Westlake Chemical Partners benefits from capital expenditures and investments in environmental compliance, which may attract ESG-focused institutional investors.
The company operates in the commercialization of ethylene and has three production facilities with a significant production capacity.
The company's balance sheet includes debts and accounts receivable with Westlake Corporation, which may not be appreciated by minority investors.
Westlake Chemical Partners ( WLKP ) continues to benefit from incoming capital expenditures related to Lake Charles Olefins and Calvert City Olefins. Besides, I think that investments related to environmental compliance may trigger the interest from ESG-focused institutional investors, which may accelerate the demand for the stock. Even taking into account the limitations derived from the agreements signed with Westlake Corporation ( WLK ), my discounted cash flow model implied significant undervaluation.
Westlake Chemical Partners
In the field of commercialization of ethylene, Westlake Chemical Partners is a company with active operations since 2014 dedicated to the operation, acquisition, and development for the commercialization of this product and its related services. The company's activities are carried out through OpCo, of which it is the majority shareholder with 71% stakes. Both companies operate at the national level in the United States, and do not operate internationally.
Source: 10-k
OpCo is made up of three facilities for the production of ethylene, where ethane is converted into ethylene, with a production capacity of close to 3.7 pounds per year.
Ethylene is one of the most widely used chemical products in the international industry, mainly for the manufacture of other products such as polyethylene or polyvinyl, which are used in the field of transportation, construction, and packaging. Considering the market growth expected from 2022 to 2030, I believe that having a look at the expectations of the company is quite appealing.
Ethylene market is predicted to bolter substantially during the review era from 2022 to 2030 at a substantial growth rate of around 6.0%. The reports further predict the market will acquire nearly USD 194.7 billion by the end of 2030. As per the documents, the Ethylene market was valued at nearly USD 129.5 billion in 2022. Source: Ethylene Market to Expand at a CAGR of 6% By 2030
OpCo derives most of its ethylene production from Westlake although it has open sales channels to other companies, where they also sell products such as propylene, pyrolysis gasoline, crude butane, and hydrogen among others.
Westlake's activities are organized in a single business segment, and its revenues are 100% derived from OpCo's three production facilities, two of them in Louisiana and one in Kentucky. In addition, Westlake has commercial alliances in the distribution lines of the products, which also generate recurring revenue for the company. Recently, Westlake and OpCo reached the ethylene sales agreement, which ensures the joint activity of both companies in the long term. On the one hand, 50-year contracts have been signed for the sale of production to Westlake along with the obligation for Westlake to buy 95% of production year after year for the next 12 years.
Solid Balance Sheet, But The Debts And Accounts Receivable With Westlake Corporation Are Not Ideal
In the last quarter, the total amount of assets decreased slightly driven by decreases in property, plant, and equipment, accounts receivable, and deferred charges and other assets. The total amount of cash increased, however I don't expect investors to like the last figures reported from May .
In particular, the cash and cash equivalents stood at $104 million, with receivable under the investment management agreement worth $52 million and accounts receivable with third parties close to $19 million. Also, with inventories of about $5 million, property, plant, and equipment stood at close to $977 million, and total assets stood at $1.342 billion. The asset/liability ratio stands at close to 3x, so I believe that the balance sheet reported is solid.
Source: 10-Q
Accounts payable with third parties stood at $15 million, with accrued and other liabilities of $21 million and long-term debt payable to Westlake of $399 million. Finally, total liabilities were equal to $452 million.
Source: 10-Q
From the last balance sheet reported, we can see accounts receivable and accounts payable with Westlake Corporation, which certain investors may not appreciate. It is also worth noting that Westlake Corporation holds a large stake in Westlake Chemical Partners. It does not look ideal as we do not know whether Westlake Corporation is signing fair trading deals with Westlake Chemical Partners. In sum, Westlake Corporation is a client and debt owner, and shareholder of Westlake Chemical Partners, which may not be appreciated by minority investors.
Sufficient Environmental Investments, Capacity Increases, And Conservative Assumptions Implied That Westlake Is Undervalued
Much of Westlake's current strategy revolves around fulfilling long-term business contracts with OpCo. I did not find a lot of information about new future acquisitions, however the company expects to continue to fund capital expenditures related to Lake Charles Olefins and Calvert City Olefins. I believe that further increases in capacity will most likely lead to FCF margin improvements and net sales growth.
Westlake has historically funded expansion capital expenditures related to Lake Charles Olefins and Calvert City Olefins. No such funding was required by OpCo during 2022, 2021 or 2020. Total capital expenditures for the years ended December 31, 2022, 2021 and 2020 were $54.1 million, $81.2 million, and $37.0 million, respectively. Source: 10-k
I also think that Westlake Chemical would most likely receive significant demand for its shares as soon as it makes sufficient communication about its cash distribution policy. The company distributes most of the CFO. More demand for the stock would most likely lead to lower cost of capital, lower WACC, and a larger fair stock valuation.
Based on the terms of our cash distribution policy, we expect that we will distribute to our partners most of the excess cash generated by our operations. Source: 10-k
Source: YCharts
I believe that investors may want to know that Westlake Chemical and OpCo do not report any employees, which, in my view, offers significant advantages. The company mainly receives services from Westlake Corporation. Hence, Westlake Chemical does not have to worry about salary negotiation, strikes, or labor law. Under my DCF model, these advantages will bring certain demand for the stock.
