Bob Robotti on $WLK and the revenge of the old economy (Podcast #102)
Bob Robotti, founder of Robotti Advisors, discusses his thesis on Westlake (WLK) and why he thinks we’re seeing the beginning of the revenge of the old economy stocks. You can find my tweet thread on WLK here.
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Transcript begins below
Andrew Walker: Hello and welcome to Yet Another Value Podcast. I'm your host, Andrew Walker. And with me today, I'm excited to have Bob Robotti. Bob is the founder of the aptly named Robotti Advisors. Bob, how's it going?
Bob Robotti: Very good. We didn't spend a lot of money to come up with that name.
Andrew: You didn't hire IBM, $5 million to tell you what. I like it.
Bob: You got it.
Andrew: Well, let me start this podcast the way I do every podcast. First, a disclaimer to remind everyone that nothing on this podcast is investing advice. Everyone should consult their financial advisors. Please do your due diligence and all that type of stuff. And then second, with the pitch for you my guest, I guess most deep-in-the-weed value investors, which I think is kind of the focal point of this podcast audience, I think most of them probably heard of Robotti.
But I've started getting to know you and especially the team around you ever since the event at Markel last year which I participated in. I've just been impressed by the depth of talents of all the team around you. You've got a bunch of PMs running around there who are all experts on a bunch of different names and played a bunch of different strategies. So, it's been good getting to know the whole team over the last year. And we're putting on another event right in front of Markel's Investor Day, May 10th to May 11th, I think. That's right.
Bob: That's correct. On May 11. That's right. Wednesday, May 11.
Andrew: We'll be doing some panels with some popular investors talking about valuation ideas, portfolio construction, and all that. And then the Markel Investor Day will be in the afternoon if I've got the schedule correct.
Bob: We'll also have a panel with several endowments allocators to get a perspective of the investor, the investor group that's directly investing and allocating capital to other managers too. We think it's an interesting extra perspective.
Andrew: Perfect. And this is going to be the morning of May 11th. It's right outside of Richmond, Virginia. For anybody who wants to come, the ticket's open. Fly on out. I'll see you there. Bob will see you there. It'll be awesome.
Bob: That's right. And they have breakfast, also with the managers of the various Markel Ventures companies, which is interesting to get the perspective of those operating people in different businesses, and their viewpoints too. So, it's an extra opportunity to hear intelligent people talk about investing, and also to network with the people who attend. It's like Berkshire in certain ways except that it's manageable and comprehensible, as opposed to the daunting and you can't do everything when you're out in Omaha.
Andrew: I don't want to put words in their or your mouth, but I'm sure part of the thought process of getting all the events spun up is, that everybody talks about 20 years ago. I went to the Berkshire meeting and it was just 50 or 100 people or something. I'm sure the hope is that 20 years from now, people will say, "Oh, I went to that Markel Meeting in 2022 and it was just 200 of us." But I'll be there. If anybody's going, feel free to slide on into my DM. Slide into Bob's DM. Reach out. Let us know if you're going and we'll see you there.
Anyway, I'm excited to have you on the pod. I'm excited to see you next month. But let's go ahead and jump into the stock we're going to talk about today. This is perfect timing because the company we're going to talk about is now Westlake Corporation. The ticker is WLK. They just went through a really big name change. They had an Investor Day last week that I know you were at, in New York City. So, it's perfect timing to talk about Westlake. I'll just flip it over to you. Who are they? Why are they so interested? All that type of stuff.
Bob: Right. One of the things about Westlake is the culmination of many different investment themes we have. Since I started investing, originally, when I ordered a Tweedy to see what they owned back in the 70s, and then work for Gabelli in the early 80s and then our own investing, there are cycles that things go through.
People lose sight of that especially when you go through a post-financial crisis, the extended time where like one thing happened, and then the economic environment was consistent but an anomaly. And so, we think we're undergoing here is the revenge of the old economy, and we think that this company perfectly incorporates it.
And we also think of this as the revenge of the stock picker, understanding businesses, which ones are going to perform well in the changing different economic environment, and Westlake's a perfect example of those things.
Andrew: Perfect. Yeah, please continue.
Bob: The business is mainly a chemical business based here in the United States. And then, the offshoots that come from that. And that's a critical element because, again, an important backdrop is that North America has a differentiated energy cost, and will for the next decade. And that is a critical element. What that means is chemical companies, fertilizer companies, and businesses based in America that are making industrial products are going to use some kind of hydrocarbon.
And that hydrocarbon is North American natural gas that is disconnected from the world's energy complex, and that's a huge advantage. That advantage has gotten bigger when people have realized the issues with energy and energy security. So that's a critical element.
The second thing is, what do they do with that? What that means is that this is a business that has a history of excellent growth, excellent returns, and excellent free cash flow generation, all with no issuance of stock, so there's no equity issuance here at all.
So, that's the record I just highlighted. Fourteen percent compounded growth in revenues over the last 10 years, 24% growth in EBITDA, and 29% growth in free cash flow per share. That free cash flow per share is the great engine, and the family itself, who controls this, is 70% shareholder. So, you got that alignment of interest for someone who's allocating capital, who's got an extended track record of reinvesting that capital and doing great things for the capital, and you continue to see that same thing.
In the meantime this company trades, the interesting thing is that the valuation on what we think is disconnected from the economic reality, well demonstrated in the past, and the future, clearly in place, and all of the elements that led to that we think will continue to strengthen with the ability to reinvest capital and do that well.
