Westlake Corp (WLK) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Westlake Chemical Corporation second quarter 2006 earnings conference call. During the presentation all participants will be in a listen-only mode. After the speakers' remarks you will be invited to participate in a question-and-answer session. As a reminder, ladies and gentlemen, this conference is being recorded today, August 3, 2006. I would now like to turn the call over to today's host, Steve Bender, Westlake's Vice President and Treasurer. Sir, you may begin.

Good morning everyone. Thank you for joining us for the Westlake Chemical second quarter conference call. I am joined today by Albert Chao, our President and CEO and Danny Gibbons, our Senior Vice President and Chief Financial Officer and other members of our management team.

The agenda for today will be as follows, Albert will first make a few comments regarding Westlake's performance during the second quarter. Danny will then provide you with a more detailed look at our financial and operating results. Albert will conclude with a discussion of recent developments and then we will open up the call for questions.

Today, management is going to discuss certain topics that will contain forward-looking information that is based on management's beliefs, as well as assumptions made by and information currently available to management. These forward-looking statements suggest predictions or expectations and thus are subject to risks or uncertainties.

Actual results could differ materially based on factors including the cyclical nature of the chemical industry; availability, cost and volatility of raw materials and utilities; governmental regulatory actions and political unrest; global economic conditions; industry operating rates; the supply/demand balance for Westlake's products, competitive products and pricing pressures; access to capital markets; technological developments and other risk factors.

Westlake issued earlier this morning a press release with details of our quarterly financial and operating results. This document is available in the press release section of our Webpage at www.westlakechemical.com. A replay of today's call will be available beginning one hour after completion of this call until 1:00 p.m. Eastern Time on August 10, 2006. The replay may be accessed by dialing the following numbers. Domestic callers should dial 1-888-286-8010. International callers may access the replay at 617-801-6888. The access code for both numbers is 95 71 24 04. Please note that information reported on this call speaks only as of today, August 3, 2006, therefore you are advised that time-sensitive information may no longer be accurate as of the time of any replay.

I would finally advise you that this conference call is being broadcast live through an Internet Webcast system that can be accessed on our webpage www.westlakechemical.com. Now I'd like to turn the call over to Albert Chao.

Thank you, Steve. Good morning, ladies and gentlemen and thank you for joining us. I am pleased to report that our second quarter 2006 results were a continuation of the strong performance we reported in the first quarter. In this morning's press release, we reported second quarter earnings of $1.03 per diluted share. This is our highest second quarter on record and is a significant improvement over earnings of $0.74 per diluted share reported in the second quarter of 2005.

Our operating margin increased to 16% in the second quarter of 2006 from 14% in the second quarter of 2005. Our year-to-date operating margin was 17%, the highest six month period since 1995. The improvement in income from operations was primarily the result of generally higher selling prices, which outpaced the rise in feedstock costs. However, the improvement was partially offset by lower production volumes and higher maintenance expense due to a planned maintenance turnaround at our facilities in Calvert City, Kentucky.

Our Olefins segment continues to enjoy high ethylene and polyethylene margins due to strong supply/demand fundamentals. Also, we benefited from falling natural gas prices. Our gas based ethylene cracking ability provided us with a strong cost position compared with liquid based ethylene crackers in the U.S. and around the world. Our Vinyls segment was affected during the quarter by the planned maintenance turnaround I just mentioned, which was successfully completed. Our Geismer facility continues to add to the strong performance of both segments and furthers our downstream integration strategy. Our integration strategy allows us to consistently run our plants at above average operating rates and boosts both our operating margins and the bottom line.

Now, I would like to turn the call over to Danny Gibbons, our Chief Financial Officer, for a review of our second quarter results.

Thanks, Albert and good morning everyone. As we reported in this morning's press release, Westlake had sales of $669 million in the second quarter, which represented a 15% increase over the $581 million of sales reported in the second quarter of 2005 due to higher volumes and generally higher selling prices. Higher sales volumes for polyethylene, PVC resin and PVC pipe were partially offset by lower sales volumes for merchant ethylene, styrene and VCM.