Neither we nor OpCo has any employees. Under the Services and Secondment Agreement with Westlake, Westlake seconds employees to OpCo to allow OpCo to operate its facilities, and we sometimes refer to these individuals, for drafting convenience only, as our employees because they provide services directly to us. Such seconded employees are under OpCo's control while they work on OpCo's facilities. Source: 10-k
I would also expect significant attention from investment funds interested in environmental investments. In this regard, it is worth mentioning that the company is expected to make significant investments related to environmental compliance. ESG-focused institutional investment is expected to grow significantly in the coming years. As a result, we may see an increase in the demand for the stock, which may push the stock price up.
We estimate that OpCo will make capital expenditures of approximately $3.4 million in 2023 and $3.2 million in 2024, respectively, related to environmental compliance. Additionally, in 2023 and 2024, capital expenditures of approximately $41.5 million and $9.1 million, respectively, are expected to be paid in connection with corrective actions required by the Environmental Protection Agency to resolve the flare enforcement matter discussed below. Source: ESG-focused institutional investment seen soaring 84% to US$33.9 trillion in 2026
Undoubtedly, the ethylene sales agreement ensures a flow of capital and productive capacities to continue with the activity, but at the same time it restricts the operational capacity of the company and this can mean a problem in the event of changes in the industry in the future.
I tried to be as conservative as possible in my financial model. I included a decrease in net income, increase in D&A, decreases in accounts receivable, decreases in accounts payable, and a decline in CFO. Even with these deteriorations of the cash flow statement, the company appears quite undervalued.
My financial model includes 2027 net income worth $278 million, changes in accounts receivable of -$57 million, changes in inventories close to $16 million, and changes in accounts payable of -$70 million. Besides, with changes in accrued and other liabilities worth -$134 million, 2027 CFO would be close to $335 million. Finally, with property, plant, and equipment close to -$75 million, 2027 FCF would be about $261 million.
Source: My DCF Model
Source: My DCF Model
With a conservative terminal EV/ FCF of 3x, I obtained a terminal FCF close to $784 million. If we also include a WACC close to 9%, the implied enterprise value would be about $1.743 billion. Finally, adding cash and cash equivalents worth $104 million, and subtracting long-term debt of $399 million, the implied equity valuation would be $1.448 billion. The implied price would be $41.13 per share, and the IRR would be 19.7%.
Source: My DCF Model
Source: My DCF Model
Competition
As mentioned earlier, due to the nature of the sales agreement, OpCo has no competition regarding 95% of its production, destined exclusively for Westlake Corporation. There is some competition with regional producers such as LyondellBasell Industries, N.V. ( LYB ), Shell ( SHEL ), BASF Corporation ( OTCQX:BASFY ), and Motiva Enterprises LLC, which are companies with historical positions in that market.
Risks
If we talk about the risks, most of the risks are determined by the commercial agreements and the obligations with Westlake Corporation. The company is almost totally dependent on Westlake Corporation's credit lines and access to capital, especially for immediate payments for production.
On the other hand, the tariff structure of the agreements with Westlake Corporation significantly limits the company in terms of the possibility of taking advantage of market opportunities in the future. To this we must add that the 12-year agreements may not be renewed for the guaranteed sale of 95% of its production. In my view, it may be very difficult for the company to achieve distribution to other sales channels.
In another sense, due to the nature of the chemical industry, OpCo's operations are subject to a large number of environmental regulations and the advancement of laws to keep up with trends in relation to climate change, which may mean complications for the activity in the future.
Finally, the company's ability to pay its shareholders is limited to the capital available in liquidity, and if it is made, it limits its operating capacity. In addition, due to Westlake's ownership structure over business agreements, payment policies may be changed at any time at the discretion of company managers.
My Takeaway
Westlake Chemical Partners will most likely continue to deliver decent FCF margins and net sales in the coming years thanks to the support received from Westlake Corporation and the ethylene market growth. Besides, the incoming investments related to environmental compliance may interest ESG-focused institutional investors, who may accelerate the demand for the stock. In addition, announced incoming capital expenditures related to Lake Charles Olefins and Calvert City Olefins may enhance capacity, which may enhance future net sales. The cash distribution policy is quite appealing even if we take into account the limitations derived from the agreements with Westlake Corporation. In sum, even taking into account the risks, I believe that Westlake Chemical Partners appears undervalued.
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Westlake Chemical Partners LP representing limited partner interests Company Name:
Jean-Marc Gilson, Experienced Chemicals Industry Executive, Appointed Director, President and CEO Albert Chao and James Chao to Remain Actively Engaged as Executive Chairman and Senior Chairman of the Board, Respectively Westlake Chemical Partners GP LLC, the general partner of ...
2024-07-05 14:30:00 ET Stock Traders Daily has produced this trading report using a proprietary method. This methodology seeks to optimize the entry and exit levels to maximize results and limit risk, and it is also applied to Index options, ETFs, and futures for our subscribers. This...
2024-05-15 04:16:00 ET Stock Traders Daily has produced this trading report using a proprietary method. This methodology seeks to optimize the entry and exit levels to maximize results and limit risk, and it is also applied to Index options, ETFs, and futures for our subscribers. This...
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