Andrew: That's perfect. You covered the overview perfectly. You hit most of the questions I'm going to have through the podcast, but I'll try and earn my bones as a podcaster. Let's start with Westlake Chemical. I jokingly said big Netname change. Now, they're Westlake Corporation. But let's just talk, what are the actual chemicals and products that they're making? Just to give people an idea of that.
Bob: Again, this is the revenge of the old economy. The key piece of the business is the Chlor-alkali business. From that, you make chlorine, and you make caustic soda, basic elements. There's absolutely nothing sophisticated about it except that there is.
What has happened is that this is an industry, like many old-economy businesses in America, that has gone through an extended period of poor results and poor returns. Poor results and poor returns lead to consolidation, scaling back and all the things that you do that are cathartic. And also consolidation. And then, it's like rinse and repeat.
And so, since it wasn't one, two, or three years, but an extended post-financial crisis of more than 10 years, with the add-on of the pandemic, you had this cathartic process. That's where they are today. In the chlor-alkali business, the United States is competitively advantaged against other producers around the world because energy is the critical element. Power, you take electricity, apply it to salt, which is easily available here in the United States, and you get chlor-alkali at the beginning. So, you get caustic soda, you get chlorine.
There are 3 guys in North America, who were the low-cost producer and pretty much controlled most of the productive capacity. And so, that means that they meet the market demand. They produce to that, but that's all that they are going to produce. Therefore, the profitability and the pricing power they have is dramatic. That's a repeated pattern too.
The critical thing is, the world a year or two ago became convinced that inflation was dead and interest rates are going to stay low forever. They didn't realize that you just lived through a hugely anomalous period, and you were at the end of that, and a new cycle was going to begin. That's why we think that inflation is going to be persistent to it because you get businesses like this with 3 guys left who can control production and have the ability to control prices. They raise prices.
That pricing power is defensible because it is a barrier to entry in this business and there are relatively few players. That's not a transitory fact, that's not a supply chain issue. That's a supply-demand fundamental issue that is favorable and that will continue to be favorable.
I would think that pricing power and profitability improve over the next couple of years too. There's nothing the Fed can do to make more chlor-alkali capacity in North America, which is a hugely expensive, daunting test with barriers to entry, and not the kind of business that everybody wants to invest in today because it is concerned about sustainability impact. All of those things are going to create extra barriers to someone getting into this business.
So, that's a fundamental piece of what they do. And then from that, they do a couple of things. They do make some petrochemicals. They also have gotten into PVC over time because that's what chlorine is mainly used for. That capacity has grown out. What they've done more recently is they continued to say, "Okay. Let's go downstream and build in more products that use the PVC that we make." And so, they started to acquire.
The first important one was probably in 2018, they acquired one of the other large chlor-alkali producers, Axiall, that they had tried to acquire 2 years earlier. Georgia Gulf got away from them and ran off to PPG. And PPG took a piece of their business in a Reverse Morris trust bid that created Axiall. The problem was that the business was under-managed, over-leveraged, and wasn't operating well. Eventually, Westlake was able to buy Axiall Corporation.
In the process, they also acquired all of the Royal Roofing product business and siding business. And so, therefore, they acquired the products downstream. So, that was the beginning of it, which they've continued to build out since. So that's a little bit of what they make at the base, how that fits in, and what they've done to extend the opportunity set that they have in front of them with their core competencies.
Andrew: Perfect. There's a lot that I want to dive into. Let me start with the one that jumps out. This is a common theme I'm seeing across the board. The simplest place is probably the oil and nat gas where they say, "Hey, since oil and nat gas, kind of busted in the 2015, 2016 time frame, no one's gone out drilling, no one's developed new wells". And energy bills have been staying for years, supplies are too tight, anything happens and prices are going to go through the roof. We're kind of seeing that now.
On the Westlake side, it's a similar dynamic. Nobody has built out any new capacity in any of their segments for the past 5 years. And I think the company's been saying, "Look, demand has been growing. We haven't had new capacity. We're, kind of at the point where demand is starting to outstrip supply." And that's when you're starting to see where all these prices are rising, and everything.
I want to ask you, with oil and gas, it takes probably 6 to 9 months to start going and turning on new wells and everything, maybe a little longer to find a lot of fields and stuff. But if somebody wanted to come and build a completely new plant to compete with Westlake, or if Westlake wanted to build a new plant, how long would it take for that new supply to come online from building out a new plant?
Bob: I don't know the answer to that, to be honest. At Investor Day, they do point out that if someone built a fully integrated chlor-alkali plant, it would take 5 years and $5 billion to do it. The fact of the matter is, nobody would go and build a brand new greenfield plant, soup to nuts. There are different pieces along the way and they regularly debottleneck. And so, the ability to bring on certain pieces and build that out slowly, there's probably some potential to do that.
But there is the advantage to oil and gas. In oil and gas, there are thousands of people and thousands of participants. Therefore, the discipline in that market doesn't exist. The discipline to many old-economy businesses in America that are energy-intensive, that have, therefore, cost advantages, given North American energy cost, given natural gas' stranded availability in North America, means they're competitively advantaged. And that's for probably a decade, if not longer and you've got 3 people, or in oriented strand board, you've got 5 people that control the market.
And even when we say things like that, there are geographic submarkets. North America is a big place. So, the fact that matter is, that if you have a plant on the east coast and you're selling products in Arizona, that plant is not part of that competitive landscape. The competitive landscape was winnowed down, and you see it repeatedly.
It was a week or two ago that the government was after Tyson chicken. Because there are only 4 producers of chicken, that's when they say, "Beef is the same, pork is the same." You can go through that litany of old-economy businesses that have winnowed down, and there are 3 or 4 guys left in the business. Because they haven't generated returns in more than a decade, that's what they did.