PVC resin sales volumes increased primarily due to the additional production capacity brought online at Geismar facility. Sales of PVC pipe were higher as a result of the distributor market tightly managing inventories during the first quarter in anticipation of lower PVC pipe prices. This was followed by a strong seasonal increase in construction activity and increased demand for PVC pipe.

Polyethylene sales volumes increased in the second quarter as U.S. polyethylene demand grew from the prior year. Additional production capacity at our Gesimer facility increased our ethylene consumption, reduced our external merchant ethylene sales volumes and furthered our integration strategy. VCM sales volumes were down primarily due to the maintenance turnaround at Calvert City and styrene sales lagged as a result of domestic demand. Prices were higher for many of our products as we were able to pass along higher feedstock costs and at the same time expand margins.

Now for a sequential discussion of second quarter versus first quarter 2006. Second quarter sales were $50 million higher than the first quarter due to higher sales volumes for virtually all of our products. These volume increases were partially offset by lower average selling prices for many of our products and higher feedstock costs. Average selling prices for olefins fell 8% during the second quarter, but olefins sales volumes improved 11% primarily due to higher polyethylene sales volumes.

Polyethylene sales volumes strengthened in the second quarter as prices bottomed out and began rising which stimulated demand. Polyethylene prices fell $0.12 per pound in the first quarter and continued falling through the early portion of the second quarter. The industry followed with a $0.06 per pound increase which was implemented in the second quarter. Overall, spreads were lower sequentially due to ethane and propane prices increasing, as a result of continued high crude oil prices despite the decline in natural gas prices. Strong ethylene production within the industry has put pressure on ethane, driving inventories to very low levels and increasing the price of ethane above its BTU equivalent value to natural gas. For the quarter, the average selling price for vinyls fell 2% while sales volumes were 17% higher than the first quarter of 2006.

Second quarter net income was $16 million higher than the $51 million net income or $0.79 per share reported in the first quarter of 2006. However, keep in mind, first quarter net income reflected the impact of a $26 million charge for the early retirement of debt. Excluding the non-operating charge, net income would have been $67 million or $1.04 per share in the first quarter versus $1.03 per share in the second quarter.

Second quarter results were positively impacted by the utilization of FIFO or first-in, first-out inventory accounting as compared to the utilization of LIFO by many of the others in the industry and this was primarily as a result of an increase in the price of feedstock. We estimate that the FIFO impact for Westlake in the second quarter was approximately $10 million after tax. In contrast, first quarter results were negatively impacted from the use of FIFO by approximately $22 million after tax. Consequently, year-to-date utilization of FIFO has had a net negative impact on Westlake of approximately $12 million after tax. Please bear in mind that the FIFO calculation is only an estimate, is not audited and is not a generally accepted accounting principles calculation.

As Albert mentioned earlier, operating income margins were the highest since 1995 for the first six months of the year. Industry operating margins remained at historically high levels despite increasing feedstock costs. Additionally, we continued to benefit from our vertical integration strategy and robust product demand for our key products.

Now, turning to our segment analysis. Our Olefins segment generated $62 million in income from operations during the second quarter of 2006 compared to $32 million in the second quarter of last year. The 94% increase was primarily due to price increases for all of our major products and increased sales volumes for polyethylene. These increases were partially offset by lower sales volumes for ethylene and styrene and higher feedstock costs for ethane and propane. Our polyethylene sales volumes increased by 7% as compared to the second quarter of last year, but merchant ethylene sales volumes were lower primarily due to the increase in internal ethylene consumption at our Geismar facility.

