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Westlake Chemical -- Sell Off Based on Industry Peak Fears Premature

Westlake Chemical -- Sell Off Based on Industry Peak Fears Premature

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Published by Stephen Castellano
Despite a challenging industry environment, Westlake Chemical (WLK) has continued to deliver impressive returns on invested capital, and in our opinion there is still a chance for ROIC upside relative to current levels and relative to implied consensus forecasts later in the year. In addition, we think investors may be overly negative on expectations for volumes and pricing later in the year.
Despite a challenging industry environment, Westlake Chemical (WLK) has continued to deliver impressive returns on invested capital, and in our opinion there is still a chance for ROIC upside relative to current levels and relative to implied consensus forecasts later in the year. In addition, we think investors may be overly negative on expectations for volumes and pricing later in the year.

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categoriesBusiness/Law, Finance
Published by: Stephen Castellano on Aug 02, 2011
Copyright:Attribution Non-commercial

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08/02/2011

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 J. Stephen Castellano Ascendere Associates LLCsteve@ascenderellc.com Page 1www.ascenderellc.com 
Ascendere Associates LLC
August 2, 2011Westlake Chemical (WLK) -- Decline on Industry Peak Fears Premature
 
OverviewWestlake Chemical (WLK)
was the worst-performing stock in our long model portfolio today, down -9.8%, despitereporting a 2Q11 quarter in line with consensus accompanied by an impressive surge in ROIC to 24.6% from 17.9% in theprevious quarter and 10.3% last year.The general volatility in the global economy as well as industry-specific price and volume volatility is what seems to besending the price of WLK shares down.However, despite a challenging industry environment the company has delivered impressive returns on invested capital,and in our opinion there is still a chance for ROIC upside relative to current levels and relative to implied consensusforecasts later in the year. In addition, we think investors may be overly negative on expectations for volumes andpricing later in the year.As a result, we believe WLK as an investment deserves the benefit of the doubt until proven otherwise. As it relates toour model portfolio strategies, we intend to hold it the stock and reassess the relative attractiveness of the position atthe end of the month -- as we do with all of our stock positions.
 
NYSE:WLK
LTMFY+1FY+2LTMInsidersStock Price$47.51EPS:4.67$ EPS:$4.42EPS:$4.48ROE:20.5%Own0.6%EBITDA/Number oMarket Cap$3.2bP/E:10.2P/E:10.7P/E:10.6Capital38.8%Analysts10EBITDebt toEnterprise Val$3.2bP/CF5.0P/CF5.0P/CF4.9Margin15.4%Captial31.4%NIDividendBeta1.68P/S:0.9P/S:0.9P/S:0.8Margin9.2%Yield0.5%
Source: Capital IQ consensus and financial data.
 
