LG Chem, Ltd. (A051910) Earnings Call Transcript & Summary

[Interpreted] Good afternoon. We will now start LG Chem's 2022 First Quarter Earnings Conference Call. This is Hyun-suk Yoon, Head of IR at LG Chem. Thank you for taking an interest in LG Chem and joining this call despite your busy schedules. We will begin with a brief introduction of 2022 Q1 earnings performance and outlook, followed by the CFO presentation, highlighting the company's earnings results and then a Q&A session. The presentations will be interpreted simultaneously, while the Q&A will be interpreted consecutively. The material presented during this conference call can be viewed by those with web access. It is also available for download from our corporate website. Let's begin today's call with the introduction of the management team. We have CFO, Dong Seok Cha; Young Suk Lee from Business Planning; [indiscernible] from petrochemical; [ Young Suk Lee ] from Advanced Materials; and [indiscernible] Park from Life Sciences. We will first address the business performance. On Page 3, we have consolidated Q1 P&L. Q1 sales grew by 20% Y-o-Y and 6% Q-o-Q to KRW 11. 608 trillion to record the highest ever quarterly sales. Operating profit was KRW 1.024 trillion and OP margin was 9%. Next page is a summary of our earnings performance excluding LG Energy Solution. Sales was KRW 7.891 trillion, an increase of 35% Y-o-Y and 15% Q-on-Q. Advanced Materials grew by 33% Q-o-Q, and other businesses, including petrochemical, all grew at a similar level. Operating profit was KRW 818 billion and OP margin was 10.4%. Next, on Page 5, we have the consolidated financial performance. As of the end of the first quarter 2022, assets were around KRW 64.400 trillion; cash was around KRW 14.100 trillion. Liabilities were around KRW 29 billion, borrowings were around KRW 35.500 trillion. Net asset value per share was KRW 387,000. After the LG Energy Solutions IPO in January, cash and capital count increased significantly. Consequently, financial ratio [ greatly ] improved with borrowing ratio at 81.5% and total liabilities to equity ratio at 1.6%. Next, earnings and outlook by division. On Page 6, you'll see Petrochemical division's earnings. 2022 Q1 sales was KRW 5.964 trillion. Operating profit was KRW 635 billion and operating margin was 10.6%. While profitability fell slightly due to the deterioration of the external business environment, such as higher oil prices from Russia-Ukraine crisis, lockdowns in China from the resurgence of COVID, supply increase from global new capacity, backed by LG Chem's differentiated product portfolio, we were able to record more than 10% in profitability by recording high profits, led by POE and SAP. In Q2, we forecast that the challenging environment to continue due to the risk of demand recovery being deferred from the global business uncertainties, such as rising raw material prices and due to continued high oil prices, China and, et cetera. In spite of this, LG Chem [indiscernible] with efforts to raise the ASP focused on high value-added premium products. Next, Advanced Materials. In Q1, Advanced Materials sales was KRW 1.568 trillion; operating profit was KRW 154 billion; and operating margin was 9.8%. Despite the automotive semiconductor and metal supply shortage that have persisted from last year, LG Chem achieved the division highest ever sales, centered around battery material business. And profitability also significantly improved from the increase in the shipments of high value-add premium products, including high nickel cathode, OLED and semiconductor materials. In Q, while we are forecasting a challenging environment with the continued risk in the industry supply chain, through the upgrade of the product portfolio towards premium products and customer portfolio diversification, we expect growth to continue, led by the battery material business. Next, Life Sciences. In Q1, sales was KRW 217 billion and operating profit was KRW 32 billion. OP margin was 14.8%. With the greater shipments of high-margin core products, including growth hormone, diabetes treatment, sales grew and profitability improved. In Q2, we expect robust sales to continue, with the market share growth of core products and R&D investment is expected to expand, led by clinical trials in the U.S. as a result of progress in new drug development projects. Next, Farm Hannong. Q1 sales was KRW 261 billion and operating profit was KRW 41 billion. With the seasonality in the first half, the business turned a profit and both sales and profitability improved Y-o-Y with greater sales of crop protection products, including greater exports of Terrad'or. With the global inflation in full steam, we expect to bear the burden of rising raw material prices in the future. However, we forecast that for the full year, performance is to improve by reinforcing our portfolio centered around products with the greater customers, including overseas business expansion of crop protection products. Lastly, Energy Solutions. This morning, Energy Solution presented their performance in detail during its earnings release conference call. However, we'd like to briefly present the earnings here. In Q1, sales was KRW 4.342 trillion, operating profit was KRW 259 billion and OP margin was 6%. Despite the sales increase in EV cylindrical batteries, sales decreased slightly due to the shipment reduction from automotive, semiconductor and supply chain issue. However, profitability improved due to the expansion of metal price pass-through contracts in response to raw material price surge and productivity gains also contributed. In Q2, while certain macro issues will continue, sales is to expand, centered around balanced demand of all products and strategic customers. And on this note, we will conclude the Q1 earnings presentation and invite CFO, Dong Seok Cha, to present the highlights of the company's earnings performance.

