2023-12-19 09:28:47 ET
Summary
- The materials sector has performed well since late October, with Westlake Chemical Partners LP up over 13%.
- WLKP is a fixed-rate MLP with a long-term sales agreement and a modest valuation, though the current distribution yield spread over the 10-yr is near historical levels.
- Downside risks include rising interest rates, weak ethylene pricing, and unfavorable regulatory changes.
- I outline key price levels to watch ahead of earnings due out in February.
Markets have snapped back in an impressive way since late October. The closing low notched on October 27 was about on par with the normal seasonal cycle, and many beaten-down niches of the broad domestic stock market have performed the best. The Materials sector is about middle of the road, up more than 13% in that stretch as we head into the traditionally strong final two weeks on the yearly calendar.
I have a hold rating on Westlake Chemical Partners LP (WLKP). With limited distribution options but a unit price that is near fair value, I assert that waiting for future catalysts is the prudent play.
Materials Bounce Big Post October 27 Market Low
According to Bank of America Global Research, WLKP is a fixed-rate MLP that owns an interest in three ethylene production facilities with an annual capacity of 3.7 billion lbs and a 200-mile ethylene pipeline. Westlake Partners has a long-term sales agreement with Westlake Corp to sell 95% of planned ethylene production at a fixed margin of $0.10 per lb. Westlake intends to drop down additional ownership interest in the OpCo over time.
The $787 million market cap Texas-based Commodity Chemicals industry company within the Materials sector trades at a modest 14.1 forward price-to-earnings ratio and pays a 12-month forward distribution yield of 8.4% as of December 15, 2023. Ahead of earnings due out in February, units trade with an elevated implied volatility percentage of 40% while short interest on the stock is negligible.
Back in November, WLKP reported a soft quarter. Q3 GAAP EPS of $0.37 missed the Wall Street consensus estimate by $0.05 while $322 million of revenue was 23% lower than year-ago levels, a sizable $95 million shortfall compared to expectations. The second half of 2023 was expected to be weaker due to reduced merchant ethylene prices and higher interest expenses, although easing yields since October may brighten WLKP's outlook slightly. The firm's interest coverage rate remains near 1.0x.
WLKP: Yield Premium Over the 10yr Near Normal Today
Downside risks include rising interest rates, a deterioration in the firm's credit standing, operational issues, weak ethylene pricing and margins, and unfavorable regulatory changes.
On valuation , analysts at BofA see earnings falling by more than 12% this year while per-unit profits are then expected to rise by nearly 16% in 2024 with continued growth through 2025. The current consensus forecast is about on par with what BofA sees but is slightly more optimistic. Sales growth is expected to be volatile, ranging from $1.2 billion this year to $1.5 billion in the out years. Distributions , meanwhile, are forecast to hold at $1.89 per year.
Modest earnings-per-unit growth should result in a more favorable valuation while the partnership is highly free cash flow positive. Still, WLKP's parent, Westlake Chemical, is in an adequate financial position and likely won't need additional funding, per BofA, so higher distribution payouts are seen as unlikely in the near term. The outlook for distribution growth is further weakened by recent trends in ethylene margins, which have been closer to WLKP's fixed margin, making improvement challenging.
Westlake Chemical Partners: Earnings, Valuation, Dividend Forecasts
On valuation, WLKP has historically traded at a low 12.2 non-GAAP forward P/E. If we assume normalized earnings-per-unit of $1.90 and apply a 12 multiple, then units should be near $22.80, making the partnership near fair value. What's more, WLKP's distribution rate has historically averaged about 450 basis points, and that is near where the yield stands today.
WLKP: Neutral Using Historical Earnings Multiples
Looking ahead, corporate event data provided by Wall Street Horizon show an unconfirmed Q4 2023 earnings date of Tuesday, February 20. No other volatility catalysts are seen on the calendar.
Corporate Event Risk Calendar
The Technical Take
Earlier this year, I was neutral on WLKP. Notice in the chart below that units have indeed performed without much excitement. The total return from early February is about -6% while the S&P 500 is higher by 15% with dividends included. A trading range has persisted throughout much of the year. I see resistance at $23 while support is apparent just under $21. In my initial analysis, I noted possible selling pressure around $26, so that is another possible layer of trouble for the bulls even if WLKP begins to rally.
Also take a look at the volume by price indicator at the top of the graph - there is a high amount of units traded in the $21 to $24.50 zone - that will make it tough for both the bulls and bears to break this battleground range. With a slightly negatively sloped long-term 200-day moving average, it's hard to get excited about WLKP from a bullish standpoint right now, though the RSI momentum gauge at the top of that shows a decent emerging momentum trend.
Overall, WLKP's chart remains lackluster, and units have underperformed the broad market this year.
WLKP: Neutral Trading Range
The Bottom Line
I reiterate my hold rating on WLKP. I see the distribution rate as fair today given its spread to the 10-year Treasury yield and based on where the earnings valuation stands. Technicals, meanwhile, are lackluster.
For further details see:
Westlake Chemical Partners: Units Near Fair Value, Yield Premium Fair