Goldman Sachs Basic Materials Conference 2016

May 17, 2016

Slides

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 on Bob Koort, I run the chemical equity research effort here, and Ryan Birney is on the other end of the stage that works with me as well, particularly in a lot of the commodity oriented stuff. We're very pleased to have some fellow Houston Houstonites, I guess we're called. From Westlake Chemical, we've got Albert Chao, who's the President and CEO of Westlake and Steve Bender, is the Senior VP, CFO and Treasurer. And as per most of the presentations today, we're going to lead off with questions. I like the full room here, and I'm hoping that Ryan and I will only have to ask a few. But 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, do you? Sure. Thank you. 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, and we also have a styrene position. And the vinyl business encompasses raw material, ethylene, chlorine, and we make PVC as well as fabricated products, building products in terms of PVC pipes, windows, vents, etcetera. You can see from the box our LTM's first quarter of this year's results. The four points on our mission statement are 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 our shareholders. We are focused on business we understand, namely olefins and vinyls business, and this is our thirtieth year anniversary since our founding in 1986. So over a span of time, we have grown the business to today's size. Also, we do business globally where we gain an edge. And 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 Vinolit, our subsidiary, which was a former Hoex and Wacker, two online German chemical companies' vinyl business. We also have a vinyls plant in China outside Shanghai. So we are one of the most global vinyl business in the world. And also very importantly, we act in a financially disciplined and optimistic manner. Just for people who understand polyethylene, polyethylene is the largest commodity polymer used in the world. And we are focused in the LDPE side, which is more specialty polyethylene, and we are focused mainly in the packaging side of the business, and a lot of our product goes to food packaging. And the vinyl side is PVC, that's a polyvinyl chloride polymer. PVC is the most widely used polymer in construction, not only goes into water and sewer pipe, it's the best. You can see from the Flint, Michigan issue, they use steel pipe, which rust and corrode. PVC, they have dug up pipe in the ground for buried for fifty, sixty years. It's as good as brand new. So PVC is the best products 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, and for sidings in The U. S. And a bunch of other construction materials. Does that answer your question, Paul? Yes, it did. Do you have other slides you'd like to show, Albert? As I mentioned earlier, this slide here, we've been in business for thirty years. And 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 and the yellow part shows capacity in our vinyls business. And for the last thirty years, from 1986 to 2016, the compounded annual growth rate of capacity increase is 14.8%. And we grew by both acquiring assets. The first green part, 1986, we acquired LDP assets from Occidental when they bought the city service business in Lake Charles, Louisiana. And the vinyl business, the first vinyl business, we bought 1990 from BF Goodrich in Culver City, Kentucky. So over time, we went backwards into ethylene, into chlorine and downstream into PVC fabricated products. So we acquire assets when they're available at the right price or we build state of the art business, the two ethylene plants of H. Charles all built by us. The Starryne plant, Linear Low plant all built by us and the new chlorine plant in Geismar, Louisiana, all built by us. And acquisition wise, we bought Eastman Chemicals polyethylene business in Longview, Texas in nineteen ninety six ninety seven? Thousand. 02/2007, sorry. Time flies in 02/2006, 02/2007. And the Vinodel business in Germany, we bought in 2013. Albert, I do have a question on that side. You don't 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 our I mentioned earlier, the largest chlor alkali plants we have. At that time before the Dow plant came up was the largest polyethylene largest chlor alkali plant in The U. S. This is our Geismar, Louisiana plant and came up in the end of twenty thirteen. And how about on the Olefins side? Olefins, we have three ethylene plants and the two Lake Charles ethylene plant was built. The first one was 1991 came up, the second one was 1997. We were the 1997 was the end of the last one. The only other ethylene plant that was built in The U. S. Was BFGoodrich plant, which was year February. And since year February, there were no other ethylene plant built in The U. S. Until the new wave is coming up now. Albert, maybe I can jump in here. Sounds like most of your products are sold domestically, both in The U. S. And in Europe. Can you give us a sense for how much you participate in the export markets for your polyethylene and caustic soda? Certainly. In The U. S, polyethylene, the industry exports about 20% of its production for many, many years now. And Westlake, we typically are much, much less than that We do have something we call domestic international, that some of our domestic customers have plants now all over the world. And because what they like our products and consistencies, they ask to supply their other overseas branches. So we are supplying from that part, and that part also comes with our export business. So 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. And because of our location, our first caustic plant is in Culver City, Kentucky. It's the middle of The U. S. So we have an advantage position to ship to the Midwest up we are on the Tennessee River, which connects to the Mississippi River. So a lot of caustic sent by barges to customers up the river. And now we have Geisner, Louisiana, which is on the Gulf Coast. And so far, that 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. So it seems there's some upward tilt, but there's also a whole lot of ethane that's being rejected. So like, what do you see the path forward there? And 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 and gas exploration, U. S. Had a tremendous growth in natural gas liquids, ethane, propane, butene production. And because like natural gas, U. S. Is a stranded market, you cannot export until now