Is now a good time to buy WLK’s big discount?

 

Coming into the end of the third quarter of the year, most of the market talk has been about the terrible performance of the past six weeks. There’s a lot of doom and gloom out there right now  as the market is wrapping up a really ugly September.

How bad is it? After a hopeful rally that stalled in mid-August, sellers have taken over, pushing all of the major market indices right around their yearly lows as of this writing, and with lots of talking heads calling for more downside through the rest of the year. That sounds scary, and for a lot of average, retails investors like you and me that usually translates to a “stay out of the market right now” kind of mindset. As I’ve studied different methods and developed the value-oriented system I lean on now, I’ve learned that even these grim-looking conditions can often spell opportunity if you’re careful, selective, and conservative.

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 major run up in price, and a plunge far past its own bear market levels. From a starting point at around $99 in January, the stock peaked above $141 in early May before capitulating to broad market sentiment. Early this week, the stock found a new 52-week low at around $81, but looks like it could be trying to consolidate in that price area.

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, but as 2022 dawned, rising inflation has prompted sharp increases in interest rates that finally appear to be starting to blunt economic growth, with more rate increases predicted for the rest of the year. 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 yet. 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 long-term downward trend and new 52-week low mean that there is 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 $11.1 billion.

Earnings and Sales Growth: Over the last twelve months, earnings increased by more than 63%, while revenues increased by almost 57%. In the last quarter, earnings improved by more than 13.2%, while sales were about 10.5% higher. The company’s operating profile is strong at a time when a lot of its industry brethren are reporting significant slowdowns; Net Income was 26.42% of Revenues for the last twelve months, and tapered just a bit, to 24.63% in the last quarter.

Free Cash Flow: WLK’s free cash flow is healthy and strengthening, at $2.24 billion. This measurement has improved significantly over the past year, when Free Cash Flow was $1.5 billion. Its current level translates to a Free Cash Flow Yield of 20.5%. 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 .49, 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 $1.3 billion while long-term debt was about $4.85 billion. The company’s liquidity has dropped over the last year, from $3.5 billion; but the company also announced two, $1 billion+ acquisitions in late 2021, and closed both of them by February of this year. 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 $1.19 per share, which translates to a dividend yield of about 1.67% 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. 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 $128.50 per share. That suggests that WLK is undervalued by about 51% from its current price. I would also like to note that about a year ago, this same metric yielded a long-term target price at around $110 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 this week at around $81; it also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock does appear to be stabilizing a little above $81, putting current support at that mark, with immediate resistance at around $90 based on pivot activity seen in December of last year and in January of this year. A push above $90 should find next resistance at around $95, while a drop below $81 should find next support at around $72, using the current distance between support and resistance as a benchmark.

Near-term Keys: WLK’s fundamentals, which continue to show signs of increasing strength, 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, and the possibility that the current bearish trend isn’t done, the stock could offer an interesting value opportunity right now. If you prefer to work with short-term trading strategies, you could use the stock’s current bounce off of support as a signal to consider buying the stock or working with call options, using $90 as a practical, albeit aggressive, counter-trend profit target. A bearish trade has a higher likelihood of success, so you could also use a drop below $81 as a signal to think about shorting the stock or buying put options; in that case, use $72 as a useful area to take profits on a bearish trade.

 
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