They right-size the supply to meet the end-market demand. Demand has been growing, some overtime. And if we're now suddenly, demand exceeds supply. And when your demand exceeds supply and there are barriers to entry, because they get into any of those businesses, it's time-consuming, difficult, and even has risks to it. It's kind of what you want theoretically.
Everybody wanted to own better businesses because they have things like barriers to entry and therefore pricing power and high returns on capital, and all of those things. What happened is, that was the same attributes that many businesses in North America have today that our old-economy businesses, after decades of poor performance, economics 101.
Things change and therefore the landscape is substantially and structurally different than it has been, and these are different businesses, even though you think it's the same thing. That's why the market is saying, "It's only going to trade 5 or 6 times earnings," because we know that that's peak earnings. We've seen that in the past.
Andrew: That leads perfectly into my next question. My next two questions would be, let's just start by throwing the valuation out there, and then we can go through that. So, Westlake, as we're speaking, what is it trading for? What type of multiple does that imply?
Bob: I don't know. Is it 8 times earnings?
Andrew: I'm sure we'll talk about acquisitions in a second. It's tough because they did so many acquisitions recently. I think it's 6 times EBITDA. Maybe 7 or 8 times free cash flow, I think, if I've got my numbers correct.
Bob: Yeah. Free cash flow should be a little bit better than EBITDA because once they buy something, that includes even intangibles. They're amortizing and depreciating, and therefore really want to own these plants, keep them. If you keep them well-maintained, you're not building a new plant. It has an extremely long life. Because effectively, you've rebuilt the whole plant over time. Every fitting and every pipe on it is different than it was. Therefore they have a longer life than their accounting and economic depreciation. There's more free cash flow than would appear to be the case.
Andrew: Somewhere around 6 times EBITDA, six times free cash flow. I mean, those are very cheap numbers for what we've described. It's competing, at this point, somewhat an oligopoly. There's a great demand tailwind. Supply is limited.
So, I think the first question would be a bear push back and say, "The market is pricing this at 6X for some reason". And I think the reason would probably be, that it's looking at the company and saying, "Earnings are peaking right now". I understand what Bob is saying, but I've got 15 years of examples of these being low-return businesses, that maybe Westlake can slightly out-earn its cost of capital. Most of them on the whole earned their cost of capital or less. I get Bob saying that.
But we've got 6 months of these businesses out-earning, and 15 years of the world telling us these businesses are return-on-capital businesses and we're buying at peak earnings right now. The one rule as a value investor, everyone knows is you don't buy cyclical at peak earnings. You'll wait until they're at trout earning, and the multiples look crazy. How would you respond to that bear pushback?
Bob: First off, let me talk about that structural thing. Maybe 4 years ago, David Kessler when we were making a presentation, came up with a checklist. Everybody got big into a checklist. And he said, even for value investors, the checklists are, "I don't want to invest in anything that's cyclical". "I don't want to invest in anything that's a commodity". "I don't want to invest in anything that's potentially trading at a high price."
There's a whole litany of reasons that you wouldn't, and that was based on experience. And there are some reasons to think that that experience was of relevance and that there would be cases, and that's what I'm saying. There are structural changes to these businesses. That means these are not peak earnings. These are sustainable earnings that grow from here.
For Westlake, there's a second answer to that question. If you look over the last decade, I think I've had a 15% return on equity. So, that's not true. This company does earn a return on equity. And the fact of the matter is if they grow their free cash flow at half the rate they did in the past so they grow at only 15%. You tell me, something that has a 50% return on capital, that will grow earnings by 15%.
That's trading at 7 times earnings, is not a stock that's going to generate a really good turn for you. Then, I don't know what you're thinking. The facts are, this company has demonstrated that it is not a business that can't continue to generate increased returns, generates a clear return on capital and that they are focused on returning capital.
Andrew: I've got this in my tweets. I'm sure somebody can read it or anybody could go look at Investor Day. They talk about, "Hey, all of our top managers are paid on economic value add," which is your returns on capital above the cost of capital and everything.
Bob: They've done that since the inception of the business. This is not some "Johnny-come-lately. Let's hire another consultant, have them come in and we'll do an EVA study, and then we'll try to change our business based on that." The business is built, founded, and fundamentally-operated, for its eternity based on that. And this is a family that has a record of understanding the business and generating great returns.
Andrew: And they own, as you said, they still own 75% of the company, which at that point you do kind of wonder why is this a publicly-traded company when they've got 75% of it. That's enough to keep them from taking down [inaudible].
Bob: No, that's a very good question. Because structurally, one of the risks that exist in Westlake Chemical, having been an investor in out-of-favor, discounted companies over my entire life with a controlling shareholder, is that there's a risk that the controlling shareholder seizes the opportunity better than I do, and can avail themselves of that opportunity. So clearly, this company, for the last 5 years, was always been something that would be easy enough for the family to leverage a little bit, take a private, and own 100% of it.
They could have done. For another company, that might be a risk. But that's what I think is fairly demonstrated. They have no interest in doing that. And so, therefore, that one risk that could stop you out on a great investment, they have a track record that that's not their intent and that's not their interest, and they are willing to let you stay long as their partners. And that's a great thing.
Andrew: I don't know if you followed Cornerstone Building, which is tangential. They just had this happen. It seemed like their earnings were about to inflect and CNR owns 65% of them, taking the shareholders out at what was a nice premium to the prior price. But here we are, just yesterday, Cornerstone came out and said, "Hey, we sold a division for 500 million, which by the way, is about all the cash that CNR is going to need to raise to pay off the minority." So, CNR is pretty much free-rolling a buyout of the whole business. It's just crazy.