Second quarter income from operations for Olefins was $2 million higher than the $60 million reported in the first quarter of 2006. This increase was primarily due to higher polyethylene sales volumes and lower energy costs. As mentioned earlier, the industry implemented a $0.06 per pound polyethylene price increase in the quarter. The industry has also announced a $0.07 per pound increase for July and a $0.05 per pound increase for August.

Turning to the Vinyls segment. Income from operations for our vinyls segment was $44 million in the second quarter compared to $51 million in the second quarter of 2005. The $7 million decrease was mainly due to a planned outage for a maintenance turnaround at our vinyls complex in Calvert City. Parts of the plant were down for 16 days resulting in lower production volumes and higher maintenance costs. In addition, raw material costs for propane and ethylene were higher despite lower natural gas prices as crude oil prices and related products were higher in the quarter. These decreases were partially offset by higher selling prices for most of our vinyls products as we were able to pass along some of the escalating feedstock costs through increased sales prices.

For the quarter, income from operations for the Vinyl's segment was $10 million below the $54 million earned in the first quarter, primarily due to the planned maintenance turnaround at our facility in Calvert City, lower selling prices and higher feedstock costs. These decreases were partially offset by substantially higher sales volumes for PVC resin and PVC pipe.

Turning to the balance sheet and summarized statement of cash flow. Cash flow from operating activities was $147 million for the first six months of 2006 compared to $144 million earned during the same period in 2005. During the first six months of this year, we spent $63 million for capital expenditures, $4.6 million to increase our interest in Huasu, our joint venture in China and $27 million to settle derivative transactions that were executed in 2005.

Our cash balance was $276 million at June 30, $40 million greater than the $236 million reported at March 31st. We have no outstanding borrowings under our revolving bank credit facility at this time. And our total long-term debt now or at June 30, 2006 was $260 million. Our debt to cap ratio at June 30, stood at 19%. If you apply our cash balance against our outstanding debt more than eliminates all outstanding borrowings.

Now, I'll turn the call back over to Albert to discuss some recent developments. Albert?

Thanks Danny. First, let me update you on the status of upcoming maintenance turnaround activity. We had expected to commence a maintenance turnaround at one of our ethylene units in Lake Charles during the third quarter of 2006. However, because of continued strong ethylene demand, potential conflicts over manpower availability and in order to avoid the potential impact of a hurricane, we have decided to postpone the turnaround until the fourth quarter of 2006 and possibly the first quarter of 2007. The turnaround at Lake Charles is expected to last up to 50 days. Sales from inventory are expected to continue during the turnaround. Postponing the maintenance turnaround will have no material impact on our operations.

Capitalized costs related to the Lake Charles turnaround are currently estimated to be approximately $20 million. While the Lake Charles ethylene plant is down we will complete the installation of our feedstock flexibility project. The project is estimated to cost approximately $60 million and will provide us the ability to switch approximately 20% of our Lake Charles ethylene facility feedstock to heavier feedstock when it is more advantaged to ethane. This project will also help reduce our energy costs.

As mentioned in our last conference call, Westlake and the government of the Republic of Trinidad and Tobago have entered into a Memorandum of Understanding to develop an ethane-based ethylene, polyethylene and other derivatives project in the Republic of Trinidad and Tobago. We are actively pursuing the project and are currently developing a detailed feasibility study. Our goal as previously mentioned, is to begin construction in late 2007 with operations beginning in late 2010.

In summary, we had another very strong quarter and based on the solid business conditions and supply/demand balance in the chemical industry, we are optimistic about the outlook for the rest of the year and into 2007.

Thank you very much. Now let me turn it back to Steve Bender.

Thank you, Albert. Before we begin taking questions, I would like to remind you that a replay of this teleconference will be available starting two hours after we conclude the call. We will provide that number again at the end of the call.

Operator, we can now begin to take questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Edlain Rodriguez with Goldman Sachs.

Good morning, guys. Quick question.

Good morning.

Good morning.

