Westlake Corporation (WLK, Financial) qualifies as one of the high-flying members of the GF Score club, with an attractive GF Score of 95 out of 100. It appears to be a quality company exhibiting strong profitability, growth and momentum, though its ranks for financial strength and valuation are average at best. Is the stock worth a look at the current price?
About Westlake
Based in Houston, Texas, Westlake is a chemicals company that produces materials used in a wide range of industries, including residential construction, flexible and rigid packaging, automotive products, health care products, water treatment and coatings. For example, its residential construction business manufactures and markets PVC pipes and fittings.
According to its 10-K for 2021, it is vertically integrated and operates internationally. In the fourth quarter of last year, it reorganized its two segments. One is Performance and Essential Materials, while the other is Housing and Infrastructure Products. The two segments have 13 operating subsidiaries.
Since its inception in 1986, Westlake has grown organically and through acquisitions. As it noted, “We regularly consider acquisitions and other internal and external growth opportunities that would be consistent with, or complementary to, our overall business strategy.” It is now a $7.38 billion company.
Competition
The company describes its housing and infrastructure markets as highly competitive, with industry players competing on product quality, product innovation, customer service, product consistency, delivery and price.
Publicly-traded competitors include Cornerstone Building Brands Inc. (CNR, Financial) and Trex Company Inc. (TREX, Financial). Other competitor names include Associated Materials LLC., CertainTeed Corporation, Diamond Plastics Corporation, IPEX Inc. and JM Eagle Inc.
The company believes it has a competitive advantage in its patents, licenses, trademarks and trade secrets.
Performance
Westlake has done well in its stock price performance over the past decade, but has not kept up with Trex - though it does not have the same volatility.
These are its average annualized returns:
- Year-to-date: 18.32%.
- One year: 29.85%.
- Three years: 14.87%.
- Five years: 11.32%.
- 10 years: 13.88%.
Total annual returns:
- 2022: 18.32%.
- 2021: 19.03%.
- 2020: 16.32%.
- 2019: 6.01%.
- 2018: -37.89%.
- 2017: 90.27%.
Westlake receives a very high GF Score for its overall performance at 95 out of 100, driven by high ranks for growth, momentum and profitability but hampered by middling ranks for financial strength and GF Value.
Financial strength
The GuruFocus system gives Westlake a middling score for financial strength, in part because of its growing debt:
That’s also reflected in the Piotroski F-Score and Altman Z-Score. Its return on invested capital is almost exactly double its weighted average cost of capital, 18.08% versus 9.01%. That’s a healthy sign and connected with its profitability.
Profitability
It has industry-leading margins that are also high compared to its results in the previous decade. Similarly, its return on equity and return on assets are well ahead of the pack in the chemicals industry.
Westlake also does comparatively well with revenue, Ebitda and earnings per share but does not dominate. Most importantly, note that both Ebitda and earnings per share are growing significantly faster than revenue, a fact that reflects well on management. This chart shows how these three line items have changed over the past decade:
Dividends and share buybacks
Looking at this chart of dividend payments over the past decade, you might think Westlake has a high dividend yield:
However, it’s a company that also has had a rapidly rising share price, and that’s made the dividend yield look anemic:
Turning to shares outstanding, the company has slowly but consistently lowered its share count:
Valuation
As a company with many customers in the housing industry, we can expect Westlake to behave cyclically, and it certainly does:
Looking at that chart alone, it’s tempting to think an investor ought to be bearish, and that the price is likely to head down again.
Other metrics, though, suggest it might be a value opportunity. Its price-earnings ratio, for example, is among the lowest in the chemicals industry and well below the 15 mark. The PEG ratio, which is the price-earnings ratio divided by the five-year Ebitda growth rate, is also low. At 0.48, it is well below the fair-value mark of 1.0.
Even the discounted cash flow calculator finds a large margin of safety given the below assumptions:
What are we to make of this discrepancy? In the short term, I think housing starts will decline, along with the broader economy, because of rising interest rates and inflation generally. That, in turn, would mean a slowdown and lower margins for Westlake. The company also noted in its 10-K, “Our historical operating results reflect the cyclical and volatile nature of the petrochemical industry.”
But over the next three to five years, I believe that it will prove to be undervalued, as the valuation ratios suggest.
Gurus
The leading investors of our time have done more buying than selling of Westlake shares over the past four quarters:
Nine gurus held positions in Westlake at the end of 2021, and the three biggest holders were:
- Jim Simons (Trades, Portfolio) of Renaissance Technologies, who increased his firm’s stake by 63.06% to 181,000 shares. That represented 0.14% of Westlake’s float and 0.02% of the firm's 13F assets.
- Charles Brandes (Trades, Portfolio) of Brandes Investments owned 138,795 shares, an increase of 2.7% over the preceding quarter.
- Michael Price (Trades, Portfolio) of MFP Investors had 77,000 shares, unchanged over the preceding quarter.
Conclusion
Westlake, as a company in a cyclical industry, offers lots of potential but certainly no guarantees about the direction of its share price. Investors should weigh its price-earnings and PEG ratios against the current economic conditions. Housing starts and the economy in general will determine its short-term value.
Beyond valuation, it has generally strong fundamentals. Its margins and returns are industry-leading, it pays a modest dividend and is growing its earnings per share more quickly than its revenue. The amount of debt may concern some investors, but it has grown its earnings per share more than four-fold since it took on the heavier load.
That debt, and the uncertain valuation, will turn away value investors, despite the high margin of safety. Likewise, income investors will want to look elsewhere, given how the yield has fallen as the price rose. However, growth investors willing to look five to 10 years ahead may see opportunity in Westlake.
