Westlake Chemical Partners: An 8% Dividend Yield In A Low-Risk MLP – Westlake Chemical Partners LP (NYSE:WLKP)

Last year, I covered the apparent strong value opportunity in the chemical company Westlake Chemical Corp. (WLK). Since the company generates a large portion of its revenue from PVC sales to the construction industry and housing starts are finally beginning to rise into full gear, Westlake’s revenue is likely to climb faster than the market currently expects. In my opinion, the buying opportunity in WLK is even better than it was last July.

That said, there is a related investment that is perhaps more attractive: the company’s LP Westlake Chemical Partners (WLKP). WLKP is tasked with operating, acquiring, and developing ethylene production facilities for sale to its GP, Westlake. The bulk of these production assets are owned by “OpCo”, which is co-owned by WLKP (23%) and WLK (77%) but managed by WLKP.

This is summarized in the two figures below

Ownership Structure:

(Source: 2019 WLKP Investor Presentation)

Operational Structure:

(Source: 2019 WLKP Investor Presentation)

The sales agreement between the two includes a stable 10 cents/ethylene lbs margin on 95% of production. The remaining 5% of WLKP’s production is sold to third parties. As long as ethylene remains above that level, the dividends will continue to come.

Speaking of which, WLKP’s dividends are quite high today and have been raised consistently since the LP IPO occurred. The LP’s price has barely budged, but the dividend increases have driven its yield to 8%, as you can see below:

ChartData by YCharts

From what I can tell, investors are valuing WLKP as if it has a similar risk profile as for typical oil & gas LP that are usually over-levered and struggling to make ends meet. On the contrary, WLKP is, if anything, underleveraged and increasingly profitable. Even more, unlike in most LP-GP relationships, its GP, WLK, actually works to benefit WLKP unitholders as seen by its significant IDR reset in 2018.

WLKP’s Exposure to Ethylene Prices

The primary risk to the company is a significant decline in ethylene prices, since it is the company’s sole product. Indeed, ethylene prices have been in the dumps since oil crashed in 2014 and have been a weight on WLKP. To demonstrate, take a look at how ethylene spot prices and WLKP’s price relate:

(Source: Price Data – Quandl/Yahoo Finance)

As you can see, the two are generally correlated, but ethylene prices have never crossed below the $0.10 threshold required for WLKP to generate steady returns. Their relationship can also be visualized as a scatter plot:

(Source: Price Data – Quandl/Yahoo Finance)

As you can see, there is a decent relationship between WLKP’s price and ethylene. The circle represents today’s price for each which is essentially on the trendline, signaling that WLKP is fairly priced given ethylene’s price.

A Look at WLKP’s Financial Situation

With an 8% yield that is covered by cash flow and likely production increases and continued growth, WLKP is very cheap and is priced as if it were a high-risk company. In truth, the primary risk to WLKP is capacity outages, as were experienced in 2016.

As you can see below, the LP’s cash flow is basically constant during normal times, but dipped slightly negative in 2016 due to an outage at its Calvert City facility:

ChartData by YCharts

Importantly, the company kept its dividend low initially in order to finance capital expenditures for production increases. In 2014, the LP produced about 1700 MM lbs of ethylene, which has since risen to 3600 MM lbs and has been flat since. Thus, it is generally unlikely that WLKP’s dividend will continue to increase at its previous rate. At least, not without declining interim to finance physical capital.

Importantly, WLKP also has very low leverage compared to most MLPs today, increasing its dividend stability.

ChartData by YCharts

As you can see, the company has enough annual EBIT for 16 years of interest payments and can pay off its entire debt with one year of EBITDA. This gives the LP essentially no material credit risk.

Now, there are quite a few LPs that offer a dividend yield greater than that of WLKP. However, most of those companies are highly leveraged and have unstable cash flows. Importantly, WLK also reset its IDR distribution tier to $1.29 from $0.31, which means that the LP can pursue more growth before WLK gets to claim some of the dividends. This is beneficial for both WLK and WLKP, since it encourages substantial growth, and that allows WLK – which has excess demand for ethylene over WLKP’s current capacity – more low-cost product.

Importantly, WLK built a 2.2B capacity facility with Lotte Chemical, which may be a drop-down acquisition opportunity for WLKP. Of course, this will likely come with dilutive equity sales, but if the deal occurs, it will likely eventually boost WLKP’s distributions.

Bottom Line

Overall, WLKP appears to be a solid, income-oriented value opportunity for investors. The MLP is far less volatile than its GP and is likely to offer a stable 8%+ dividend yield. Ethylene prices are depressed, but that depression allows WLKP to acquire facilities at lower prices.

In my opinion, given its shareholder-oriented management, stable income, and conservative balance sheet, the MLP ought to pay a dividend yield of 5%, which implies a 60% higher unit price of $35, which is around its IPO price.

WLKP has been undervalued for quite some time – perhaps since the crash in ethylene prices in 2015 right after it was launched. It is unclear if the price will return to fair value soon, but it is clear that the downside risk is relatively low and that it will likely continue to pay an above-market-rate 8% dividend yield, allowing long-term investors to accumulate units by reinvesting. Overall, I believe that WLKP is a solid “Buy” and makes for a great relatively low-risk opportunity.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in WLKP over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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