2023-12-18 09:46:30 ET
Summary
- Westlake Corporation has experienced strong growth in sales and margin, driven by increased demand in residential reconstruction, remodeling, and packaging products.
- The company has strategically acquired other companies to improve operations and achieve economies of scale, diversifying its portfolio and insulating itself from downturns in specific product segments.
- However, recent macroeconomic conditions, including softening in the housing market, have led to a decline in sales for Westlake.
Growth at Westlake Corporation ( WLK ) has continued to outpace its industry peers. Over the past few years, Westlake has considerably grown its sales and margin. Increased needs in residential reconstruction, remodeling, and demand for packaging products drove higher sales during the years 2021 and 2022. Westlake Corporation has also continued to strategically acquire companies to improve its operations and achieve further economies of scale. The diversified portfolio achieved through these acquisitions also helps insulate the company from downturns within a particular product segment. Despite the achievement of Westlake, the company has recently begun to see some sales decline due to macroeconomic conditions.
Recent softening in economic conditions, especially within the housing market, has impacted Westlake's top line. Higher interest rates and inflation continue to dampen global industrial activity with no end in sight. The Federal Reserve recently highlighted a potential reduction in interest rates in spring but there is no guarantee the rates will be adjusted down. Long term, rates are expected to come down and Westlake should begin to see some returning demand especially in remodeling and house construction as customers begin to purchase homes again. Even with these headwinds, Westlake is still generating sales comparable to the previous two years.
When considering these current stories about Westlake Corporation, we need to determine which news topics will have a long-term and ongoing effect on the company and its share price. Westlake Corporation has been able to drive a strategic growth strategy through acquisitions and investment into its core business that drives improved operations as well as diversified revenue streams. Even with the continued excellence and diversified revenue streams, Westlake has not been immune to worsening economic conditions. Short term this will continue to impact sales but in the long run, Westlake should rebound with returning demand. Whether this potential growth is not already incorporated into Westlake's stock value will be determined throughout this article.
While current news stories, good or bad, can sway our opinion about investing in a company, it's good to analyze the fundamentals of the company and to see where it's been in the past and in which direction it's heading.
This article will focus on the long-term fundamentals of the company, which tend to give us a better picture of the company as a viable investment. I also analyze the value of the company versus the price and help you determine if Westlake Corporation is currently trading at a bargain price. I provide various situations which help estimate the company's future returns. In closing, I will tell you my personal opinion about whether I'm interested in taking a position in this company and why.
Snapshot of the Company
A fast way for me to get an overall understanding of the condition of the business is to use the BTMA Stock Analyzer's company rating score. Westlake Corporation shows a rating score of 73.6 out of 100. In summary, Westlake seems to have decent fundamentals.
Before jumping to conclusions, we'll have to look closer into individual categories to see what's going on.
Fundamentals
The overall trend of Westlake's stock price has been increasing over the past ten years with some dips from economic downturns. Since the pandemic, the share price has increasingly grown due to low interest rates and improved economic activity, especially in remodeling, housing construction, and global industrial activity. The strategic acquisitions also have been implemented well and driven improved operations and sales for Westlake. The current economic softening will impact Westlake's sales and should also begin to shift this trend line into a decline. Overall, the share price average has grown by about 80.6% over the past 10 years, or a Compound Annual Growth Rate of 6.8%.
Earnings
Earnings per share have recently skyrocketed since the pandemic. This is driven by the large increase in demand compared to previous years. The previous high seen in 2017 was mainly due to the tax cut, increased prices improving margins, and strong demand for Westlake. The downward trends on the graph generally coincide with economic downturns and reduced demand. The current economic softening will impact the EPS over the short term. I expect the company to remain higher than in previous years due to its strategic accomplishments and operational excellence.
Since earnings and price per share don't always give the whole picture, it's good to look at other factors like gross margins, return on equity, and return on invested capital.
Return on Equity
The return on equity shows a surge after the pandemic with a recent downward trend from declining demand. Westlake also has continually bought back shares reducing overall shares by 5 million, which would contribute to a higher Return on Equity. If Westlake's rise in ROE was only driven by stock buybacks, I would be concerned but the company has shown strong net income growth also. For return on equity ((ROE)), I look for a 5-year average of 16% or more. So, Westlake Corporation meets this requirement.
Let's compare the ROE of this company to its industry . The average ROE of 38 chemical basic companies is 34.78%.
Therefore, Westlake Corporation's 5-year average of 17.092% is below its peers.
Return on Invested Capital
The return on invested capital shows an increase in the years following the pandemic. Even with the company increasing capital expenditure in the previous 2 years the return Westlake received is better than in the previous 5 years. Most of the reduction in 2022 is driven by declining consumer demand from weakening economic conditions and not a reduction in how efficient Westlake is at generating returns from its investments. For return on invested capital ((ROIC)), I also look for a 5-year average of 16% or more. So, Westlake Corporation falls short.
Gross Margin Percent
The gross margin percentage ((GMP)) has improved since the pandemic aside from the recent downward trend. The declining gross margin is driven by price competition eating away profits for Westlake. The company continues to invest in improving operations to grow gross margins but will need to counter competitive price pressure to retain its competitive advantage. I typically look for companies with gross margin percent consistently above 30%. So, Westlake Corporation is well below mainly due to its previous years of smaller margins compared to recent trends. Whether the company will return back to previous levels remains to be seen.
Financial Stability
Looking at other fundamentals involving the balance sheet, we can see that the debt-to-equity is less than 1. Therefore, Westlake is not over-leveraged.