[Interpreted] Good afternoon. I'm Dong Seok Cha, CFO of LG Chem. I'd like to begin by thanking everyone who are joining this call despite your busy schedule. Thank you very much for your interest. First, looking back on the first quarter, we began the year facing a deeply difficult business environment. Oil prices surged to over $100 due to the Russia-Ukraine conflict. And prices for most raw materials, including lithium and nickel, also significantly rose. Consequently, other expenses like -- likewise increased significantly, such as transportation and energy costs. In petrochemical industry, amidst a full [ flat ] supply of new capacity additions in Northeast Asia, demand weakened and spread tightened for core products due to China's strong lockdown measures brought on by COVID. Despite such a challenging business environment in the first quarter, we posted robust earnings. On a consolidated basis, we were able to generate the highest ever quarterly earnings and operating profit of around KRW 1 trillion. And excluding Energy Solution, there was a high sales growth along with a double digit OP margin. The drivers of such performance are: first, portfolio realignment focused on high value-added products that the company has been pursuing over time, along with increased shipments of premium product groups, such as Petrochem POE and SAP, as well as NCMA, a high-energy density cathode and OLED materials from efforts to strong -- strengthen product competitiveness. Also to respond to global inflation, including surge in raw material prices and rising transportation costs internally, we are more focused than ever on cost-cutting efforts, while expanding the price pass-through contracts of raw material costs to defend our profitability in the challenging business environment. Dear investors, we forecast that the uncertainties in the business environment at home and abroad we faced in Q1 will continue into the second quarter. Amid the wide spread of global inflation, including rising raw material prices with automotive, semiconductor shortage and continued lockdowns in China affecting us, we believe that demand remains still unclear. To overcome such difficult circumstances, LG Chem plans to focus on 2 areas. First, on one hand, we'll continue to improve product and quality competitiveness, centered around differentiated premium products. And on the other hand, in line with the global inflation trend, we plan to have our ASPs more actively reflect rising costs in raw material prices and transportation costs. Moreover, LG Chem declare that this year is the year of customers. Thus, we are channeling all the company's competencies into improving customer satisfaction from product to after-sale support and endeavoring to be more recognized by customers by raising the value of our core products. Second, we plan to accelerate the development of the top 3 new growth drivers that we have been focusing on. In sustainability business, to build the recycled ecosystem, we are cooperating with houses, CJ Logistics, [ CinCity ] and greatly increased bioproduct shipments from increase in demand. In Battery Materials business, we are already generating some visible results in our earnings performance. Sales in Q1 grew 90% on the quarter, and we are planning for continued growth going forward. Along with full fledge increase in the portion of the high energy density cathode, such as NCMA, sales to third party is growing in a meaningful way, and we expect this to play a big role in Advanced Materials sales and profitability growth. We also made progress in new drug development. Already, in the United States, NASH treatment, which is in clinical trial stage and another NASH treatment with a different active mechanism has been approved for clinical trial Stage 1. This 2-way track improves the possibility of a successful new drug development and increased synergy. Backed by the high growth of new growth engines, LG Chem expect sales to grow on quarter in Q2 and for the full year surpass the targets that we have announced at the beginning of this year. On top of this, in the face of an uncertain environment, to improve operational efficiency by efforts, such as cost saving, strengthening our product competitiveness and improvement in customer satisfaction, we will endeavor to continue generating robust profits. We ask for your continued support going forward. Thank you.

Next, we will move to the Q&A session. [Operator Instructions] [Foreign Language]

So the first question is from the line of Anna Park from Macquarie.

[Foreign Language] Yes. Thank you for the opportunity to ask questions. This is Anna Park. I would like to ask you 2 questions. First is about your chemical business outlook for the petchem business. Even amidst a very high oil price environment, you have been able to achieve a very high level of profitability. So the question that I would like to ask you is that for the business going forward, do you believe that you would be able to maintain a double digit operating margin in the future? The second question that I would like to ask you is about your battery materials business. In the current environment, we do see lithium prices surging. And as a result of that, I do believe that there's a growing interest for our high nickel batteries. So if the nickel content in the batteries continues to increase, then what does that mean for your cathodes business in terms of the overall yield, in terms of the product prices and in terms of the material sourcing? What would be the overall impact on your business operations? And in addition to that, in terms of diversifying your customer base outside of your captive customer, what progress has been made on that front?

