the LDPE assets from Occidental, when they bought the Cities Service business in Lake Charles, Louisiana. The vinyl business, the first vinyl business we bought 1990 from BF Goodrich in Calvert City, Kentucky. Over time, we went backwards into ethylene, into chlorine, and downstream into PVC fabricated products.
We acquire assets when they're available at the right price, or we build state-of-the-art business. The two ethylene plants in Lake Charles are all built by us. The styrene plant, linear low plant, all built by us. The new chlorine plant in Geismar, Louisiana, all built by us. Acquisition-wise, we bought Eastman Chemical polyethylene business, in Longview, Texas, in 1997? No. 2007. 2007, sorry. Time flies. 2006, 2007. The Vinnolit business in Germany, we bought in 2013.
Albert, I do have a question on that slide. You haven't built a greenfield plant in a long, long time. Is there some reason? Was it just on the hierarchy of profitability and attractiveness that incremental projects were better? Or is there some reason that you wouldn't find a greenfield as appealing?
Actually, we finished, I mentioned earlier, the largest chlor-alkali plants we have. At that time, before the Dow plants came up, was the largest chlor-alkali plant in the U.S. This is our Geismar, Louisiana plant, and came up in the end of 2013.
How about on the olefins side?
Olefins, we have three ethylene plants, and the two Lake Charles ethylene plant was built. First one was 1991, came up. The second one was 1997. 1997 was the end of the last one. The only other ethylene plant that was built in the U.S. was BF Goodrich plant, which was year 2000. Since year 2000, there were no other ethylene plants built in the U.S. until the new wave coming up now.
Albert, maybe I could jump in here.
Sure.
It sounds like most of your products are sold domestically, both in the U.S. and in Europe. Could you give us a sense for how much you participate in the export markets for your polyethylene and your caustic soda?
Certainly. In the U.S., polyethylene, the industry exports about 20% of its production for many, many years now. Westlake, we typically are much, much less than that and still do. We do have something we call domestic international. That some of our domestic customers have plants now all over the world. Because they like our products and consistencies, they ask to supply their other overseas branches. We are supplying from that part, and that part also consider our export business. The true export commodity, export is very little part of our sales. In caustic, again, the industry in the U.S. typically exports about 20% of its production as well. Because of our location, our first caustic plant is in Calvert City, Kentucky. It's middle of the U.S., so we have advantage position to ship to the Midwest up.
We are on the Tennessee River, which connects to the Mississippi River. A lot of caustic sent by barges to customers up the river. Now we have Geismar, Louisiana, which is on the Gulf Coast. So far, we are very happy. We don't have to sell export caustic, which are usually much lower price than domestic prices.
What are your views on ethane and where we're going to go forward? Obviously, fractionation spreads are terrible at the moment, it would seem there's some upward tilt, but there's also a whole lot of ethane that's being rejected. Where do you see the path forward there? Is there anything you can do to lock in these small spreads that the fractionators have now, or are they unwilling to offer you long-term contracts?
That's a very important question. As you know, through the shale revolution in oil gas exploration, U.S. had a tremendous growth in natural gas liquids, ethane, propane, butane production. Because, like natural gas, U.S. is a stranded market, you cannot export until now you have export terminal LNG. Likewise, ethane was kept in the U.S., and when the supply increased from oil and gas production, ethane was a byproduct, and they had to get rid of it. As a result, the chemical guys enjoyed the very low cost ethane. Ethane, it's like a natural gas. It has BTU value. Whatever ethane that's not sold, people have called rejected. They leave the natural gas and sell as natural gas, hence the BTU value.
At times, when there's so much ethane and there's a heat value is somewhat higher than natural gas, some of the pipelines have a limitation how much ethane you can put in. They have to sell below BTU value to get rid of it. Again, the price is being very low. On the long-term basis, you cannot expect that if you need it for chemical value, which is higher than fuel value, as you know, gas is very low in the U.S. for $2 a million BTU. People should pay for the higher value products for making ethylene. We believe, and now it is, that ethane now has gone above the BTU value. Going forward, we believe that you have to pay cost to extract, transport, and fractionate ethane.
