Westlake Chemical Partners LP (NYSE:WLKP) - Buy Recommendation - $30.25 Price Target
Thesis: September 8 will conclude the 40-day quiet period on WLKP, formed by Westlake Chemical to acquire and operate ethylene production assets and facilities. WLKP's share prices could enjoy a temporary rise as a result of the publishing of the likely positive underwriter reports. Long-term, we like WLKP, for its potential to generate strong yields, given the steady flow of revenue from OpCo's fixed-margin sales to Westlake, along with strong management. Short-term, WLKP could see at least a 2% increase in share price in the days surrounding the quiet period expiration, according to recent and historical research.
September 8 will conclude the 40 day quiet period on underwriter analyses that began with the July 29 IPO of Westlake Chemical Partners LP.
The conclusion of the quiet period will allow the firm's IPO underwriters to publish research reports on the limited partnership formed by Westlake Chemical to acquire and operate ethylene production assets and facilities. WLKP's share prices will likely enjoy a temporary rise as a result of the publishing of the underwriter reports.
Early Market Performance
WLKP's IPO priced well beyond its expected price range of $19-$21 per share at $24 per share; the stock made a strong first-day return of 28.3%. WLKP has since cooled somewhat to close at $29.49 per share on August 20th.
WLKP's IPO underwriters, including Barclays Capital Inc.; UBS Investment Bank; BofA Merrill Lynch; Goldman, Sachs & Co.; Deutsche Bank Securities Inc.; J.P. Morgan Securities LLC; Wells Fargo Securities, LLC; and Morgan Stanley & Co. LLC, will seek to recapture the firm's excellent first-day performance through the publishing of positive analyses with the conclusion of the quiet period.
Underwriters, Quiet Period Expirations, and Buying Opportunities: Academic Studies
The Journal of Finance (VOL. LVIII, NO. 1; 2003) describes the process by which an increase in share prices will typically appear before the date of the quiet period expiration, as investors anticipate positive reports from the IPO underwriters and begin to buy up shares in advance in order to take advantage of the forthcoming analyses.
Lead author Dan Bradley, PhD, CFA, affiliated with the University of South Florida, and his colleagues state that analyst coverage is immediately initiated for 76% of firms on the conclusion of the quiet period, typically with a rating of 'Strong Buy' or 'Buy.' After coverage is initiated, firms enjoy abnormal positive returns of 4.1% for the two days prior to and the two days following the date of initiation. When more than one analyst initiates coverage, returns have been found to increase further-to 6.4%.
The work of Carter, Piwowar, and Strader (2001) supports Dr. Bradley's conclusions. Carter et al state that the mean analyst rating at the expiration of the quiet period is a "Buy," and that higher ratings correlate to higher returns. Lach and Highfield (2009) find that analyst initiations have been less positively biased since the Global Settlement and the NASD and NYSE rules. Nonetheless, Highfield, Lach and White (2008) find that the five-day cumulative adjusted returns remain statistically significant at approximately 2%.
Bradley et al also find a significant correlation between the quantity and visibility of IPO underwriters and rising share prices near the expiration of the quiet period.
Our own research, performed on a sample of 2014 IPOs, shows above-market returns of 2.3% within an 8 day (-5, +2) window (day 0 being expiration). Our data are statistically significant at the 90% level. Excluding IPOs for REITs and banks, returns increase further and remain within the 90% significance level. We also found that a greater number of underwriters could lead to reduced volatility of returns in the quiet period. We observed no significant linear relationship between market capitalization and returns or volatility of returns in the same period. We also observed no significant linear relationship between the percentage of the company floated at the time of IPO and returns or volatility of returns.
In all cases, investors' early share purchases often generate an atmosphere of rising demand, leading to an increase in share prices before the quiet period ends and creating a short-term buying opportunity
Overview of WLKP's Business
WLKP is a limited partnership formed by Westlake Chemical to acquire and operate ethylene production facilities and assets. The firm primarily conducts its operations through Westlake Chemical OpCo LP, which owns three ethylene production facilities as well as a 200-mile ethylene pipeline. Almost all of the ethylene produced at the facilities will be used by Westlake to make polyvinyl chloride (PVC) and polyethylene.
The OpCo is engaged in a 12-year agreement under which Westlake will buy 95% of OpCo's ethylene on a cost-plus basis at a fixed margin of $0.10 per pound. OpCo's three facilities have a total annual capacity of approximately 3.4 billion pounds. Per a separate agreement, Westlake provides all of the feedstocks required for the OpCo to produce ethylene, the most important of which is ethane.
WLKP owns OpCo's general partner and controls its assets and operations. WLKP also holds a 10% limited partner interest in OpCo; the rest of the limited partner interest is held by Westlake. Westlake also holds 55.7% of WLKP's limited partner units. WLKP's 10% interest in OpCo is its only revenue-generating assets.
See our previous article on WLKP for additional information.
Solid Outlook For Annual Yield
WLKP plans to make minimum quarterly distributions of $0.2750 per unit, or $1.10 per unit per year, assuming that it has sufficient cash available to do so. At WLKP's August 11 closing price of $29.51 per share, this would be equivalent to an annual yield of 3.73%.
Nearly No Competition
Since essentially all of OpCo's ethylene will be purchased by Westlake under the fixed-margin agreement, WLKP is more or less without competition for the time being.
Management Credentials (Academic, Industry)
Albert Chao serves as president and CEO of WLKP's general partner and as the sole director of OpCo's general partner. Mr. Chao has served as Westlake's CEO since July 2004 and as Westlake's president since May 1996; he also served as Westlake's executive vice president from its 1985 founding until he became the firm's president.
He has worked in various positions in the Technical Department of Hercules Incorporated, in the Controller's Group of Mobil Oil Corporation, and in the Plastics Group of Gulf Oil Corporation. He has also served as assistant to the chairman of China General Plastics Group and deputy managing director of a plastics fabrication business in Singapore.
Mr. Chao received a bachelor's degree from Brandeis University and an M.B.A. from Columbia University.
Conclusion: New Buying Opportunity For A Promising Firm
We like WLKP moving forward.
The firm's potential to generate strong yields remains enticing, especially given the steady flow of revenue that WLKP can expect from OpCo's fixed-margin sales to Westlake.
The firm's supply of feedstocks from Westlake also provides a measure of security to the firm.
WLKP is headed by strong and highly experienced leadership.
Though the fixed-margin agreement will prevent OpCo from taking advantage of potential increases in ethylene prices, the safety gained from the agreement in combination with the solid yields will likely continue to make the stock attractive to investors.
The upcoming quiet period expiration will likely make for an excellent buying opportunity.
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Disclosure: The author is long WLKP. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.