WESTLAKE CHEMICAL PRTNRS LP WLKP
October 19, 2020 - 10:00am EST by
otto695
2020 2021
Price: 18.91 EPS 0 0
Shares Out. (in M): 35 P/E 0 0
Market Cap (in $M): 663 P/FCF 0 0
Net Debt (in $M): 375 EBIT 0 0
TEV ($): 1,038 TEV/EBIT 0 0

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Description

Description:

WLKP is an MLP that is differentiated from most other MLPs.  First, it is a non-energy MLP with approximately 3.7 billion pounds of annual ethylene production.  Ethylene is used in a wide variety of products including plastics, textiles, vinyls and rubber. [The partnership was set up by its parent and primary customer, Westlake Chemical (WLK)].  Second, unlike many if not most MLPs, WLKP has a very stable distributable cash flow profile due to its take-or pay contract with WLK whereby the parent takes 95% of WLKP's annual budgeted production at a fixed 10 cent per pound margin net to WLKP.  The margin is above operating costs and also above any maintenance capex and capex needed for turnarounds.  The other 5% of volumes are sold to third parties at prevailing margins, which have averaged above 10 cents historically.  Here's a look at historical margins:

 

 

The contract with the parent runs through July of 2026. Though it is likely several years out, we anticipate that the contract will either be renewed on the same terms net to WLKP or (we believe, more likely) there is a chance of a renegotiation in favor of WLKP given that the long-term industry margins are above ten cents and given that Management at WLKP has been touting this possibility for some time now and likely wouldn’t be suggesting this if they didn’t get tacit agreement from WLK about this possibility (there is significant cross-pollination between the management & ownership of WLK & WLKP). 

Lastly, WLKP also differs from most other MLPS in having a much better debt profile, with approximately a net debt/ebitda of 0.80x versus many MLPs with 3-4x or more. [Note also the debt is held by the parent, reducing credit risk further].

In short, non-energy/commodity-linked, very stable take-or pay contract, better balance sheet.

 

Current setup:

 

So, why now?  The units were trading at about $23 just before the pandemic and at about $21 just before the two recent hurricanes which came through the St. Charles area.  But, the units are now below $19 despite:

  •    Yield at/near all-time absolute and relative high (other than brief period at the depths of the Covid sell-off in March/April). 
  •    No/negligible impact on distributable cash flow from the pandemic.
  •          No/negligible impact on distributable cash flow from hurricanes Laura and Delta - even despite Laura causing a “force majeure” at its       most important facility in St. Charles, Louisiana.
  •          Interest rates having come down significantly relative to pre-pandemic levels and pre-pandemic forward expectations.
  •          We are likely to see a relative improvement in the tax advantage of MLPs versus corporations once Biden raises the corporate tax rate.
  •          WLK, the parent, stock is now back to its pre-pandemic trading levels.
  •          The units now trading at a distribution yield some 600 basis points higher than investment grade debt from issuers such as WLK.

 

So, while we are not suggesting this is a “homerun” idea that will double or more, we find the current WLKP setup here attractive.   We expect the units to trade back up to the $21-$23 for at least a 10%+ return from here on the units plus the 10% distribution over the next year, for a 20%+ total return, with potential for more over the intermediate-term.  Given the demonstration of the stability of cash flows through the first half this year, and, to come on the 3Q report, along with the Alerian MLP index near its all-time lows set during 1996-2000, we think downside is very limited, other than perhaps a temporary decline during some future black swan event.

 

Initial Catalysts:

 

  • We expect a confluence of several immediate catalysts for the units to come into focus in early November:  1) WLKPs 3Q financial report during the first week of November, will prove to the market that there was no/negligible impact from the two hurricanes, and that WLK has continued its ethylene purchases from WLKP, despite not needing full volumes itself because of its own shutdowns during the hurricanes, 2) the end of the hurricane season (approx. 11/15), taking any lingering perception of storm risk off the table, at least for now and 3) a (likely) Biden victory and the almost guaranteed higher corporate tax rate that will come with it, making the tax advantages of MLP structures (relatively) more attractive.

 

Other Catalysts:

Beyond the 3Q financial report, end of hurricane season, and Biden victory

  • Investor conferences: RBC 11/18 & Wells Fargo 12/8
  • Asset dropdowns.  In particular, we would expect the Lotte JV to get dropped down to WLKP once the units recover.  This dropdown would add ethylene capacity net to wlkp of 1.1 billion pounds on a base of 3.7 billion.  So, a 30% increase.  WLKP will not do this unless it is accretive and provides a pathway for distribution growth, as previous dropdowns have done.
  • Covid pandemic waning with vaccine/treatments & Industrial end-markets normalizing.  This should benefit margins for the 5% of volumes the company sells to 3rd parties and be positive for overall sentiment.
  • Recovery in MLP space as more MLPs eliminate/restructure IDRs/simplify their corp. structures and/or as energy prices recover.
  • Extension of low interest rate environment.

 

Aside from the headline attractiveness of the 10% yield for a very stable business which has now demonstrated almost no volatility in distibutable cash flow from pandemics and head-on hurricanes, also note that WLKP traded in a range of about 250 bps to 550 bps wide of treasuries for the 3+ years pre-pandemic.  Now, despite 6+ years of demonstrated stability of cash flows since IPO, including despite pandemics and hurricanes in 2020, and the no-cost, significant IDR re-set completed in 2018, the units are trading approximately 900 basis points wide of treasuries.  Could it trade even wider to treasuries?  We dont want to say it’s impossible - if, for example, the Alerian MLP index were to track even lower.  But the Alerian index is now within 10% of its all-time lows that were seen during the 1996-2000 period, at a time when interest rates were about 500 basis points higher than where they are now, so we see the risk-reward as skewed very heavily in our favor.

 

Risks:

·        Despite being differentiated in multiple ways from other MLPs, could remain disconnected/disconnect even further from underlying         value simply because the energy-dominated MLP group does. 

·        Interest rates move up higher and/or faster than expected.

·       Sustained drop in ethylene prices.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

3q eps report- realization of stability of of cash flows at WLKP in face of pandemic/huirricanes is a real differentiator

investor conferences

asset dropdowns/other growth levers

continued low interest rates

recovery in MLP space as more and more MLPs restructure or elimnate IDRs

recovery in energy commodities (even though WLKP not directly impacted)

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