Summary
- I believe that this “Left for dead” growth MLP should be rediscovered by institutional investors over the next 12 months, causing a substantial rerating of the unit price.
- Long-term “take or pay” contracts with investment grade sponsor lock in stable margins out to the year 2026, creating predictable cash flows and growth potential.
- Already huge inventory of drop-down assets was expanded by the sponsor’s recent acquisition of Axiall.
- Asset drop-downs will fuel distribution growth and improve liquidity in the units, which will trigger an upwards revaluation as institutions pile in.
- I see the stock rerating to a 4.2% distribution yield within 12 months, creating 50% total return upside.
I wanted to provide a quick note on one of the securities we hold in the Active Opportunity Strategy, Westlake Chemical Partners (NYSE:WLKP). I believe that at the current price, this security offers a compelling combination of capital appreciation potential, yield, and margin of safety.
Westlake Chemical Partners is an MLP formed in 2014 to operate ethylene facilities for Westlake Chemical (NYSE:WLK). The original story was clearcut. The MLP would provide stable and growing tax sheltered income to investors while providing Westlake Chemical with capital for growth initiatives. The security was considered a highly promising growth story and traded (just prior to the negative event to be described) at a 3.8% distribution yield.
Unfortunately for Westlake’s investors at the time (but fortunately for us) The IRS threw a wrench in the plan. In May of 2015, the IRS proposed new regulations that would disallow Ethylene processing as a source of qualifying income for MLP status. This contradicted a private letter ruling from the IRS that Westlake has previously received, and triggered a massive selloff in the stock.
Since this time, Westlake Chemical Partners has been listless – largely forgotten by the investment community. Low trading volume in the shares suggest that the security has been “left for dead,” which discourages institutional participation in the stock.
On January 19th 2017, the situation once again changed. The IRS issued a final ruling which upheld the previous private letter ruling – Ethylene production, transportation, storage and marketing does indeed constitute “qualifying income” for the purpose of obtaining MLP status. While the stock did move up on news of this ruling, I believe the upward revaluation in the stock is just getting started. Institutional investors are waiting to buy in on asset drop-downs, while individual investors have not yet woken up to the story.
I believe that over the next 12 months Westlake Chemical Partner’s stable margin profile and huge growth runway will be “re-introduced” to the market, which will trigger a substantial rerating in the security’s share price. Westlake Partners currently owns 13.3% of Westlake Chemical OpCo LP, while Westlake Chemical owns 86.7%. The Westlake Partner’s assets include Lake Charles Olefins, Calvert City Olefins, and Longview Pipeline:
Westlake Chemical Partners
95% of Westlake Partner’s sales agreements are sold under a long-term contract (2026) with Westlake chemical that are designed to provide stable margins.
Multiple levers for DCF growth
- Increase OpCo ownership – Westlake Partners can increase its ownership of the OpCo by “dropping down” assets into Westlake Partners, or by purchasing outstanding interests in the OpCo from Westlake Chemicals. This is a huge growth opportunity for Westlake Partners, as it currently only owns 13.3% of the OpCo’s assets
- Make Acquisitions – Purchase complementary assets from third parties
- Organic Growth opportunities – Enhance the profitability of OpCo’s existing assets by pursuing growth opportunities including capacity expansion projects. In the Q4 2016 call, management stated that capacity expansions at Petro 1 (Lake Charles) and planned expansions at Calvert City would be enough to fund 2017’s planned distribution growth
- Expand margins – Negotiate higher ethylene margins with Westlake Chemical, which essentially shifts cash flows to the tax advantaged MLP Westlake’s acquisition of Axiall further improved the growth story for Westlake Partners
As a consequence of the Axiall acquisition, Westlake now has a larger pool of1 assets that can be dropped into Westlake Partners. In addition (and as a result of the Axiall acquisition) Westlake Chemicals is now short 1.8-1.9 Bls/yr of Ethylene that cannot be fulfilled by its existing production capacity. Building assets to meet this capacity need will further increase the number of assets that can be dropped down into Westlake partners.
“…now that the IRS has removed the uncertainty regarding the status of our operations, we have the full complement of strategies available to us to continue our growth inearnings and cash flow at a low double-digit growth rate including organic expansions of our current units, future drop down transactions with OpCo, third party acquisitions, and negotiating a higher ethylene margin.”
-Mark Steven Bender, CFO – Q4 2016 conference call
Conservative balance sheet and distribution coverage philosophy
Net Debt / EBITDA is substantially below a peer group average. Since its IPO, Westlake partners has demonstrated double digit growth while maintaining target coverage of 1.1X.
Westlake Chemicals is committed to reigniting the Westlake partner’s growth engine
I noted the following slide in a recent (April 2017) Westlake Chemical presentation. Notice that Westlake Partners is fully integrated into Westlake Chemical’s strategy:
My 12 month target
I believe that 12 months from now, Westlake Partners will be trading at a distribution yield of around 4.2% – 50 basis points higher than its yield just prior to the unfavorable IRS ruling. This suggests a share price of around $36.5. Adding in the approximately $1.48 in distributions that will be received over the next 12 months creates a total value of $38, or 50%
upside from today’s price of $25.2 per unit.
Disclosure: Mr. Stewart is Portfolio Manager of the Opus Active Opportunity Strategy. The Active Opportunity strategy is a “go anywhere” concentrated value strategy that focuses on under-followed and misunderstood securities. The objective of the strategy is to maximize investor returns while minimizing the risk of permanent capital impairment. Qualified Investors are invited to contact Opus Capital Management in order to learn more. Opus Capital Management reserves the right to make investment decisions regarding any security without further notification except where such notification is required by law.
Article by Opus Capital Management
