The market’s increasing volatility over the past week has forced a lot of stocks off of near-term highs, with speculation increasing about whether the market could be increasing in risk.
Market drawdowns are scary for most investors, but for value-focused investors and contrarians, they’re new opportunities to mine the market for useful value. In my search for value, I’ve found it helpful 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 nice, 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 company 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 2022 peak at around $141 to a low in September at around $81. From that point, the stock rallied to a high in February of this year at around $125, only to fall back with the rest of the market to start this month. In the last week, it appears to have found a new, lower consolidation range at around $104 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 even some declines in home prices from their earlier highs.
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. They also complicate another important aspect of the housing market for a company like WLK, which applies to existing homeowners investing 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 those 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, followed by the latest market-driven decline mean that there could be a new, 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 $13.5 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by almost -64%, while revenues were almost -6% lower. In the last quarter, earnings a little more than 42% lower, while sales slipped -16.6% lower. The company’s operating profile is healthy, but also reflects the reality of the current inflationary environment; Net Income was 14.23% of Revenues for the last twelve months, and dropped to 7.03% in the last quarter.
Free Cash Flow: WLK’s free cash flow is healthy, at $2.29 billion. This measurement has improved over the past year, when Free Cash Flow was $2 billion. Its current level translates to a Free Cash Flow Yield of 17.15%. 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 a little over $2.2 billion in the last quarter while long-term debt was about $4.9 billion. The company’s liquidity has improved over the last year, from a little over $1 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 $1.43 per share, which translates to a dividend yield of about 1.37% 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 stable, 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 at around $135 per share. That suggests that WLK is undervalued by about 30% 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 a May 2022 peak at around $141 to its low, reached in October of last year at around $81; it also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. After staging a new upward trend that peaked at around $125 in February, the stock dropped sharply from the start of March to a low last week at around $104, where the 38.2% retracement line sits, to mark current support at that level. Immediate resistance is at around $109, based on pivot high activity in that price area in December of last year. A push above $109 should see short-term upside to about $113.50, while a drop below $104 could see the stock fall to about $99.50 before finding secondary support.
Near-term Keys: WLK’s fundamentals, which continue to show signs of strength despite some drawdowns in operating margins that have now extended over the last two quarters, 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 bounce off of support at around $104 to consider buying the stock or working with call options, using $109 as a somewhat speculative profit target, and $113 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 $99.50 as a useful area to take profits on a bearish trade.