Bob: Yeah, that's right. And that's the reward they get for having owned it all these years. Clearly, there's been mismanagement at the ownership level. The idea that they put this company together with NCI Building Products made no sense at all. Now suddenly, after mismanaging and not paying attention, they're buying the business because it's worth more than what the public market price is putting on it.
In the meantime, Cornerstone is a great example though, because Cornerstone, in many of the building products-- if you look through the acquisition they made of Boral... Substantially, this is Westlake when they bought Boral. They did the presentation. They talked about who the competitors were, and they go product-by-product. They go in siding, roofing, and who that is. There's a laundry list of Cornerstone businesses, whether that's Ply Gem or Atrium. A whole bunch of Cornerstone businesses is a competitor to Westlake-- which we also think is an interesting dynamic, in that they bought Boral, who we think was undermanaged, definitely. They've done really expensive things like they put on a new shift and they raise wages a little bit. Therefore, they produce a lot more capacity out of the same plants they have to sell more products into a market that has strong demand, increasing profitability.
And they've integrated them, so they've saved some cost in the process. But they're also competing against Cornerstones' products. And the turnover of senior people, the continued change in management, the misdirection of that business means that they have a competitor who's not optimally being managed for a number of years. That provided the opportunity and will still continue to provide opportunities as they consolidate in that business today. They'll have some impacts of that that will be beneficial to Westlake also.
Andrew: I want to dive into a point you just made. This is something that jumped out at me. Westlake has been built over time through acquisitions. That's been their main source of growth. And one of the things you said is one of the things that jumped out at me. They were talking about that recent acquisition and they said, "Hey, one of the things we did to increase capacity is we just add a line. We run the thing 24/7."
And they talked about a lot of their other acquisitions, a lot of other basic "blocking and tackling" as what I'd call it, things that they do in these acquisitions. You see, the proof is in the pudding. Their returns on capital are great. Over time, they substantially outperformed. But I guess my question to you is, these are hundred-million-dollar-plus businesses, how are they mismanaged, that a buyer can come in, and buy that one number and say, "Hey, basically, I'm doubling earnings because I'm just going to add a second line in," or something? How was it this bad?
Bob: There's a commentary on things that could be run poorly. But the actual acquisition, you say, is the same thing. That was mismanaged. But some of that is capital because they always talk about debottlenecking, and whatever else, and changing, and Axiall's business was undercapitalized. That's a combination then. If you don't spend enough money to do the right things with the capital, the plant, keep it up-to-date and have it run efficiently, then that means the people aren't happy and that means you've got discord. Therefore, you don't have as good a business the assets can produce.
And then, when you get acquired by somebody who's thoughtful of who raised the rates... They said in one of the plants that the guy at McDonald's was making more money than the guy who was working in their plants at Boral. And so, they raised the rates. Suddenly, you have employees who like you. And it's the same thing in a different company. [inaudible] bought Georgia-Pacific's plants. Georgia had closed down the plant. They started back again, and employees suddenly love them. Georgia-Pacific didn't run it well, didn't like it, and shut down the plant. The people lost their jobs. This other guy comes along, hires people, runs it well, and therefore you have a happy employee. And employees are critical elements in making the hard assets productive and generate the maximum opportunity. It's hard to measure that but that fact is critical and really does make a difference here.
Andrew: It's one of those things, when you're starting as an investor, everyone says, "Oh, you want to invest in the great management teams or the great companies." It sounds so trite but then, over time... You've probably been doing this a little longer than I have, but you just see these companies, like, "Oh, they're [inaudible] cheaper. I'll buy them." And then, three months later, it turns out that with their acquisition, they overpaid or the operations are off, or something.
I always think in my head, Charter versus Altice. I'm not sure if you follow cable super closely, but Altice was always so much cheaper than Charter. But guess what, Altice is falling off a cliff because their operations are awful and the executive team lost the handle, and Charter just chugs along. Everything's going perfectly. And yeah, it's just the difference between great management teams, okay and poor ones.
Bob: But I will warn you, Andrew. That's true, but I will warn you, though. What do you think about that? And how do you characterize it? And what's the proof? And what is causing what's effect? There are plenty of businesses that have great records. Therefore, people then assume there's great management, and that may not be the case. And then, they get a hell of valuations. There are fundamental problems with some of those businesses.
It's more difficult to know what's a well-managed company because the tendency is, that if the record is poor, there must be poor management. But as Buffett says, a manager with a great reputation needs a business with a poor reputation. You know who wins. That's fundamental to, "Was that a great business or was that a great manager?" There's something that's changing in the business that the manager, therefore, is oblivious to because he's busy making money, and it looks great and he's getting patted on the back.
Andrew: The one I was thinking about, as you're saying when you say great acquisitions, they come in, they find synergies and operations that no one thought of. Everybody thinks of Danaher, which has been great, but the other one that people used to think of was GE. They buy a company. They'd cut working capital in half within 48 hours. They figure out all these costs energies. And guess what? That blew up spectacularly. It turned out that a lot of that was based on some funky accounting and stuff. It's so hard. Or, everybody wants to invest in businesses with a great culture. Three years ago, you know what business everyone thought had a great culture? Activision Blizzard. And guess what? It turned out that there was a heck of a lot of sexual harassment and all sorts of other crazy stuff going on. So, it's just so hard from the outside to see what's luck, what's real skill, and all that sort of stuff.