 J. Stephen Castellano Ascendere Associates LLCsteve@ascenderellc.com Page 2www.ascenderellc.com 
Details:Westlake Chemical (WLK)
was the worst-performing stock in our long model portfolio today, down -9.8%, despitereporting a 2Q11 quarter in line with consensus accompanied by an impressive surge in ROIC to 24.6% from 17.9% in theprevious quarter and 10.3% last year.The decline in the stock seems to reflect concerns that volume and price conditions have peaked for the company evenwhile it is planning to embark on a significant capital spending program that will fully integrate its polyethyleneproduction to natural-gas based feedstock.Sellers of the stock seem to be focusing on the margin compression relative to 1Q11, recent price declines, fears of slowing export volumes and cynicism regarding near-term industry price increases and expectations for lower feedstockstocks later in the year, while ignoring the most important metric -- the impressive surge in its profitability relative to itsoperating capital.Consensus forecasts currently imply that ROIC is set to peak in 3Q11 and decline next September to about 20%, whichwe estimate is nearly 2x its cost of capital. However, if industry price increases stick, feedstock prices and oil pricesstabilize or drift higher again, we think there is a reasonable chance of further ROIC expansion beyond 3Q11.In other words, we think management has done an excellent job in navigating a challenging environment and, untilproven otherwise or until there is a relatively compelling better idea, it should be given the benefit of the doubt. We donot see today's report changes the relative attractiveness of the stock at the current moment. We believe this isespecially so given that the only selling at 1x sales and 11x earnings, as well as the flexibility that the $837m inunrestricted and restricted cash provides it versus its $765m debt.In more detail, we note that on the conference call management stated that current market conditions, expect furtherdecline of polyethylene prices in July, however inventory adjustments and other factors that led to the decline in priceshave now run their course, and industry has announced price increases for August and September due to higherdomestic and global demand and higher domestic ethylene pricesBased on the conference call, today's sell-off seems driven in part by negative bias related to management comments ona $0.04/lb giveback of an early-June $0.06/lb price increase in polyethylene prices caused by inventory destocking andlower industry exports and rising ethane feedstock prices. The volatility in prices may be causing some cynicismon$0.02/lb and $0.03/lb industry increases planned for August and September. The cynicism may not be baseless, but inour opinion it is not actionable as a sell signal. This is because managements' strong track record of delivering solidresults in challenging environments in our opinion provides it with some leeway.We also think a short-term focus on near-term industry price swings may be clouding the importance of its long-termadvantage in having access to shale-based natural-gas feedstock, which seems likely to be continue to be more costcompetitive than oil-based naphtha feedstock for some time.Despite the increasing negative bias seen in the price of the shares, we do not see earnings estimates decline much dueto language of planned price increases in August and September. Instead, we would expect any cautious analysts todowngrade the stock while maintaining estimates. If we are right, this will have little impact to our relative analystrevision rankings for the company.In summary, the general volatility in the global economy as well as industry-specific price and volume volatility is whatseems to be sending the price of WLK shares down today. However, despite all of this the company has deliveredimpressive returns on invested capital, and in our opinion there is still a chance for ROIC upside relative to current levels.As a result, we believe WLK as an investment deserves the benefit of the doubt until proven otherwise. As it relates to
 
 J. Stephen Castellano Ascendere Associates LLCsteve@ascenderellc.com Page 3www.ascenderellc.com our model portfolio strategies, we intend to hold it the stock and reassess the relative attractiveness of the position atthe end of the month -- as we do with all of our stock positions.
Westlake Chemical Corp.
500499498497496
WLK
20001999199819971996
MaterialsCommodity Chemicals
500
6/30/2011# EstimatesForecastActualVarianceLTM MarginGross Revenue
8924$
925$
1$High960$ (35)$Low871$ 54$
EBIT
7138$
138$
0$ 15.4%High159$ (21)$Low117$ 21$
EPS quarter
91.19$
1.21$
0.02$High1.41$ (0.20)$Low1.00$ 0.21$
Shares Outsanding
67 
67 
- 
Diluted Shares Outsanding110 
Source: consensus estimates via Capital IQ
Source: Capital IQ data and estimates, and Ascendere Associates data and estimates.
Margins9/29/126/29/123/30/1212/31/119/30/11
 
Trend6/30/113/31/1112/31/109/30/106/30/10
Revenue growth3.8%6.0%8.3%9.1%18.1%113.0%11.4%26.2%23.3%42.4% Gross margin19.3%20.2%18.9%19.2%19.5%(2)18.1%19.3%20.3%17.3%15.4%SG&A & Other margin6.2%6.2%6.2%6.2%6.2%(3)6.2%6.2%6.9%7.1%6.5% R&D margin0.0%0.0%0.0%0.0%0.0%0.0%0.0%0.0%0.0%0.0%EBITDA margin16.7%17.4%16.2%16.8%16.9%(1)18.5%20.0%19.0%17.9%16.1% Depreciation margin3.6%3.6%3.6%3.6%3.7%(1)3.5%3.8%2.2%4.1%3.9% EBIT margin (or EBT)13.1%14.0%12.7%12.2%13.2%(2)15.0%16.2%16.8%13.8%12.2% Income (excluding exceptions)7.7%8.3%7.4%7.0%7.7%(2)8.6%9.3%9.9%7.8%6.9%

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