This is in regard to VCM PVC, your vinyls business. Georgia Gulf is now buying oil polymers. How is that going to impact the VCM contract that you have with them and what do you thing the impact on the volumes will be if Georgia Gulf starts supplying oil polymers instead of you being the supplier.

Yes, thank you. We have a contract to supply VCM to Royal Group and the contract as you know is in dispute in the Court of Canada. So, that contract needs to be settled, but right now, Royal is taking these products and we're selling VCM to them.

Okay, thank you. Just a quick follow-up, you talked about the price increases for polyethylene in July and August, July is over now, so far what have you seen in terms of what prices have been implemented and do you expect them to be implemented in time?

Yes, we believe with the strong supply and demand conditions in the polyethylene market, it's -- with also increasing feedstock cost, we believe that there's a strong likelihood that price increases will be accomplished.

Okay, thank you.

You're welcome.

Your next question is from Mike Judd with Greenwich Consultants.

Yes. Good morning and congratulations on a good quarter.

Thank you.

The PVC market, the volumes were strong in the latter part of the quarter for the industry and evidently, that continued into July. Can you give us your outlook in terms of the impacts of potentially a slower housing market, but at the same time maybe a fairly robust business or commercial construction. How that sort of balances out as you look at the third and fourth quarters in terms of PVC demand, please.

Yes, the PVC demand is quite strong as evidenced by the result of our second quarter. And with the quite active business activities in the construction market in total, from both residential, commercial and [inaudible] condition, we believe the demand for PVC should be pretty strong for the rest of the year.

When you say pretty strong, is there -- can you quantify that at all. In other words, do you expect sequentially that you could have an unusual pattern this year in the sense that maybe some of the purchasing that should have occurred in the second quarter could be shifted to the third quarter. Anything along those line?

We believe usually the second and the third quarter are the strong months for construction and for PVC demand. And fourth quarter will be a somewhat slowdown compared with the second and third quarter. And we believe the seasonal pattern would be the same for this year.

Okay, but I mean sequentially in the third quarter, do you think that demand will be slower typically seasonally slower in the third quarter but this year is a little unusual in terms of the second quarter there wasn't as much of a pick up in the early part of the quarter.

Yes, we believe inventory for the industry is both from PVC resin side as well as from the converter side are fairly low. So that means that demand is quite strong and usually when people have projects they have to get it done. So once the projects are approved and money spent, usually there needs get done. So we believe that this year PVC demand as a whole is pretty strong.

Thank you.

You're welcome.

Your next question is from David Begleiter from Deutsche Bank.

Thank you good morning. Albert, going back to polyethylene price increases, can you be a little more specific, are you expecting $0.03 to $0.04 to be successful in August and maybe $0.03 in September, a little more clarity on how you see this 7 - 5 flowing through going forward?

Well, I think from reading CMA and CDR and other consulting businesses, they are [cautious] as to whether the full $0.07 and $0.05 will get through. We believe certainly, a large portion of that will go through again because of the supply demand situation in the market. As well as the higher feedstock cost push in the market.

And Albert, switching to [inaudible] what's your working assumption on Shintech and what do you think the impact will be when they do come on line.

Well, Shintech has announced that they have a 1.3 billion pound capacity expansion to come along around late '07 and '08. And they've announced that the expansion will be done in two phases and as they are one of the largest PVC producers in the business, I'm sure they are very good at doing their inventory and sales management.

And lastly as your cash builds and I'm not sure what you'll need to put in some cash for Trinidad, do you having any interest in other properties globally over the next couple of years as they may become available, in either olefins or [inaudible]?

Can you repeat the question again, please?

Do you have any interest as your cash balance grows and there are some properties for sale globally in olefins, do you have any interest in pursing those properties over the next couple of years?

Yes, certainly we'll look at opportunities on a global basis in our core businesses. But as you know, we also announced our Trinidad operation which we're working very much in that area. And that will give us a very strong position in olefin side for the American market.