you have export terminal LNG. And 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. And it takes ethane it's like a natural gas. It has BTU value. So people who whatever ethane that's not sold, people have called rejected, they leave the natural gas and sell as natural gas, hence the BTU value. But at times when there's so much ethane and there's a heat value that's somewhat higher than natural gas, some of the pipelines have a limitation on how much ethane you can put in. So they have to sell below BTU value to get rid of it. And again, the price has been very low. On a 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. Dollars 2 per million BTU, People should pay for the higher value products for making ethylene. So we believe and now it is that ethane now has gone above the BTU value. And going forward, we believe that you have to pay cost to extract, transport and fractionate ethane. So but today, for example, with potential export potential, people are waiting for the export ship, I think enterprises, at Walden Point starting up in July, people are buying ethane storage for shipping. So 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 still between $0.10 to $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. So it's much higher than from ethane. And 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 few years, mid-30s. But even then, in terms of ethylene cash cost price still below naphtha, which comes from oil production. So it depends on oil price. If oil stays at $30 or lower, then ethane will probably be very close in cost into making ethylene. But oil price projection to go up, then ethane will be still a more attractive feedstock even at a higher price than oil to make ethylene. And would you have an interest in locking in a price? Is there a counterparty that would offer it or no? Yes. I think there is a futures market for ethane. It's very a thing and also not very many years forward. So it's very difficult for chemical guys to lock in prices because the oil and gas guys, they said, we are paid to be oil gas marketers, and we think and swim with it. So if we lock it at low prices, then our destiny is doomed. So especially today, dollars 100 is a different story. But today, I don't know if anybody was locking low prices. Charlie, do you have a question? Albert, you went through a process twice now with Axial. Going back, what was it 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, but also you're getting more caustic in the equation. So give me your thoughts on where you were trying to go to. Well, back in 2012, we approached the time of Georgia Gulf. There's only five PVC producers in The U. S, and 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 feedstocks 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 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. So for PVC, you got to build an ethylene plant, can build a chlorine plant, a VCM plant, it's a gas from chlorine ethylene, then you got to build a PVC plant to take the VCM to make PVC. And maybe you want to consider building a power plant to provide power to your chlorine plant, which is low power. So you talk about huge investments. And then in PVC, assuming construction, which is the largest market for PVC, there are seasonality. So wintertime, you don't sell much and summertime, you got to sell a lot, put inventory. So 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 20 fourseven. So we looked at historically back, if you build grass roots everything PVC, the ROI for that compared with polyethylene, ethylene, the vinyl business is much lower than the olefin business. So if you get assets at the right price, maybe you can get cost money back, cost of capital back. So hence, at that time, we're looking at Georgia Gulf being a they were four in PVC, we're five we're the smallest PVC guy in the business. And today's logic, same thing. They are number four. We're number five. They are bigger now with the acquisition of PBG's chlor alkali business. So they are more of a chlor alkali company. And there's synergy in our business still like it was back in 2012. And we're trying we're paying 143% premium over the unaffected price. They were $9.5 when we made the offer. And we think it's a very compelling price. We also offer 40% of the offers in our stocks, which has been low and compared with our comparables. So if the synergy is very good, they will enjoy 40% of that, they will enjoy from the synergies. So we think it's a very compelling price, a lot of industrial logic doing the deal, and we wish Axcel's management and Board will engage in earnest dialogue with us to negotiate a deal. Do you want add anything? 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. And we see the synergies here in putting the business together. We've been very clear in that synergy value we see between 90,000,000 and $100,000,000 of value. And I think when you risk when you adjust that price that we're offering at 10x multiple, really with those synergies, we think it's a reasonable multiple to pay for the business. And as Efret said, it's a very compelling multiple, very compelling price. And 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. Just one, when the DowDuPont merger gets done and they get reconstituted and you have a Dow Chemical petrochemical commodity company and then you have yourselves and Lyondell and whoever else one wants to talk about, whether oil, the exons or whoever else you want to talk about, what do you think the implications of that industry structure Well, the Does it change anything? Does it Everything changes and keeps on changing. So DowDuPong together, the commodity on the polymer side, petrochemical side of business will be stronger than Dow or DuPont by itself. DuPont is not a real big player in the petrochemical side than Dow is. And as you know, that the industry and olefin business in The U. S. Are building new ethylene plants and downstream plants. So the all in thing business in The U. S. Is getting bigger. But going back to the vinyls business, our competition is fierce. You have Shintec, one of the largest company in chemical business in Japan. Formosa, a very large company Occidental, a very large company Oil Site. Axial today is not investment grade. Westlake, we are 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. So I think there's a lot of industrial logic, not only on the Westlake side, on the Axo side as well, for its employees, for