The Company Cashing In On This Epic Bear Market

Joseph Hogue's picture

Monday, December 21, 2015 - 7:30am

by Joseph Hogue

This year's bear market in oil has taken the spotlight in the press, but it's not the only commodity that has struggled. Natural gas has fallen 50% over the last year, reaching a low not seen in two decades.

Many investors have been left scrambling to cover their losses. But I see this drop as an opportunity to focus on companies that will benefit from this epic bear market. 

In fact, one company will have a huge advantage against international competition and is selling for a 35% discount to its long-term average.

How To Play The Epic Bear Market In Natural Gas
Bear markets like the one in natural gas are extremely rare. And with prices touching 20-year lows on an inflation-adjusted basis,  you'd be hard-pressed to find an investment that has produced more losses. 

There doesn't appear to be any bottom for prices either. Both cost drivers, industrial demand and weather, look unfavorable for at least another quarter. Industrial output in the United States declined in August and September and broader economic growth has been mostly a result of consumer spending. Across the United States, record temperatures are being recorded as the El Nino weather phenomenon looks to keep heating needs down through spring. 

As I mentioned, energy prices are down for all products. And while natural gas has fallen 50%, the price of Brent crude has fallen 38% over the last year. 

The difference in the price of Brent crude and that of natural gas is important to today's pick.

Brent crude is used in European and Asian production of naphtha, which is used to make ethylene. Ethylene is the key component to make polyethylene, the most common plastic. This isn't the only way to make ethylene, however -- natural gas can also be used to make ethane, which can also be converted into ethylene. 

Much lower natural gas prices relative to Brent crude mean chemical producers that use natural gas could have a huge price advantage for making ethylene and polyethylene.

This Natural Gas User Is Trading For A Huge Discount
Westlake Chemical (NYSE: WLK) is the largest North American producer of polyethylene and a major producer of PVC components used in construction. The company spun off a master limited partnership (MLP) in 2014 which acts as a ready buyer of assets and has allowed it to consistently increase cash return to shareholders. 

Besides its advantage as a low-cost producer of polyethylene, the company's PVC business should benefit as water utilities upgrade systems after years of underinvestment. Ernst & Young estimates that the U.S. water sector is on the verge of a transformation with $1 trillion in new investment needed just to rehabilitate current infrastructure. Westlake estimates global PVC demand growth at an annualized 3.6% through 2020.

Shares are down 6.5% for the year on sluggish economic growth and trade for less than 10 times trailing earnings. That's a 35% discount to the five-year average P/E of 15.3. 

Earnings are so strong, however, that cash on the balance sheet has doubled since 2010 to $1.25 billion, nearly 18% of the market cap. The stock's dividend has also grown by an annualized 41% over the period. The company is taking advantage of the valuation discount by authorizing an additional $150 million in share repurchases, effective immediately and beyond the $114 million it has already repurchased this year. 

Risks to Consider: The company has booked record profits since 2012 on lower natural gas prices and margins are already high. Management will have to book higher sales to keep earnings growing, something that might be difficult to do if the economy slows quickly.

Action to Take: Take advantage of the historically low natural gas prices as well as the selloff in shares of Westlake. Buying the stock gets you a position in one of the top producers of ethylene with a strong cost advantage over international producers. 

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Joseph Hogue does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.