Business context and reporting period
Westlake Chemical Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2018. The company is a vertically integrated global manufacturer and marketer of petrochemicals, polymers and building products, operating through Olefins and Vinyls segments. Unless noted otherwise, figures are in millions of dollars.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $2,235 | $1,979 | $4,385 | $3,922 |
| Gross profit | $552 | $403 | $1,094 | $769 |
| Gross margin | 24.7% | 20.4% | 24.9% | 19.6% |
| Operating income | $404 | $264 | $805 | $498 |
| Net income attributable to Westlake | $278 | $153 | $565 | $291 |
| Diluted EPS | $2.12 | $1.17 | $4.31 | $2.23 |
| EBITDA (non-GAAP) | $568 | $411 | $1,147 | $802 |
- Second-quarter sales rose 12.9%; average selling prices increased 7.1% and overall volume increased 5.8%. Six-month sales rose 11.8%, with prices up 8.3% and volume up 3.5%.
- Q2 operating income improved to $404 from $264. Vinyls operating income increased to $271 from $141, while Olefins rose to $158 from $143. For the first half, Vinyls operating income was $537 versus $211; Olefins was $321 versus $323.
- Management attributed stronger results principally to higher prices, stronger caustic soda and PVC demand and volumes, lower ethylene costs, improved Vinyls operating rates, lower interest expense and the lower tax rate. Offsets included higher ethane costs and reduced styrene volume; first-half Olefins results also reflected lower polyethylene volume and planned turnarounds.
- Q2 interest expense was $31 versus $39; first-half expense was $68 versus $79. Effective tax rates were 24.4% for Q2 and 23.7% for the first half, compared with 30.0% and 29.0%, respectively, largely reflecting the Tax Act’s reduction of the federal corporate rate to 21%.
- Operating cash flow was $324 in Q2 versus $323 a year earlier, and $549 for the first half versus $480. First-half working-capital changes used $375 of cash, compared with $121 in the prior-year period, mainly reflecting higher receivables and inventory and lower payables and accrued liabilities.
- First-half capital expenditures were $312 versus $281; investing cash outflow was $354 versus $310. Financing cash outflow was $1,242, primarily due to redemption and repayment of $1,173 of notes. Cash and cash equivalents were $482 at June 30, down from $1,531 at year-end 2017; cash, cash equivalents and restricted cash totaled $505.
- At June 30, long-term debt, net, was $2,666; principal debt was $2,715. The company had no borrowings under its then-current $1 billion revolver, $4 of letters of credit and $996 of availability, and was in compliance with its leverage covenant. Current liabilities were $1,186 and current assets $2,694.
- Quarterly dividends were $0.21 per common share, versus $0.1906 in Q2 2017. No shares were repurchased under the public repurchase program in the first half.
Material changes, outlook and notable items
- Westlake redeemed its $688 principal amount of 4.625% notes due 2021 in February and $450 principal amount of 4.875% notes due 2023 in May. The redemptions reduced debt and interest expense; the 2021-note redemption generated a reported $6 gain in other income.
- On July 24, 2018, after quarter-end, the company replaced its existing revolver with a $1 billion facility maturing July 24, 2023. On July 27, Westlake Partners amended its incentive distribution thresholds.
- Westlake’s LACC joint venture ethylene plant was under construction, with start-up anticipated in 2019. Westlake had funded approximately $160 of a maximum $225 commitment as of June 30.
- The company provided no specific earnings or operating guidance in this filing. Management said current cash, operating cash flows and available borrowing were expected to fund normal operations and ongoing capital expenditures; significant expansions or acquisitions could require additional financing. It cautioned that new industry capacity, global demand and economic conditions, trade-policy changes, raw-material and energy prices, and the cyclical chemical market could pressure margins, liquidity or results.
- Environmental reserves were approximately $53 at June 30. The company also disclosed reasonably possible additional environmental losses of $55–$110 beyond reserves. At Calvert City, EPA’s amended proposed remedy had an estimated total implementation cost of $107, but Westlake’s allocation was unresolved and depended in part on pending arbitration with PolyOne; the company could not estimate the financial impact. These estimates concern the overall remedy, not a stated Westlake liability.
- Other environmental and regulatory proceedings included potential sanctions that the company believed could exceed $100,000 in certain matters. Management did not believe the resolution of the described matters would materially adversely affect financial condition, results or cash flows. The filing notes that individual outcomes could affect results in a particular period.
- Commodity price exposure is material: the company said a hypothetical $0.10-per-gallon increase in ethane prices would raise pretax income by $1 based on open derivatives. It had $11 of variable-rate debt; a 1 percentage-point increase was not expected to materially affect interest expense. A 1 percentage-point increase at refinancing of fixed-rate debt could add approximately $27 to annual interest expense.
Most important facts for investors to verify
- Whether elevated Vinyls pricing, volumes and operating rates persisted, and whether upcoming capacity additions or weaker supply-demand conditions compressed margins.
- How working-capital demands and capital spending affected operating cash flow and liquidity after the substantial first-half cash decline.
- The final environmental exposure, Calvert City remedy and arbitration outcome, including Westlake’s share of costs.
- Progress, remaining funding needs and timing for the LACC facility’s anticipated 2019 start-up.
- Debt and liquidity after the note redemptions and new revolver, including covenant headroom and any future refinancing costs.