Thank you very much.

You're welcome.

Your next question is from Kevin McCarthy with Banc of America.

Yes, good morning. Two questions on vinyls, what is the impact of the maintenance turnaround at Calvert City in the quarter? And then would you comment on where you believe hype margins are, or recent pipe trends in pipe relative to resin, please.

Okay, I'll let -- go ahead.

We think that, Kevin, we think that the impact from the Calvert City was probably about 10 million. Between the completion and the maintenance cost and those kind of things. So we think it was about 10 million.

Okay and then on the fabricated product side?

I have no idea.

I don't think there's much impact. We manage our inventory of resin supply in both our merchant market as well as internally.

I'm sorry, I meant, my question about pipe prices and margins, would you comment on trends you're seeing in the pipe business relative to PVC resin itself?

Certainly the pipe market prices following the PVC business decline starting in the first quarter and into the second quarter and bottomed out in -- during the second quarter. And now with a strong demands for pipe and PVC the price to move up.

Okay, so you've seen a resurgence it sounds like through the summer months?

:Yes, sir.

Okay. And then on capital expenditures, given the deferral of the feedstock flexibility project and the shut down at Lake Charles, where would you expect CapEx to come in 2006? And then longer term, what kind of rough levels should we be thinking bout for '07 and '08 as you ramp up in Trinidad and Tobago.

Kevin, let me answer the capital expenditure number for this year. We've been talking about 150 to 175 million. We really haven't changed much. And just because we're moving the turnaround out, the feed flex project will be pretty close to done as we move towards the August/September timeframe. So most of that money will be spent this year. I mean, obviously when we take the units down and we've piped the things together we'll spend a little bit more. But as far as the capital on feed flex that's going to be done this year. So, our capital expenditure estimate is still in the same range that it has been.

Okay and any preliminary thoughts on how you would finance the new project in Trinidad and what kind of cap ex might hit your cash flow statement from that?

Yes, we mentioned that the capital costs of the project which is still very preliminary is about 1.5 billon. And that will not start the construction we think until late 2007. So later on this year or early next year, usually we give a estimate of our capital expenditure for the year. So, we will inform you later on.

Okay, we'll stay tuned. Thank you.

Thank you.

Thank you.

[OPERATOR INSTRUCTIONS] Your next question is from Gregg Goodnight with UBS.

Good morning, Albert.

Good morning, Gregg.

The Trinidad project, have you modified your capacity or intended capacity of that yet. I seem to recall that the cracker was smallish?

Yes, we mentioned looking at 37,500 barrels a day of ethane cracker which is about 1.25 billion pounds. That is still the estimate right now and we are working on the visibility study. So until that's complete, that's still the estimate we have.

Is there a likelihood that it will increase or is it too early to say?

It's possible.

Okay. Second question, if I could, I would like your comments on this recent disconnect of ethane prices versus natural gas. If you take $0.85 or $0.80 ethane you're looking at $10 to $12 gas. So it seems like natural gas or ethane has become disconnected from natural gas. Is this a permanent paradigm shift, is it temporary or what are your thoughts.

Gregg if I might, as you've seen ethane inventories being depleted and they are being depleted faster than ethane is being produced. As crude oil prices have risen there has been an incredible demand from everybody that can to crack ethane. Consequently, the demand for it and the obviously the effect on inventories has created the disconnect. You're right, we're seeing ethane at $0.83, $0.80 a gallon and as long as the -- and as you know in this industry and all the other types of industries, feedstock prices will equilibrate. If the demand gets too great for one, the demand will shift to something else. And I think that's what we'll ultimately see here, as ethane prices have gotten to this range. And it's probably favored if you look at some of the numbers out there, it's favored to crack butane, it's favored to crack NPRA. So you'll see more of the demand for that start to increase and we'll see s me of the pressure come off the ethane.

Do you look for the pressure to come off third quarter, fourth quarter, next year?

