The start of a new year, naturally is always a hopeful look ahead to better times. That’s coming after a bullish final quarter of 2022 that had some analysts talking about a new bull market starting this year.
In my search for value, I’ve found it useful to develop a watchlist of stocks that I can check on a regular basis. That means that I often recycle stocks that I’ve previously used to make useful investments in, but don’t currently have a position in. That’s useful, because the familiarity that comes with the company and its approach builds a shorthand that I think can help to make the analysis process more efficient. As changes happen over time, it also helps to provide a historical context that aids perspective about current events and changes.
Westlake Chemical Corporation (WLK) is an example of a stock I’ve followed for a while, have used for some very productive previous investing opportunities, and that I like quite a bit. Technically speaking, the stock has been one of the more interesting stocks to watch in the Chemicals industry. In the last year, the stock has experienced both a long downward trend, falling from a May peak at around $141 to a low in September at around $81. From that point, the stock rallied to a November high at around $113, and has established a consolidation range since then, with the stock current holding right around $108 per share.
WLK’s niche in the Chemicals industry is driven primarily by the housing market. One of the most interesting trends to come out of the pandemic was the sustained rise in demand for housing, leading to outsized increases in real estate prices across the country. That meant that stocks tied to housing had a nice headwind to propel their businesses forward through 2021. In 2022, rising inflation prompted sharp increases in interest rates that have been restricting economic growth, with more rate increases predicted in 2023. Not surprisingly, the housing market has seen drops in mortgage applications and new home sales, with many of the hottest housing markets during the pandemic starting to see their own declines in activity and plateaus in home values.
Rising interest rates make new and existing home purchases more difficult, on top of the acceleration in housing prices in 2020 and 2021 that saw the average home price rise above affordability levels for the average American family that still haven’t seen significant corrections. They also complicate another important aspect of the housing market for a company like WLK, which applies to existing homeowners investing home improvement projects. WLK is one of the biggest producers of PVC products, which are driven primarily by new home starts, but also by improvement projects in existing homes. The company’s most recent earnings reports suggest that WLK has weathered the pandemic storm, and current difficulties like rising input costs better than most. The company also boasts healthy liquidity and free cash flow to work with along with a strong, stable operating profile. Does the stock’s rally since September, and current price activity mean that there could still be a useful value-based opportunity? Let’s find out.
Fundamental and Value Profile
Westlake Chemical Corporation is a global manufacturer and marketer of basic chemicals, vinyls, polymers and building products. The Company’s products include a range of chemicals, which are fundamental to various consumer and industrial markets, including flexible and rigid packaging, automotive products, coatings, water treatment, refrigerants, residential and commercial construction, as well as other durable and non-durable goods. Its segments include Olefins and Vinyls. It manufactures ethylene (through Westlake Chemical OpCo LP (OpCo)), polyethylene, styrene and associated co-products at its manufacturing facility in Lake Charles and polyethylene at its Longview facility. The Company’s products in its Vinyls segment include polyvinyl chloride (PVC), vinyl chloride monomer (VCM), ethylene dichloride (EDC), chlor-alkali (chlorine and caustic soda) and chlorinated derivative products and, through OpCo, ethylene. It also manufactures and sells building products fabricated from PVC. WLK’s current market cap is $14 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by almost -34%, while revenues increased by almost 29.5%. In the last quarter, earnings were more than -53 lower%, while sales were about -11.76% lower. The company’s operating profile is healthy, but also reflects the reality of the current inflationary environment; Net Income was 16.62% of Revenues for the last twelve months, and dropped to 10.14% in the last quarter.
Free Cash Flow: WLK’s free cash flow is healthy, at $2.26 billion. This measurement has improved significantly over the past year, when Free Cash Flow was $1.7 billion. Its current level translates to a Free Cash Flow Yield of 16.25%. The strength in this metric is a solid counter to the Net Income picture I just described.
Debt to Equity: WLK’s debt/equity ratio is .47, which is conservative and implies the company takes a careful approach to debt management. WLK’s cash and liquid assets in the last quarter were almost $1.8 billion while long-term debt was about $4.8 billion. The company’s liquidity is somewhat lower over the last year, from $1.9 billion; but the company also announced two, $1 billion+ acquisitions in late 2021, and closed both of them by February of 2022. Their operating profile indicates they should have no problem servicing their debt, with healthy liquidity providing additional flexibility.
Dividend: WLK pays an annual dividend of $1.43 per share, which translates to a dividend yield of about 1.31% at the stock’s current price. While the dividend yield is conservative, it should be noted that management announced a 10% increase in its dividend payout in late 2021, from $1.08 per share, and again from $1.19 per share in the third quarter of 2022. I consider a consistent dividend to be a sign of fundamental strength; an increasing dividend is an even stronger assertion of management’s confidence in their operating and competitive strategies.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $143 per share. That suggests that WLK is undervalued by about 30.5% from its current price. I would also like to note that in mid-2022, this same metric yielded a long-term target price at around $128.50 per share.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line traces the stock’s downward trend since May, from a peak at around $141 to its low, reached in October at around $81; it also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock rallied strongly from that low, hitting a peak at around $113.50 in November that has since defined the top of the stock’s consolidation range as well as immediate support. Current support is at around $104 where the 38.2% retracement line sits. A push above $113.50 should see upside to between $118 and $122 before finding next resistance, while a drop below $104 could see the stock fall to about $99 to secondary resistance.
Near-term Keys: WLK’s fundamentals, which continue to show signs of strength despite some drawdowns in operating margins, lend credence to the stock’s value proposition, which is compelling and warrants a diligent eye. If you’re willing to accept the volatility associated with the stock’s general price action and current market conditions, the stock could offer an interesting value opportunity right now. If you prefer to work with short-term trading strategies, you could use a push above $113.50 to consider buying the stock or working with call options, using $118 as a practical profit target, and $122 if buying activity accelerates. You could also use a drop below $104 as a signal to think about shorting the stock or buying put options; in that case, use $99 as a useful area to take profits on a bearish trade.