[Interpreted] Yes, maybe I can address your first question about the petrochemical industry outlook. As you have just mentioned, if we look at the current market backdrop in terms of the market environment, both on the supply side and on the demand side, the overall backdrop is not very favorable. So in terms of the overall supply, as you are aware and -- in terms of the overall demand, as you are aware, since the Chinese holiday season, we haven't seen -- there has been a delayed recovery. And in addition to that, China has also gone into a lockdown, whereas on the supply side, we do see new capacity additions coming from China. In addition to that, if we look at material costs, due to the Russia-Ukraine overall situation, oil prices have been surging. And as a result of that, that has not been favorable for our overall business. For the business environment, unfortunately, we do think that the second quarter will be a continuation of the first quarter in terms of the overall backdrop. And if we look at the second half of the year, we do think that in terms of the capacity and in terms of supply, that, that will continue. And at the same time, that the high oil price environment will continue to put upward pressure on costs. However, on the demand side, we do think that there is a possibility to have some expectations, for example, once some of the lockdown in China is relieved, then we do think that there is a possibility of there to be some economic boosting measures. And in addition to that, if the automobile semiconductor issues are also addressed, then we do think that there can be some more higher expectations that we would see in the second half. One of the things that we do think is fortunate for our business is that in terms of the overall business portfolio and product portfolio, we do have a very well-diversified portfolio. And in addition to that, for the products that we hold, a lot of the products are focused on the high value-added segment. So as a result of that, in terms of the impact on the negative side or the losses that we are actually experiencing, that is less than what we would see on a relative basis versus our peers. Going forward, if we look at it by business segment, for the [ NCC/PO ] and generic products there, we do believe that, that will continue to be very lackluster. However, for the high value-added PVC and ABS areas, we do think that the market there will continue to be healthy. And in addition to that, for the more high-end products that we see, so for example, for solar panel purposes or for EVA and also automobile semiconductor IPA products, we do think that, that will continue to be very robust, which should help our overall profitability. So maybe I can address your question about the overall battery materials business, for the nickel price and what that impact that has had on our overall operations and also our customer diversification efforts that we are making. As you have mentioned, the nickel prices have been on the rise. However, basically, the overall structure that we have for our pricing plan is that the metal index prices are reflected into our overall sales price and are transferred there. So as a result of that, the rising nickel prices in themselves do not have an impact on our profitability. If we talk about the high nickel batteries, of course, these are premium high nickel battery materials. These are premium products, and therefore, the profitability that we're able to enjoy on these products would be larger than that of generic products. And as a result of that, as the portion of these type of products continue to increase within our overall business portfolio, that will help contribute to the bottom line of the business. In terms of new customer acquisitions outside of LG ES, we have been working and we have been able to acquire some small to medium-sized Chinese companies. And in addition to that, we continue to pursue spec-ins of NCM batteries and high nickel batteries with battery producers who supply to global OEMs. So we do think the results of those efforts will start to kick in from next year or the year after during which we will be able to see higher growth. [Foreign Language]

The next question is from the line of Yu-Jin Jeon from HI Investment & Securities.

[Interpreted] I am Jeon Yu-Jin. As you have mentioned, there has been a decrease in demand in -- from China. And added to that, we also see naphtha prices continued to rise, which may lead to more lackluster performance going forward. So as a result of that, what has been the overall utilization of your capacity in light of this situation? And going into the second quarter, do you have any plans to adjust the overall utilization of the capacity that you have? The second question that I would like to ask you is about your Life Sciences business. You did mention that you have NASH development projects that will be going into clinical trials. What plans do you have outstanding on that side? What development is taking place? And in addition to that, for the development that you have, what type of competitive edge do you think that you have versus your competition?

[Interpreted] Yes. For the petrochemical business, maybe I can address your first question. For the company and the capacity that we have on a per month basis, we actually do look at the market environment and also the overall cost levels to actually look at how we want to run our productions. And as a result of that, we do have a flexible utilization rate that we manage accordingly. So if we look at our NCC capacity because the ethylene spreads recently have been weak, as a result of that, our overall utilization has been adjusted downward by around 10% to 20%. In the second quarter, we do think that the market environment will continue as is the first quarter -- on the back of the first quarter. So as a result of that, we do think that for the NCC levels, it will be maintained at a similar level. And in addition to that, on the downstream side, for the low profit or a more commodity-type PO products, we do want to adjust that also accordingly.

