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.
One of the drawbacks, however is that familiarity can also make it easier to gloss over troubling information. The burden on any investor, no matter what your approach may be, is to make your investing decisions as objective and systematic as possible. If you’ve been following a company for a while, it’s natural to start forming an emotional connection with it, or with the management team in one form or another. I think it’s part of the reason that we gravitate to the same brands and products in our personal lives; after a while, the familiarity of that product makes it easier to stick with it. As an investor, I think that can be a risk, because just as the economy ebbs and flows from prosperity to austerity, all companies experience their own ebb and flow in their business models. That also means that as an investor, there are times where even the companies you like the best won’t represent smart investing opportunities.
Westlake Chemical Corporation (WLK) is an example of a stock I’ve followed for a while and have used for some very productive investing opportunities, and that I like quite a bit. Technically speaking, the stock looks like it could be setting up a an interesting, new upward trend at the end of a very extended downward trend – and that is something that automatically piques my interest, as both a contrarian and a value-oriented investor. Running through the stock’s fundamentals, and taking the temperature of current economic conditions suggests that this might not be a great stock to use right now. WLK’s niche in the Chemicals industry is driven primarily by the housing market. Recent reports suggest that new home purchases are down all over the United States, which isn’t too surprising when you factor in that, as of the latest unemployment report, more than 30 million people are out of work right now.
Unemployment also means that, even with increased unemployment benefits provided by the federal government, people are going to be tightening their belts. Existing homeowners may still be able to pay their mortgage; but they aren’t going to as likely to invest in 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 long-term impact of COVID-19 remains to be seen, even as efforts are underway to gradually get the economy going again, which I think means that bearish pressure could continue for this company, possibly into 2021. Combine that with some troubling patterns on the fundamental side from the company’s latest earnings report, and I think this is a situation where a long-term investor will set the stock aside for now, and check back again down the road after a couple of quarters have passed to see if things are better. Let’s dive in to the numbers so you can decide for yourself.
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 $5.6 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined sharply, by almost -64%, while revenues dropped by -5.61%. In the last quarter, earnings dropped -70%, while sales slid -8.8% lower. The company’s margin profile is narrow, and is showing signs of deterioration that match its negative earnings pattern; Net Income was 5.19% of Revenues for the last twelve months, but dropped to 3.82% in the last quarter.
Free Cash Flow: WLK’s free cash flow is generally healthy, at $514 million. This measurement is also showing signs of erosion, since it was a little over $1 billion in the third quarter of 2018. Its current level translates to a Free Cash Flow Yield of 8.9%.
Debt to Equity: WLK’s debt/equity ratio is .59, 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 about $728 million while long-term debt was about $3.45 billion. While WLK’s operating profile indicates they should have no problem servicing their debt, their deteriorating free cash flow and net income suggest that a continuation of this pattern could create a more challenging situation.
Dividend: WLK pays an annual dividend of $1.05 per share, which translates to a dividend yield of about 2.25% at the stock’s current price.
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 $69 per share. That means that WLK is significantly undervalued, offering about 53% upside from its current price.
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 from May of 2018 to its recent low around $29 last month; it also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. From that March low, the stock has rebounded nicely and is currently approaching resistance at around $46. A push above that level could give the stock to rally to somewhere between $51 and $57, based on previous pivot lows between April and October of 2019. Current support is around $41, with room to fall to about $35 if that level is broken.
Near-term Keys: WLK’s fundamentals, combined with broad economic pressures that I think will continue to weigh on the company, mean that I don’t think the stock’s value proposition, as attractive as it may be at first blush, is worth taking seriously right now. I would prefer to see reversal in the company’s earnings, net income and free cash flow patterns first. If you’re looking for a short-term trade, I think there could be a good signal to think about buying the stock or working with call options if the stock can push above $46, with some nice short-term room to look at $51 as a useful exit target. If the stock drops below $41, consider shorting the stock or buying put options, with $35 acting as the profit exit point on a bearish trade.