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 has been one of the more interesting stocks to watch in the Chemicals industry. From a pandemic-driven, bear market low in March 2020 that actually marked the bottom of a long-term, extended downward trend at around $28, the stock moved into a very extended long-term upward trend that saw the stock nearly quadruple in price, peaking in June at around $105. 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 has been the sustained rise in demand for housing, leading to outsized increases in real estate prices across the country. That means that stocks tied to housing have had a nice headwind to propel their businesses forward. Continued, accommodative Fed policy in regards to interest rates is only expected to keep fueling this trend, which is at least part of the reason that some analysts are expecting revenues in related industries, to remain healthy into 2022.
Favorable conditions in the housing market have applied both for new homes as well as existing homes, as existing homeowners will probably be more 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 company’s most recent earnings reports suggest that WLK weathered the storm better than most, with healthy liquidity and free cash flow to work with along with an increasing operating profile. Has the stock’s drop over the last month from its multiyear high translated to useful value, or has the long-term trend outpaced the company’s improving fundamentals?
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 $11.4 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by nearly 188% (not a typo), while revenues increased by 22%. In the last quarter, earnings improved by almost 115%, while sales were about 20% higher. The company’s margin profile narrowed in 2020, but is starting to show useful signs of improvement; in the last quarter, Net Income was 5.39% of Revenues for the last twelve months, and increased to 10.27% in the last quarter.
Free Cash Flow: WLK’s free cash flow is healthy and strengthening, at $999 million. This measurement has improved significantly over the past year, when Free Cash Flow was $676 million. Its current level translates to a Free Cash Flow Yield of 8.84%.
Debt to Equity: WLK’s debt/equity ratio is .52, 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 $1.4 billion while long-term debt was about $3.5 billion. 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 $1.08 per share, which translates to a dividend yield of about 1.22% 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 $101.50 per share. That suggests that WLK is undervalued by about 15% from its current price, and a very useful bargain price at around $81.
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 upward trend over the past year, from a low at around $50 its June high at around $106.50; it also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock has dropped back significantly from that high, and is approaching expected support around the 38.2% retracement line at $85. Immediate resistance is around $90 based on a pivot high in the last week that lines up with pivot activity in April and January. A push above $90 should have short-term upside to about $93.50, while a drop below $85 should find next support at around $80.
Near-term Keys: WLK’s fundamentals, which are showing useful signs of improvement, lend strength to the stock’s value proposition, which is interesting but not high enough to be compelling. If you’re willing to accept some volatility associated with the stock’s current bearish momentum, the stock could offer an interesting value opportunity right now, or even better at around $85. 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 $90, with a quick-hit, useful exit target at around $93.50. If the stock drops below $85, consider shorting the stock or buying put options, with $80 acting as a useful profit target on a bearish trade.