The economics right now would favor -- again, favor butane. So as long as that occurs, I think you'll start to see that. When the effect is, is it next week or next month, we don't know. But again, things will equilibrate.

Okay. Well thanks for those thoughts. Last question if I could, with your switch to heavy feed at Lake Charles, do I understand you correctly that 20% of both Petro 1 and Petro 2 feed capacity could be switched to heavies?

Right. It's 20% of Lake Charles capacities, 40% of Petro 2 and --

Okay.

-- one plant.

Okay, good. And do I also remember correctly that you're going to get a boost of around 100 million pounds a year of additional capacity with this project?

That's an approximate, correct.

And finally, you're -- the cost for the heavy feedstock, am I correct in looking at benchmark like NPRA prices as a proxy for your feedstock cost, the heavy portion, anyway?

Yes, that's correct.

Okay, hey thanks. That's all I had.

You're welcome.

Thanks, Gregg.

And you're next question is from [Mills Wallen] with Credit Suisse.

Good morning. Thanks for taking my question.

Good morning.

I have, first of all I was wondering within the pipe market are you seeing different levels of demand between say small diameters, versus large diameter pipe?

We are seeing demand being robust in all diameters. But particularly the largest volumes are moving into the 8, 10, 12 inches diameter range. And those are certainly being in robust demand.

Okay and would you -- how would you say the inventories, I know earlier you mentioned inventories are low, but is there any sort of differential in inventories for the various diameters?

We believe they are low across the board.

Okay, thanks. And then another question on sort of ethylene prices. Do you have a sense how the ethylene spot market, what direction that is moving in with the fact that you won't be taking the turnaround now?

Well, we are still a small portion of the market. The spot is moving up as we speak, with also the country price moving up. So that further illustrates the tight supply demand condition in the ethylene and petrochemical market in the U.S.

Great. And then what is the contract market for ethylene this in August? What is the -- what are the price increases, there seem to be a number on the table and which one -- what do you think is attainable?

Well, I think there is some discussion of $0.02 contract price movement up.

That's for July though isn't it?

July and possible August as well. The spot price not only reflect our pressure on that. But certainly August will not be finalized until as you know, the end of the month.

Right. All right, well thank you very much for taking my questions.

You're welcome.

And there is a follow-up question from Kevin McCarthy with Banc of America.

Yes, good morning. If I were to look at your vinyls business, Albert and carve it up into three buckets, how much would you say is exposed to residential construction versus non-residential construction versus other uses for the vinyl products that you make?

On the pipe side, for our pipe business we concentrate mainly on the underground sewer and water section of the market and that's the residential. And also the residential market generally is quite small, because what goes in the house is small diameters. So, I think they are about what, 10, 20, 30% range of the market is residential.

Okay and what about non-construction applications?

PVC? Well the rest of PVC is about 80% of the total U.S. market and certainly a big part of that is pipe, sidings, window profiles and all that. So they follow construction, but not just residential.

Okay, so would it be fair to say that two-thirds of your business is exposed to non-residential?

Definitely for the pipe side is not directly built in the house. Also in windows business a lot of the window business is built into the replacement market, as well as the new home market. So as new home construction slows a bit, the replacement market usually picks up.

Very good. Thanks very much.

You're welcome.

At this time the Q and A session has now ended. Are there any closing remarks?

Thank you very much again for participating in today's call. We hope you will join us again for our next conference call to discuss our third quarter results.

Thank you for participating in today's Westlake Chemical Corporation second quarter earnings conference call. As a reminder, this call will be available for replay beginning two hours after the call has ended and may be accessed until 1:00 p.m. Eastern Time on Thursday, August 10th. The replay can be accessed by calling the following numbers. Domestic callers should dial 1-888-286-8010. International callers may access the replay at 617-801-6888. The access code at both numbers is 95 71 24 04. This concludes the conference call and you may now disconnect. Have a good day.