[Interpreted] So to address your second question for NASH or nonalcoholic steatohepatitis, this is a metabolic disease that also results in obesity and chronic diseases. So it is a serious illness that starts with fatty liver and may lead to other more serious illnesses, such as steatohepatitis, liver cirrhosis and ultimately, liver cancer. In addition, the mode of action is complex and includes fat liver, also inflammation and liver fibrosis. Thus, there is no approved treatment yet. And if a new drug is launched, we believe it would have the potential to address a roughly KRW 20 trillion market in 2029. The Life & Sciences division is researching and development treatments from various approaches that would block a wide variety of mechanisms. For example, we have one project that aims to block the inflammation and has completed the Phase I clinical trials in the U.S. and is expected to move on to Phase II. In addition, we have another project that would limit fatty accumulation. This is a project that has received Phase I approval from the FDA in March and will be starting soon. In addition, we have a project related to liver fibrosis that is in the research stage. So as mentioned before, NASH can occur for many different reasons. And thus, we expect that combination therapy to address these different aspects will be required. Therefore, we expect that the various projects that we have ongoing will be able to create a mutual beneficial synergy.

[Interpreted] The next question is from the line of Cindy Park from Nomura Financial Investment.

[Interpreted] Yes. There are 2 questions that I would like to ask you. One is about your petrochemical business. Recently, if you look at your PVC and ABS business, in China, of course, I do believe that these operations would have some impact from the Chinese lockdown. So what has that been? And you have said that the PVC and ABS business really regardless of this have shown strong performance. So if you could elaborate a bit about that. And also, for example, the expansion plans that you would have for PVC, ABS and other high end or premium products. The second question that I would like to ask you is about your shareholder return policy. You have disposed off some stake in LG Energy Solutions. And as a result of that, you have cash on hand. The company has announced that the dividend payout ratio intention was to have around a 30% payout ratio. However, in addition to that, does the company have any plans to, for example, engage in treasury share purchases and maybe have a share buyback and cancellation type of scheme?

[Interpreted] So maybe I can address the question that you had for the petrochemical business. If the lockdown situation in China does continue and becomes more intense, then we do think that it will have an impact on the downstream industries, in the area of home appliances and also automobiles. And as a result of that, also for the production sites that we have in China, there could be a negative impact there. So that may be of a -- bit of a concern. So as a result of that, we do think that the China ABS operations, they have an impact. However, on the flip side of that, if we look at the PVC products because of infrastructure potential and also the possibility of economic stimulus taking place, we would actually have to see what the impact is, whether it's negative or positive at the end of the day. So for ABS and PVC and to talk about our mid- to long-term intentions and strategies, first on the ABS side, I think that for the next 2 years or so, there are large capacity additions from China that are expected. So as a result of that, from the second half of this year, we do think that there will be some pressure on the supply that comes into the market. And as a result of that, we do think that the market backdrop will weaken. However, because we are the global #1 player in ABS, and in addition to that, the product portfolio that we have is differentiated in terms of providing, for example, transparent ABS or other types of products, we do think that, that factor, added to the fact that we have been able to achieve a economy of scale in this area, enables us to have a point of differentiation versus the new players that are emerging in the Chinese market. So as a result of that, we do think that we would be able to defend our bottom line. On the PVC side, I would have to say that we do think that, again, there could be some adjustment in the market in itself. But overall, we think that the market will continue to be robust. And we do think that because the supply/demand dynamics are a bit more stable, that as we continue to see a improvement in the overall utilization, that, that should be helpful. And in addition to that, in terms of the processing methods that we use versus the ethylene-based methods that we're using versus the carbide-based PVC does have an upper hand. So that also is in our benefit. In addition to that, on the area of caustic soda, we also see that there is increasing demand coming from secondary batteries. So as a result of that, we do think that there is profitability that we would be able to enjoy in that area also.

[Interpreted] So this is the CFO, Cha Dong Seok, and maybe I can address your second question about our overall shareholder return policy and including any intention to maybe purchase some treasury shares. I think that with regards to this topic, the company's position is that we need to look at this with a long-term horizon and a long-term view. As you are aware, if we look at the current market environment, there is an increasing emphasis on going green and also reducing carbon emission. So in the petrochemical industry, we do believe that this is a two folded situation, in which on one side, there are risks that we have identified that could actually have an impact on the livelihood of our operations. And at the same time, we do actually believe that this backdrop also provides us with new opportunities and a vast array of new business initiatives that we may look at. So as a result of that, in addition, for the battery and also EV market, the growth that we see in this area has exceeded all expectations that people have laid out, and it does continue. So as we have mentioned before, for the time being, we do think that to make use of these new business opportunities and to be able to address these opportunities in a timely manner that we will need to continue to invest into our 3 new business areas that we have mentioned before and continue to foster these areas as new growth drivers. So for the time being, we do believe that there will be a need to focus our R&D and CapEx efforts within these 3 areas. So on a per year basis, if we look at the CapEx for the next 5 years, we do think that for each year, there will be a need to invest around KRW 4 trillion to KRW 5 trillion. And that would be a large investment that would be required for the time being. In addition, for these new business areas, to be able to launch them in a timely manner, we also believe that being very focused is very important. So what we want to do is be able to drive those initiatives, achieve growth, and at the end of the day, increase the overall firm value and the enterprise value of our company. And we do believe that in the longer term, that, that will also be in the benefit of our shareholders.