In addition, Westlake Corporation's Current Ratio of 2.6 indicates it can pay off short-term debt with its current assets.
Ideally, we'd want to see a Current Ratio of more than 1, so Westlake Corporation exceeds this amount.
Westlake Corporation maintains a healthy balance sheet currently. The company could take on additional debt if needed to finance any additional acquisitions or investments. Westlake has used an acquisition and investment strategy over the previous years. The company is able to continue utilizing these strategies and should maintain its competency based on historical success.
Additionally, Westlake Corporation pays a regular dividend.
This analysis wouldn't be complete without considering the value of the company vs. share price.
Value Vs. Price
The company's Price-Earnings Ratio of 6.68 indicates that Westlake Corporation is undervalued when comparing Westlake Corporation's Ratio to a long-term market average PE Ratio of 15.
The 10-year and 5-year average PE Ratio of WLK has typically been 15 and 22, respectively. This indicates that WLK could be currently trading at a low price when comparing to its average historical PE Ratio range.
The Estimated Value of the Stock is $134.40, versus the current stock price of $140.1. This indicates that Westlake Corporation is currently selling above its value.
For more detailed valuation purposes, I will be using a diluted EPS TTM of 9.36. I've used various past averages of growth rates and PE Ratios to calculate different scenarios of valuation ranges from low to average values. The valuations compare growth rates of EPS, Book Value, and Total Equity.
In the table below, you can see the different scenarios, and in the chart, you will see vertical valuation lines that correspond to the table valuation ranges. The dots on the lines represent the current stock price. If the dot is towards the bottom of the valuation range, this would indicate that the stock is undervalued. If the dot is near the top of the valuation line, this would show an overvalued stock.
This analysis shows an average valuation of around $107 per share versus its current price of about $140, this would indicate that Westlake Corp is overpriced.
Summarizing the Fundamentals
The recent surge in price per share, EPS, ROE, and return on invested capital was driven by low interest rates driving increased global industrial activity after the pandemic. This saw the company reach new highs across the board fueling Westlake's strategic acquisitions and investments. The gross margin has also improved considerably due to improved operations and increased prices before the recent price pressure. Aside from these main metrics, the company has a healthy balance sheet and can leverage additional financing if needed for additional strategic growth objectives to continue to hold off competitors within its industry. Overall, these metrics show great growth over the previous two years as we have also seen an increase in the stock price. From the current economic landscape and the analysts' forecasts, a correction is expected and a reduction in the stock price.
Westlake Corporation Vs. The S&P 500
Now, let's see how Westlake Corporation compares versus the US stock market benchmark S&P 500 over the past 10 years. From the chart below, we can see that Westlake is consistently below the overall market in terms of returns except for some outliers. Due to Westlake's dependency on macroeconomic trends, I do not see it diverging too much from the overall market trends. Overall, it seems that most of the time an investor would be better off investing in the S&P 500, unless Westlake was selling for a ridiculously discounted price.
Forward-Looking Conclusion
Over the next five years, the analysts that follow this company are expecting it to reduce earnings at an average annual rate of -9.3% .
In addition, the average one-year price target for this stock is $136.35 , which is about a 2.67% decrease in a year.
The Expected Annual Compounding Rate of Return is 7.03%.
Does Westlake Corporation Pass My Checklist?
- Company Rating 70+ out of 100? Yes (73.63)
- Share Price Compound Annual Growth Rate > 12%? No (6.8%)
- Earnings history mostly increasing? No
- ROE (5-year average 16% or greater)? Yes (17.09%)
- ROIC (5-year average 16% or greater)? No (11.54%)
- Gross Margin % (5-year average > 30%)? No (21.5%)
- Debt-to-Equity (less than 1)? Yes
- Current Ratio (greater than 1)? Yes
- Outperformed S&P 500 during most of the past 10 years? No
- Do I think this company will continue to successfully sell their same main product/service for the next 10 years? Yes
Westlake Corporation scored 5/10 or 50%. Therefore, I would be hesitant to add this company to my portfolio.
Is Westlake Corporation currently selling at a bargain price?
- Price Earnings less than 16? Yes (6.68)
- Estimated Value greater than the Current Stock Price? No (Value $134.4 < $140 Stock Price and Detailed Analysis value of $107 < $140 Stock Price.)
Westlake Corporation has seen unprecedented growth driven by low interest rates driving increasing global industrial activity. Demand has skyrocketed post-pandemic before beginning to retract in the current economic climate. As interest rates and inflation have reduced demand, the company has seen a withering revenue stream. Even with this decline the overall sales still exceed previous highs because of strategic acquisitions and investments to improve gross margin. These acquisitions have also increased the company's product line.
Even with these positives, there are many concerning signs. The company is volatile and directly correlated with economic factors. Westlake Corporation rarely outperforms the market and is less diversified than the market benchmark. Current price pressure and short-term high interest rates continue to paint a bleak picture in 2024. The company also fails to meet over 50% of the metrics we look for to determine that a stock is primed to drive long-term returns for investors. These factors give me major doubts about the long-term potential of the stock.
In the end, I would not look to enter a position in the company. I would rather just invest in the overall market than this stock as I do not expect it to outperform in the long term. Additionally, I believe its recent growth has been overly priced into the stock. For me, the choice is clear, I will pass on Westlake, because there are other available stocks to invest in that are stronger fundamentally and selling at a discount price.
For further details see:
Westlake Corp. And Its Real Value