Today, for example, with potential export, not potential, people are waiting for the export ship. I think Enterprise's Morgan's Point starting up in July. People are buying ethane storage for shipping. The ethane prices moved up to $0.19, $0.20 a gallon. Even at that price, the cash cost making ethylene, as published by IHS, is still between $0.10-$0.11 a pound. A very low cost, whereas today's oil price to make ethylene from naphtha is about $0.23-$0.24 a pound. It's much higher than from ethane. There are projections going forward with new ethylene plants coming on stream and with the export of ethane, whether by pipeline to Canada or by ship to Europe and Asia. I think forecast for next year could be in the highest. Next three years, mid-30s.
You talk about ethylene cash cost price still below naphtha, which comes from oil production. It depends on oil price. If oil stays at $30 or lower, ethane will have probably very close in cost into making ethylene. Oil price people projecting to go up, ethane will be still a more attractive feedstock, even at a higher price than oil to make ethylene.
Would you have an interest in locking in a price? Is there a counterparty that would offer it or no?
Yeah, I think there is a futures market for ethane. It's very thin, and also not very many years forward. It's very difficult for chemical guys to lock in prices because the oil and gas guys, they say, "We are paid to be oil gas marketers, and we sink and swim with it." If we lock it at low prices, our destiny is doomed. Especially today. If it was $100, a different story. Today, I don't think anybody want lock in low prices.
Charlie, do you have a question?
Albert, you went through a process twice now with Axiall. Going backward, what were you trying to accomplish in terms of where you're trying to get to the next level, obviously. You're trying to get more chlorine-
Well-
Also you're getting more caustic in the equation. Give me your thoughts on where you were trying to go to.
Back in 2012, we approached, at that time, it was Georgia Gulf. There's only five PVC producers in the U.S. The PVC business is not a great business if you have to build new plants. In polyolefins, you only need two plants. If you have cheap feed stocks as ethane or whatever, you build an ethylene plant, you build a polyethylene plant, and that's it. If you want to be in the vinyls business, you've got to build an ethylene plant. Half of a pound of PVC is ethylene, half a pound is chlorine. Whereas it takes one pound of ethylene to make one pound of polyethylene. For PVC, you've got to build an ethylene plant, you can build a chlorine plant, a VCM plant. That's the gas from chlorine ethylene. You got to build a PVC plant to take the VCM to make PVC.
Maybe you want to consider building a power plant to provide power to your chlorine plant, which uses more power. You're talking about huge investments. In PVC, assuming construction, which is the largest market for PVC, there's seasonality. Wintertime, you don't sell much, and summertime, you got to sell a lot to put inventory. It's very seasonal. Whereas polyethylene, it's for packaging, for food. People eat, whether it's winter, summer, whether it's hurricane or not, people use packaging all the time. Industrial wrapping, plants run 24/7. We looked at historic back. If you build grassroots, everything PVC, the ROI for that compare with polyethylene, ethylene, the vinyl business is much lower than the olefin business. If you get an asset at the right price, maybe you can get a cost money back, cost of capital back.
Hence, at that time, we were looking at Georgia Gulf. They were number four in PVC, we were number five. We're the smaller PVC guy in the business. Today's logic, same thing. They are number four, we're number five. They're bigger now with the acquisition of PPG's chlor-alkali business. They are more of a chlor-alkali company. There's synergy in our business still, like it was back in 2012. We're paying 143% premium over the unaffected price. They were $9.50 when we made an offer. We think it's a very compelling price. We also offer 40% of the offering are stocks, which is being low, and compare with our comparables. If the synergy is very good, they will enjoy the 40% of that, they will enjoy from the synergies.
We think it's a very compelling price, a lot of industrial logic doing the deal, and we wish Axiall's management and board will engage in earnest dialogue with us, negotiate a deal. Ed, please.