Bob: Someday I'll go on and I'll give you my tirade about GE. I thought Jack Welch is probably the worst manager that probably ever lived. His reputation was so misleading and so untrue and he's the guy who ruined that company. And he retired and got a four-hundred-plus-million-dollar bonus, the largest bonus ever, for setting up a house of cards. That's what it was when he left that business. It was a house of cards. And that was all manipulated earnings. That was a horrible environment.
And I love people talking about Six Sigma, and they talk about GE, and they said, "Oh, yeah, you know, good managers, we move them around from different divisions to different divisions." In the meantime, in the energy business where I'm a heavy investor for a long time-- whenever I met anybody who's in the energy business and they competed against the GE subsidiary or an acquisition of a company that was acquired by GE, they said, "Field day for us. This is just going to be great." Anybody there who's competent is going to leave. Whatever advantage they have they're going to lose, because GE isn't going to be able to know how to run that business. They paid too much for it, probably, and they're going to mismanage the business. So, great! I love having GE as a competitor. So, that was my experience in the business who would compete head-on-head with a division, and that's the opinion of GE.
Andrew: Westlake is a business that's been built through acquisitions. Obviously, people think of them as good capital allocators, good acquirers. Someone, kind of, asked this at the Investor Day, like, "Hey, you're in the business of acquisition, so I trust you with capital allocation," is what it comes down to, right?. And right now, at the Investor Day, somebody asked, "Hey, you're going out and buying businesses for a higher multiple than your stock trades for, kind of, on the stock exchange?".
And whenever I see that, I have the question, like, "Is there a kind of signal in that noise?" where, instead of going out and aggressively repurchasing and retiring shares, or something, the business seems still, kind of, committed to going in and acquiring businesses. Maybe that's great. They've created value through it over time. But I look in and say, "They don't think the best use of their capital is their stock." So, should I think that the best use of my capital is the stock?
Bob: I don't think you can actually do that. Don't get too hung up on the numbers. I do think of a business that generates free cash flow, that sees opportunities to expand its business, fill out the business, to generate good returns that, potentially, are incremental to the business they already have. Those opportunities don't come along that often and those opportunities you need to see. You can, kind of, buy back your stock almost at any time, although you can't because you only want to buy it at the right time. If it's right a bit straight to get too much money, you don't want to buy it back. But if it's trading at fair value and much value-add.
But acquisitions that make sense, I've come to believe, are the best use of capital because those opportunities don't come along all that often. And I'm sure they're doing the calculations, in terms of what that business is, what they think that business will generate, and what returns I think they'll get on that.
They have the experience of having done this, the conviction, and the understanding of those businesses that they're acquiring because they are related to what they do. I think their calculations in penciling those numbers and what they're paying for it is a good economic return.
Andrew: And the other thing with the business that is 75% are owned by insiders, I'm sure they'd love to buy back stock. But there's, kind of, only so much stock they can buy back because it's thinly traded. It might make more sense for them to just spend all their time on acquisitions, where they actually can move the needle versus thinking a lot about repurchases and maybe buying back 3% of their shares over the next year.
Bob: You know, that was interesting because that question got asked once or twice, at least, in the breakout session after. I thought they were unequivocal, in the terms of, "No, we have the authorization to buy back stock. We will buy back stock." And so, that's a regular thing that we understand. The value creation of buying stock for less than what the business is worth is incremental to the earnings. And those earnings mean that we get more of the same earnings.
So they're more aggressive in buying back stock, I believe, than I would think. Because I'm saying, that's right. There's a limited amount you can buy. It floats only so much. Therefore, that does limit the ability to, kind of, take advantage of that opportunity, especially in an environment, where these stocks are trading at very little multiples when the company has the sustainability of those earnings being a high probability. Therefore, that's a great investment of capital. But it seemed to me that they buy back more stock than I would have thought because I would have the same kind of thing. You can't do much there. It's just a limited opportunity.
Andrew: Music to my ears. Anybody who loves this podcast knows that I love share repurchase. That's close to the top for me for investing in a company.
So, the company used to be Weslake Chemical. They renamed themselves Westlake Corporation, in large part, because they've been moving a lot into housing and infrastructure-- hip is the segment, I believe, where they're competing with CNR, and everything.
The company addressed it at their Investor Day. They said, "Hey, here's why hip and performance and essential material..." which is their legacy chemical stuff, "... here's why these two segments belong together..." But I think the reason they put it in their Investor Day is that a lot of analysts look at this and say, "Do these need to be together? So, I just want to turn it over to you. What do you think about the move into housing, and do these two segments need to be together?
Bob: You know, it's interesting in a world in which everybody wants to separate everything, everybody wants to spin off businesses. They have different valuations, so let's do something that helps the public markets. I do think that too many corporations that run their businesses make strategic acquisitions or divestitures or structures based on the market flavor of the day. And to run your business based on what the market likes today is a poor way to run your business. And so, I think that's one of the advantages you get. You have a family that owns 70% of the business. The idea of spinning it off just because you get the sum of the parts that would have a higher valuation, they're not going to do that.
I would suggest that, over the last couple of years, the fact that they are integrated has probably been advantageous for them. And it's interesting because there's a difference. Because in the chlor-alkali business, they're making PVC. Now they're doing the home building products. That's very different than Olin's approach.
Olin is a merchant producer of chlorine and caustic soda, and they sell it to somebody else. Five years ago, I met with the CEO of Ply Gem and it was right around the time that Westlake acquired Axiall. And in the process, they got Royal business products, siding, and roofing. And his comment to me was, "Well, you know, they can't be in that business because that makes no sense. There's a channel conflict. They're the PVC producer and supplier. And now they're going to compete with me, who's making the siding product. So they can't stay in that business. They're going to divest somehow with the Royal business."
