2023-03-28 12:10:24 ET
Summary
- The Materials sector has struggled lately despite a downtick in the dollar.
- Westlake Chemical sports ample free cash flow expectations in the quarters ahead despite a big Q1 earnings drop in the cards.
- With the stock breaking down on the chart, I point out key price points to monitor.
The US dollar is down notably from its 2023 highs notched earlier this month. Normally, the giveback in the greenback is a good thing for Materials sector equities, but that has not been the case in March. The relative chart below illustrates that the XLB Materials SPDR Fund has struggled mightily against the S&P 500 ETF. The cause? Recession worries and fears of a global growth slowdown have hit cyclical niches hard – Materials being one of those sectors.
I am downgrading Westlake (WLK) to a hold based on weaker technicals, but I still like the valuation case.
Dollar Down, Materials Fail to Rally
According to Bank of America Global Research, Westlake is a petrochemicals producer with revenue of over $11.5bn in 2021 in two businesses: olefins and vinyls. The olefins business produces ethylene, polyethylene, and coproducts. The vinyls business produces PVC and sells caustic soda.
The Houston-based $14.1 billion market cap Chemicals industry company within the Materials sector trades at a low 6.4 trailing 12-month GAAP price-to-earnings ratio and pays a modest 1.3% dividend yield, according to The Wall Street Journal. Back in February, the company reported misses on both the top and bottom lines. Shortly after, RBC downgraded the stock due to a weak outlook for the demand for plastics in housing and construction.
On valuation , analysts at BofA see earnings falling hard this year following 2022’s very strong first-half performances of so many commodities and a tight global supply chain. Next year’s per-share profits are seen as normalizing with more growth in 2025. The Bloomberg consensus forecast is more upbeat than BofA this year, but I am inclined to believe BofA’s EPS outlook given the recent downtick in Q2 and Q3 growth expectations around the world. But the downtick in interest rates recently should help the valuation and BofA thinks 1Q23 could be the trough in the PVC market. So, there are mixed signals.
Dividends, meanwhile, are seen as rising steadily while the yield stays low. WLK trades at a modest forward earnings multiple of 11.0 at last check using operating EPS estimates. With an EV/EBITDA multiple sharply below the market’s average and a double-digit free cash flow yield using 2024 numbers, shares are still a buy on long-term valuation in my view. Consider that the forward non-GAAP P/E is at a 29% discount to WLK’s 5-year average, about the same discount as its look-ahead price-to-sales multiple. If we use $10 of normalized earnings with a 14 multiple, that’s a $140 stock.
Westlake: Earnings, Valuation, Free Cash Flow Forecasts
Looking ahead, WLK is slated to report Q1 2023 earnings on Tuesday, May 2 before the open. The calendar is light on volatility catalysts aside from the reporting date.
Corporate Event Risk Calendar
The Options Angle
Digging into the upcoming earnings report, data from Option Research & Technology Services (ORATS) show a consensus EPS forecast of $2.17 which would be a sharp 63% YoY decline, but Q1 and Q2 of last year were an unusually bullish time in the Chemicals space. Unfortunately for the bulls, though, the stock has traded lower in each of the previous three earnings reports with a pair of EPS misses.
This go-around, the options market has priced in a somewhat small 5.4% earnings-related stock price swing when analyzing the at-the-money straddle expiring soonest after the reporting date. Shares rarely move more than 5% up or down post-earnings, so I’m not a buy of that premium here. With some bearish near-term technicals, selling calls could be a play. Let’s outline some price levels to watch.
WLK: A Sharpy YoY EPS Drop Expected
The Technical Take
I went with a shorter-term view of WLK in this refresh. Notice in the chart below that shares appear to have broken down below a symmetrical triangle consolidation pattern. That is a bearish sign, so selling calls at the $115 strike in advance of earnings could be a play.
I see support near $103 at the March low and where the falling 200-day moving average comes into play. There’s also high volume by price in the $85 to $105 range that should offer cushion on a further fall. That would be an ideal range to scoop up shares on the cheap and at favorable risk/reward levels on the chart.
WLK: Breakdown Below A Consolidation Pattern
The Bottom Line
I continue to like WLK’s valuation and earnings growth outlook, but the technicals warrant near-term caution.
For further details see:
Westlake: Strong Forward Free Cash Flow Yield, But Shares Have Moved Below Support