No, I think, when you think about what we're trying to do here, as Albert said, is really find an opportunity to put the capital to work and provide a return. We see the synergies here in putting the business together. We've been very clear in that synergy value we see between $90 million-$100 million of value. I think when you adjust that price we're offering at 10x multiple, really with those synergies, we think it's a reasonable multiple to pay for the business. As Albert said, it's a very compelling multiple, very compelling price. We think that we certainly would like to engage them, but if we can't, we have another path.
I just have a follow-up question, Albert.
Okay.
Just one. When the DowDuPont merger gets done and they get reconstituted, then you have a Dow Chemical , petrochemical commodity company, then you have yourselves and Lyondell and whoever else one wants to talk about. The oil, the Exxons or whoever else you want to talk about. What do you think the implications of that industry structure are?
Well.
Does it change anything?
Everything changes and keep on changing. DowDuPont together, the commodity on the polymer side, the petrochemical side of the business will be stronger than Dow or DuPont by itself. DuPont is not a real big player in the petrochemical side, and Dow is. As you know that the industry and olefin business in the U.S. are building new ethylene plants and downstream plants. The olefin business in U.S. is getting bigger. Going back to the vinyls business, our competition is fierce. You have Shin-Etsu, one of the largest company in the chemical business in Japan. Formosa, very large company. Occidental, very large company, oil site. Axiall today is not investment grade. Westlake, we're investment grade. We have the financial strength to combine the company together to service our customers better and provide opportunity to grow the business further.
I think there's a lot of industrial logic, not only on the Westlake side, on the Axiall side as well, for its employees, for its shareholders, who will be a shareholder of Westlake as well. I think makes a lot of sense. For really both parties, we believe will earn the cost capital back over the cycle for Westlake shareholders. I think it's a win-win for both parties, and I hope that we can get a deal done with Axiall's management.
Thank you.
You mentioned synergies quite frequently in your comments there. Synergies seem to be the sticking point between Axiall and yourselves in terms of valuation of what the ultimate enterprise is worth. I'm just fearful, kind of listening to the strategic value you put into this that not recognizing them fully may allow this asset to transfer to another player. What are your thoughts there as they investigate other potential outlets for the asset?
Yes. Synergy is a very nebulous term. Sure people quote synergies. I wonder how many people have really achieved what they said. When Dow acquired PPG's assets, they said $140 million synergy. Today, in 2016 or 2015, they achieved a $330 million EBITDA. That's with $140 million synergy in it. They said. Suddenly, we had a due diligence with Axiall's management team. We were able to increase our offer price from $20 a share to $23.35. Our offer reflects synergy in terms of $90 million-$100 million. Also reflects they have a $100 million cost down. They are in the process of completing that. Our offer price also includes that. Also, as you know, in any merger of companies, there are also dis-synergies. For example, we know the only five producer of PVC in the U.S.
We know which customers buy from we have a good idea from both Axiall and Westlake. If we're able to successfully acquire Axiall, some of the customers may not want to buy from one company. They may buy from other companies, or they are bigger now as a customer. They want a better price. There's dis-synergy. There's cost also to achieve synergies with the cost down. There's all these things, and we figured out all that into our equation. We also included a projection of improvements in the chlor-alkali business, improvement in PVC business over time. That's why we're able to offer today, based on LTM, we're offering 10x EBITDA multiple over Axiall's LTM first quarter this year. When Olin merged or bought Dow's chlor-alkali business, it was 8x EBITDA multiple.
When Dow acquired PPG's chlor-alkali asset was 5x or 5.1x multiple. We're offering a very high multiple. Only able to get a ROI to our shareholders is by synergy and by value creation from the improvement in the cycle of both chlor-alkali and PVC business. If the synergy number is higher, the fact we offer 40% of the offering price in Westlake shares, Axiall shareholder would enjoy the benefit of the synergy as well. Tom.
There's I think you guys
Yeah. When you think about polyethylene price increases, we've had a series of increases. We had $0.05 go through, another $0.04 following that. We've certainly seen price increases also in the vinyls chain of four and two. We think that really what you're seeing therefore is a really good balance in supply-demand. Polyethylene has been very consistently strong on demand side, and certainly on a seasonal basis, we've seen year-over-year, quarter-over-quarter, really strong demand in the vinyl side of the business as well. When you think about both the vinyl and the olefins chain, we see, I think, very good strength in PE and PVC. You think about what's happening in the chlor-alkali chain, certainly with the strength that you've seen in chlorine going into PVC, you're producing 10% more caustic when you make that chlorine.