Instead, they didn't. They build it out. And I would imagine, maybe in the last year, there were times wherein Ply Gem was in need of raw materials because there were issues with that. That's part of that structural change, too, the fact that you potentially want to be integrated, because that gives guaranteed sources supply of the critical elements to, therefore, make your products to sell them into the marketplace.
So, I'm thinking that their belief is that being a little bit vertically integrated is advantageous, and enables me to have an advantage over my competitors in building products, because I know I'm going to get my source of supply.
Andrew: Yeah. It's one thing, I think, the pandemic and the post-pandemic times illustrated. As you said, it used to be so much caught up with your supply chain. As much as possible, you just want to focus on one piece. But I think we're seeing people that own their entire supply chain, like, they've just got so much more flexibility. And I get, yes, you should be able to do everything with a contract and stuff, but in tight supply change, when things get crazy, there's an advantage to being vertically integrated. We're seeing that now. And just with the way the world is, kind of, deglobalizing a little bit right now, it seems, like, it's worth paying up for companies that are vertically integrated versus, maybe, who can be, kind of, at the whims of the market, or their suppliers, or anything.
Bob: You said this chlor-alkali business is interesting, I do think in terms of how American industry has changed and what it's done because they have a very consolidated, competitively advantaged North American chlor-alkali industry. And what drove that to the culminating event, really, was not Axiall being bought by Westlake. That was a nice incremental one that took two other competitors that were four and five, and made them three or two. Therefore, that was nice.
But the key one was really in 2015, 2016. Dow and DuPont merged. And so, when Dow and DuPont merged, they said, "Okay, now we want to only be in specialty chemicals because everybody knows specialty chemicals, barriers to entry, stability of earnings, higher returns on capital. What are these other things? Chlor-alkali. This is is a base product. We don't want to be in this business." So, they took the chlor-alkali business and spun it off into Olin. So, Olin was one of the top competitors.
But the combination of those two-- the shareholders of Dow and DuPont ended up owning 51%, but that ended up, probably, being close to 40% market share in the chlor-alkali business, took them out of the business.
But Dow needs those base products, and so contracted to buy them back for 10 years at a fixed price. Therefore, they have a secure source of supply on key integral inputs into making their high-end products with their high-end margins. I'm interested to see what happens in 2025 when that contract expires, and Dow and DuPont suddenly need products in the chlor-alkali chain but don't have that capacity.
Bob: What happened with Olin in the last two years is, that Olin's pricing has dramatically changed. The profitability has gone from 600 million of EBITDA to over 2 billion of EBITDA within an 18-month time period because the industry was able to adjust to the fact that we're going to produce what we need to produce, and therefore we have pricing power. So, the margins expanded dramatically in that business.
So, the culmination of the consolidation that hadn't occurred happened. Structurally, you would think that would have happened a long time ago.
But it also will be seen, again, how people run their businesses based on what Wall Street tells them to do and how they potentially have divested of something that is an integral part of their supply chain to make a lot of the products that they make, and what happens at that point where they have to now contract in an open market from someone who probably has strong pricing power. It'll be interesting.
But again, "vertically integrated, not vertically integrated, making those decisions", and "what's the longer-term outlook for those", are critical questions that kind of come into play. And if you make those decisions based on what Wall Street tells you, then that's a mistake. If you make those decisions based on your understanding of the business and what you see the outlook to be, and where you see these opportunities, that seems to me a much superior approach. That may take some time because, for Olin, it didn't immediately culminate into something. That company, Olin, is cheaper than Westlake.
Andrew: Westlake is the first one of these companies I looked up. But I'm liking the story. I like the valuation. You did a great story-- six times EBITDA, demand growing, supply frozen, these are great dynamics. That's awesome. And that was the next question I was going to ask: opportunity cost.
Olin-- I'm just looking at Bloomberg, looks a little cheaper than Westlake, seems maybe a little simpler. You probably get a repricing story in 2025. So, why was Westlake the choice, the horseshoe [inaudible] here over Olin, or some other chemical company I'm not thinking of?
Bob: I followed it since it IPO'd and we bought it, like, five years later. We followed it. We didn't buy it, and the stock had to run up. Businesses have cycles. There was a cycle where the earnings got depressed, the stock came in, and then we bought the stock. So, we've owned it for a long time. I visited with the people. I have the conviction that-- because that's what it is. For a company that generates a lot of free cash, the question becomes, "Okay, what do you do with that free cash?" In my mind, Olin is cheaper than Westlake, but I'm not sure what Ohlin does with its free cash.
Bob: I have no idea what particular thing Westlake's going to do with their cash. But I know, from their track record, that they're going to get high returns in reinvesting that capital. So, it's not only an evaluation today. It's what the growth opportunity is because that's what it is.
I'm not a value investor. I'm not looking to buy a cigar butt for 50 cents that's worth a dollar, and then, when it gets to a dollar, sell it. I'm looking to buy businesses that are trading for vastly less than what they're worth, I think, at times, frequently less than 50 cents in a dollar. But more importantly, I'm looking for a business that's going through a difficult time. That's why I buy cheaply. But that cyclicality leads to changes in that company and that industry that makes for an opportunity for a return to the cycle and much higher returns.
Andrew: Looks like I had some video issues there. But, no, that makes total sense.
Bob: So, that's what it is. We're looking to buy a dollar for 35 cents, but we're looking for elements in place that give us the conviction that that dollar can turn into $2, to $4, to $10. And, of course, that is a huge win. We've had success a couple of times in being fortunate to do that.