its shareholders, who will be a shareholder of Westlake as well. So I think it makes a lot of sense for really both parties, we believe, will earn the cost capital back over the cycle for Westlake shareholders. So I think it's a win win for both parties, and I hope that we can get a deal done with management. You mentioned synergies quite frequently in your comments there, but synergies seem to be the sticking point between Axial 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 Johto Gulf acquired PPG's assets, they said $140,000,000 synergy. And today, in 2016 or 2015, they achieved a $330,000,000 EBITDA that's worth $140,000,000 synergy in it. So certainly, had a due diligence with Axial's management team. We were able to increase our offer price from $20 a share to $23.35 We our offer reflects synergy of 90,000,000 to $100,000,000 also reflects they have a $100,000,000 cost down. They are in the process of completing that. So our offer price also includes that. But also, as you know, in any merger of companies, there are also dissynergies. For example, we know the only five producer of PVC in The U. S. We know which customers buy from have a good idea from both Axial and Westlake. So if we're able to successfully acquire Axial, some of the customers may not want to buy from one company. May buy from other companies or they are bigger now as a customer. They want a better price. So there's the synergy. There's cost also to achieve synergies with the cost down. And there's all of these things, and we figured out all that into our equation. And we also included a projection of improvements in the chlor alkali business, improvement in PVC business over time. So that's why we're able to offer today, based on LTM, we're offering 10x EBITDA multiple over Axial's LTM first quarter this year. And when Olin merged or bought Dow's chlor alkali business, it was 8x EBITDA multiple. When Georgia Gulf acquired BBG's chlor alkali asset, it was 5x or 5.1x multiple. So we're operating at very high multiple. Only able to get a return on investment to our shareholders is by synergy and by value creation from the improvement in the cycle of both chlor alkali and PVC business. And if the synergy number is higher, the fact we offer 40% of the operating price in Westlake shares, Axial shareholder will enjoy the benefit of the synergy as well. Yes. And so when you think about polyethylene price increases, we've had a series of increases. We had a $05 go through, another $04 following that. We've certainly seen price increases also in the vinyls chain four and two. So 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. So 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 core 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. So the Ben announced price increases of $75 or so. And I think that we'll see some traction, maybe $10 or $20 of that price increase be placed into the marketplace. But at the same time, remember, we've oversupplied the market with caustic soda going back to really about eighteen months or so ago. We put about 8% more capacity in the market as an industry. And that caustic doesn't get absorbed in the market at GDP, in fact, it's a subset of GDP. So 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 in pricing for the caustic. And this year, it's about 300 to 400,000 tons of new chloroplast capacity being added in The U. S. Starting we have the smallest yet the newest styrene plant in The U. S. It was built started up in 1990. So styrene business has enjoyed good times after many years of sub par performance, mainly because of benzene. 70% of or almost 80% of styrene feedstock is benzene as oil price came down and benzene price dropped a lot. And as a result, the fine business margin has improved a great deal. Albert, you've been in this business thirty 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, and now it looks like it's nothing but NGLs. Just curious, 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? Yes. I think interesting. When we first built our first ethylene plant in 1991, Salvador, people were wondering why we built an ethane cracker. Don't you know that ethane can be short? And so we said, well, U. S, many ethylene plants are built with a flexible flexibility of going through ethane, propane, butane, naphtha. So 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 feedstocks and make other products like propylene and benzene, toluene, xylene. And the investment cost is very high also. So at that time, 1990, we were a small company in The U. S, so we bought and built the cheapest plant. And luckily, what we said was right. Suddenly, ethane price was high and low, but people switched to naphtha and propane. We're always able to access ethane. We never had short of ethane. And the return on investment speaks for itself much better than building naphtha cracker. Albert, maybe you could speak a little bit to the new polyethylene that's going to come in here to kind of 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 be mostly high density? Yes. I think on the pounds wise, high density near low are the biggest part of the expansion. There are certainly LDPE plants being built in The U. S. As well for a long time. The LDPE plant built is they are all tubular LDPE. There are two types of process that 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. And by and large, the average return selling price for tubular LDP is less than autoclave. Autoclave plants are more expensive to build per pound of output. They are able to make various types of copolymers. We make three, four different kinds of copolymers with ethylene and the finished products are very varied. We are very strong in coating grades, but we can also make polyethylene wax and applications for from road paving for hot weather of asphalt to wax on apples and oranges that you may eat to carpet backing. So the application adhesives are very different. And EVA copolymers make solar panel encapsulation of the silicon wafers. So there are different applications, whereas the tubular LDP goes to more commodity, more general applications. So Westlake is the largest LDP manufacturer by capacity in Americas, both North And South America. And we believe we'll be close to number one, number two after all the expansions on stream. Thank you. Thank you. Any last question from the audience? All right. Let's wrap it up there. Thanks, guys. Thank you. Thank you very much. Have a great day.