There've been announced price increases of $75 or so, I think that we'll see some traction, maybe $10 or $20 of that price increase be placed into the marketplace. At the same time, remember, we've oversupplied the market with caustic soda going back to really about 18 months or so ago. We put about 8% more capacity in the market as an industry. That caustic doesn't get absorbed in the market at GDP. In fact, it's a subset of GDP. We've got a number of years before we work our way to a more balanced equation, and that's why we're being very, I think, pragmatic when we talk about what we see in terms of pricing in the caustic market. While we see some traction, we're only seeing a portion of the traction and pricing for the caustic.
This year is about 300,000-400,000 tons of new chlor-alkali capacity being added in the U.S.
How about styrene?
Styrene. We have the smallest, yet the newest styrene plant in the U.S. It was built, started up in 1990. Styrene business has enjoyed good times after many years of sub-par performance, mainly because of benzene. 70% or almost 80% of styrene feedstock is benzene. As oil price came down, and benzene price dropped a lot, and as a result, the styrene business margin has improved a great deal.
Albert, you've been in this business 30 years, seen a lot of different things. I can recall at one point it looked like a good idea to use naphtha to crack and make ethylene. Now it looks like it's nothing but NGL. Just curious, as you look out in the future, is it really different this time, or do you think we're going to go back to sort of the historical cycles and margin levels that we've seen?
Yeah, I think interesting. When we first built our first ethylene plant in 1991, started up, people wondering why we build an ethane cracker. Don't you know that ethane could be short? So we said, "Well, U.S., many ethylene plants are built with the flexibility of going through ethane, propane, butane, naphtha." If ethane truly can be short, let other people switch to naphtha, so we still have ethane. The reason is it takes 1.3 pounds of ethane to make a pound of ethylene. It takes three pounds of naphtha to make a pound of ethylene, which means naphtha crackers are very large. To take all these feedstock and make other products like propylene and benzene, toluene, xylene. The investment cost is very high also. At that time, 1990, we were a small company in the U.S., so we built the cheapest plant.
Luckily, what we said was right. Suddenly, ethane price was high and low. People switched to naphtha and propane. We're always able to access ethane. We're never short of ethane. The return on investment speaks for itself, much better than building a naphtha cracker.
Albert, maybe you could speak a little to the new polyethylene that's going to come in here to match the ethylene production we have coming. You're very vocal about the premium you have in LDPE. Do you have a sense for maybe how much of that new polyethylene capacity is going to come in, whether or not any of that's going to compete with your LDPE product, or if it's really going to be mostly high density?
Yes. I think from the pounds-wise, high-density and linear low are the biggest part of the expansion. There are certainly LDPE plants being built in the U.S. as well, but not for a long time. The LDPE plant build is all tubular LDPE. There are 2 types of process to make LDPE. There's tubular and there's autoclave. The tubular plants are cheaper to build per pound. It makes more commodity type of polymers. By and large, the average return selling price for tubular LDPE is less than autoclave. Autoclave plants are more expensive to build per pound of output. They're able to make various types of copolymers. We make 3, 4 different kinds of copolymers with ethylene, and the finished products are very varied. We are very strong in coating grade, but we can also make polyethylene wax.
Applications for some road paving for hot weather, for asphalt, to wax on apples and oranges that you may eat, to carpet backing. The application adhesives are very different. EVA copolymers make solar panel encapsulation of the silicon wafers. They are different applications where the tubular LDPE goes to more commodity, more general applications. Westlake is the largest LDPE manufacturer by capacity in the Americas, both North and South America. We believe we'll be close to number 1, number 2 after all the expansions come on stream.
Thank you.
Thank you.
Any last question from the audience? All right. Let's wrap it up there. Thanks, guys.
Thank you very much. Have a great day.