Andrew: That's one of the things I love about share repurchases and businesses that are kind of going to grow because if you buy that 50 cents for a dollar, as you said if it's just a traditional value trap, it takes five years to get your dollar back, like, "That's a nice IRR but it's not great." But if you buy a business for 50 or, you said, 35 cents, for a dollar and that dollar grows to a dollar fifty in the meantime because the business is growing, and they're repurchasing shares at a discount. It really puts time on your side to do that. Anything else we should be talking about with Westlake here?
Bob: I don't know but that does make me digress for a moment.
Andrew: Go ahead.
Bob: We have some sense that we know something about building products. And a large part comes from our investments in the distributors to the home builders, that's Builders FirstSource and BMC, starting in '09, and then in '10. And then, we increase our positions over time. Those industries in cyclical situations, in most cases, never bought back stock.
Frequently, in the early years, the finances were still, kind of, tough on the business. They're in no position to be drawing back stock. Actually, Builders had to even dilute shareholders by doing recapitalization, and therefore, there was some dilution in the process.
But what happened was, that there were opportunities for consolidation and that's what they did. So, they made acquisitions, they consolidated the business, and then suddenly, today, that industry landscape is a different industry than it's ever been. And that's what people don't recognize. The market share of Builders BMC is not only in structural business products they distribute but also in the component part of the business. It's vastly different and it's driven so much more value.
Today, Builders FirstSource is making a lot of money. It's extra free cash flow. Last year, they put back 2 billion dollars worth of stock therefore, they have the financial flexibility. But they're still looking for acquisitions. If there's an acquisition to make, it still continues to make sense for them to do that. So, acquisitions, probably, clearly grew the value, there, much more. If they had been able to buy back some stock, it would have been a little bit better, but that wouldn't have been as incremental.
Andrew: Builders always make me laugh because I need to get back up to speed on it. I always feel like I've missed it just because of the run-up. But I remember last year when they announced a share repurchase and all my friends who followed it were like, "That's a quarter's worth of EBITDA. They're going to be done with that in two months if they don't do it."
And sure enough, the next earnings came along, and like, "Hey, we had a billion-dollar share repurchase program. We generated that in free cash flow. We bought that back in stock. We re-up in it like that." It's just incredible how good the cycle is for them right now.
Bob: Well, the stock's fallen off because home building's going to go to hell in a handbasket because interest rates are wrong. Interest rates have been wrong for a lot of years. But with inflation today, that's the new kid-- new thing on the block, and suddenly, people realize it. So, interest rates are going to move and it's just probably going to go up.
The problem is that there are not enough homes. The demographics are that we need more homes and it's not changing. So, that means that rents go up. That means, therefore, "Is it cheaper to rent or own?" all those things. That's a headwind for sure in a quarter or two.
In the meantime, stocks are falling down for Builders FirstSource. They look through their numbers in terms of the free cash flow, with very modest expectations. That is a stock buyback story, and that's what it is. They say, "We will make acquisitions if they make sense. If they don't, we will buy back stock." And this is 6-, 8.8 billion dollars [?] over the next four years is what we have to deploy in that way, and we will do that. And the markets giving them the opportunity because now, the stock pulls in further. So, they don't have to use nearly as well. They buy a lot more with the same dollar.
Andrew: It's funny because it all rhymes. People say this has been the thing forever. Anything touching homes, interest rates aren't rising, you need to sell. And interest rates aren't rising, you need to sell the cyclical. But with Westlake, since, "Hey, we underbuilt supply for 10 years and now we're in a place where demand is rising and supply can't keep up.
And with Builders FirstSource, anything touching homes. It seems, like, it's similar, "Hey, since the financial crisis, we underbuilt home for 12 years.
So yeah, interest rates are rising, but guess what? People still want to start homes. People still want to move into homes and start families, and we've underbuilt for 12 years." It does seem like the cycle is different this time.
Bob: What people have ignored is, in 2008, '9, '10, '11, that industry went through the worst depression ever. The right-sizing and the downsizing of those businesses have been dramatic. The consolidation that followed has been dramatic. Today, there are a limited number of people who make oriented strand boards. Every plant in America is running. We're building not a huge amount of homes and capacities fully employed. Lumber's the same thing.
And what is the industry doing in these strong times? They're not building a new plant. They're acquiring the competitor and they're buying back their own stock. So, the supply side of the equation is not changing. And the demand side is sustainable and probably is going to grow over time. And when you only have three suppliers, and you're the distributor, that's a fundamentally different place than being 10 suppliers and 15 distributors. That's a mess. Nobody has pricing discipline and you have cyclicality. You've got a different industry structure, both of the people who are making products that go into homes, and the people who are distributing that. That's a fundamental difference.
And the whole industry, on all sides, has been downsized to fit 800-, 900,000 homes a year, maybe a million homes a year. That's it. That's less than what we need. The demand for their products exceeds the market's ability to supply that, and they're not changing that supply number because it took a decade-plus to get there.
Bob: That's the change. That's what's different. That's what people are ignoring.
Andrew: I'm with you. You mentioned lumber. I think last week when we talked, we talked a little bit about oil and gas stocks, across-the-board, chemicals Westlake. I just see all these companies that are earning. They're trading for 6 times EBITDA, just minting money and free cash flow at this point. All of them are saying, "Hey, demand is outstripping supply and there's no supply coming on". And the market just, kind of, yawns. It seems to me that the market's just pricing an imminent recession, but it seems like the cycle is much different.
I think, earlier this year, U.S. Steel, X is the ticker, was trading for about 20. Tangible, both value, there's 27. They were a lot of money and I kept looking at them and saying what the heck was going on. And now, they got a boost from a war [?] and a couple of other stuff. But I think the stocks almost doubled since then and it's because if things trade this cheaply while they're making this much cash, it doesn't take much for the stocks to start having to go higher.
Bob: So, revenge of the old economy.
Andrew: That's it.
Bob: But what I also will say is that, in addition to really cheap valuations, is given the financial conditions of these businesses, many of them with no net debt. So, if there's a hiccup and a slow down, these are historically levered businesses, too.
So, the risk associated with a downturn, a slow down, and their ability to manage that is vastly different because I don't have debt payments that have to make up if I got to sell products to get cash. Instead, I'll lay off a couple of people, I'll get rid of a shift, I'll make less product. I'll just make the product to market, and I'll keep pricing. Pricing is my profitability. It's not a valium game. It's all about pricing and profitability.
Andrew: That's what I was saying with U.S. Steel. Everybody would treat [?] me and say, "Hey, you don't buy cyclicals at low multiples. That's at the top of the cycle." I get that because what? We've had a little multiple for nine months now, and we've never seen a cycle where they do super normal profits like this for 9 months. And in that time, they went from 2x levered to negative 1x levered with lots of net cash. So, if the cycle falls off tomorrow, they're not going to be on the verge of bankruptcy like they did every other cycle, which I thought was hugely different.
We've been running for almost an hour. I've been enjoying this. Any last thoughts on Westlake or any last thoughts on cyclicals, revenge of the old economy, or anything you want to get out before we wrap this up?
Bob: What happened is, it's also the revenge of the stock picker because it's not every base business and it's not every company. I think it is company-specific. You got the right company and the right business with the right management, and the right capital allocation. Those are critical differentiators. And so, being able to identify those and invest in them is an extra reason. And index can't do that, right? Energy moves from large-cap. What's happened over the last decade was that the large-cap's done well. Of course, the sub-component of a large-cap is a few who have done extremely well.
And so, therefore, if you own the index, you kind of own it all, plus, and it's efficient and it works. And everybody becomes, "Oh, yeah, passive investing is the way to go. Why would you pay money? That's ridiculous." If suddenly, the hockey puck is in a different spot and everybody's at the ice fighting over there, where it used to be, and you got to get to where it is and move down. And the market caps on all of those companies have compressed, so it's a much tinier universe. And so, it's all that capital, and it's not just equity capital. Likewise, fixed income markets are bigger than equity markets.
In 2000, people say, there are certain similarities less every year to the internet bubble. It was different. At that time, I think the 10-year treasury was six and a half percent. The fixed income market was not mispriced than misvalued. So now, you have all public markets. And it's not public, it's private because the private markets have grown. But it's all based on the interest rate and the interest rates were wrong. And if you've got a one-and-a-half percent 10-year treasury as your base when you start to then price up based on the risk, you're in the wrong place.
And so much of that has to move. There's going to be so much capital movement it would seem to me in the next decade. The idea that 2020 is going to be like tense work [?]. That's just laughable. That wasn't a huge one-time anomaly. And that's not the way the world is on a sustainable basis and we're moving to a different place.
Andrew: Over the past seven years, I just felt like the easiest thing in the world was to own anything tech, and if you did it, you got massively rewarded. But one of the things I've always thought about-- I hope it comes one day. If at any point, you see Facebook, Amazon, Microsoft, Netflix, all these guys-- if you ever saw them stumble for any reason, the indices would be down huge. And there are so many, as you're saying, like, energy's 5% of the S&P 500 these days. These home building companies are barely even in the S&P 500 these days.
There are so many companies that if you, kind of, had a regime change like that, I'm with you, I think there are and will be opportunities just out the [inaudible]. I don't know about you but I spent a lot of time in an event-driven ... I just feel like the opportunity is incredible right now. Markets are probably down 15 or 20 percent from their highs, but there are so many of these smaller guys that are just completely disregarded, things like Westlake that are trading at 6X and have great fundamentals. And I just feel like not a lot of people really care about them.
Bob: Right, yeah.
Bob: That's the land that investment dollars have forgotten but they will find it because it's a weighing machine and they weigh cash. And that cash is accumulating.
Andrew: Exactly. If they don't find it, the cash is accumulating so quick, either, they're going to buy their stocks back or the private equity companies are going to come in, buy the whole company and pull the
Brookfield and re-IPO them for 10 times what they paid two years later, or something.
Bob: Well, one of the guys we have on one of the panels, that stock big panels, is a guy, Andrew-- Adam Katz that I met a couple of different times. He left Elliott and has some private funding that he's doing. He thinks that the opportunity is in small-cap because large firms, whether it's Elliott or whether it's an LBO firm have got so much capital. You have to move up. Where do you fish? You have to fish where the fish are.
So, they've avoided and eliminated. And the small companies' valuations have come down. So, you've got this perfect confluence of events. I think he's going to have great success in raising capital to identify small public things that have the opportunity and have a valuation entry point that makes it, kind of, a no-brainer.
Andrew: Well, I'm 100% with them. That's a great way throughout the show because I'm not looking forward to seeing, it was Andrew Katz.
Bob: Adam Katz.
Andrew: Adam Katz. I'm looking forward to seeing him at the Markel event. So, I'll just remind everyone, that Bob and I will be at the Markel event on May 11th.
Bob Robotti, thank you so much for coming on and looking forward to seeing you in person in about a month.
Bob: Okay, great. Thanks. Take care, bye.