[Interpreted] The next question is from the line of Parsley Ong from JPMorgan.

Congratulation from the good result. So I have 2 questions. The first question is on your Advanced Materials division. So obviously, this was the highlight. Your OP margin rebounded to 10% in first quarter. Could you share with us some of the key drivers behind that? For example, what portion came from the rollout of NCMA cathode? Or was it because of your new separators division? And over the next few quarters, how sustainable do you think this 10% OP margin is? And in the mid- to long-term, do you see potential for margins to be higher or lower for the Advanced Materials division? The second question is with regards to your single crystal cathodes. Could you share with us when does LG Chem plan to launch single crystal cathode? And what would be your expected capacity or margin for single crystal cathodes? For example, for margins, would this be higher than your existing cathode margins, for example? And also, maybe please share some of the benefits of single crystal cathodes versus existing products.

[Interpreted] So maybe I can address the first part of your question first and then talk about the other parts. For the first quarter performance, in terms of the OP margins, I do think that if we look at the drivers behind that, of course, the cathode materials would be a big driver. As mentioned before, the 20% that we have in the high-nickel cathodes and also the high end or premium products, high value-added products, such as OLED-related materials and also semiconductor-related materials, have increased in terms of overall contribution. So that has had a positive effect. And in addition to that, there also has been the effect of metal prices increasing. So in the first quarter, because of higher metal prices, there has been somewhat of a lagging effect on the inventory that we had. So that was also a plus factor for us. Going forward, we do believe that this level of margins will be sustainable, if not improved because the portion of our high-end products will continue -- or high value-added products will continue to increase, which should result and also translate into better profitability for our business. In addition to that, for the separator business, from 2025, we will be able to actually start to include the raw separators themselves or the material that we have [indiscernible] into our overall operations. So again, over the mid to long-term, we do think that there are various elements that indicate that the overall margins will improve.

[Interpreted] And to address your second question about the single crystal cathodes, I think that in terms of the revenue generation, this is something that will start in the second half of this year. We -- the -- for the capacity that we have in Changzhou, the factory there, we have modified it to be able to produce a single cathode -- single crystal products. And so that overall conversion has already been completed. In addition to that, if you compare the products themselves, they have a longer life and also are more stable. So as a result of that, there is a premium in terms of the pricing that people are able to enjoy. And as a result of that, we do think that it will lead to better profitability.

[Interpreted] The next question is from the line of Nikhil Bhandari from Goldman Sachs.

Two questions from me. Firstly, on the cathode business, can you share how much of your current cathode capacity NCM622 versus 811 versus others? And LG Energy Solution is also planning to do LFP battery for ESS and also the high manganese chemistries in future. Is LG Chem also planning or is already working on such cathode materials? Or will the focus for LG Chem's cathode business may continue to be on NCM batteries, cathode and more for the pouch batteries? So I think if you can just share your more medium-term plans and away from NCM as well, that would be great. A second question is on the petchem business. Can you share how much of impact we have seen from naphtha lagging impact in terms of benefit to the operating profit of petchem in the first quarter? And also, in this challenging tight naphtha environment, how is the sourcing strategy for naphtha? Is LG Chem able to source naphtha at a competitive price? Or do we have to pay premiums? And yes, so I think those 2 will be my questions.

[Interpreted] So for the cathode question that you have, maybe to answer that, in terms of the breakdown between the different cathode types that you have mentioned, unfortunately, we would not be able to give you specific numbers. But what I can say is that the high nickel cathodes account for around 20% to 30%. And we think that going into next year, that most of the revenue generated will be from high-nickel cathodes. In addition to that, you also asked about LG Energy Solutions, LFP for ESS purposes. As of the current time, the focus that we have is for EV batteries. And as a result of that, for LFP, we have reviewed the possibility of LFP. However, we're not currently in a situation in which we are developing anything in that area. In addition, on the EV side, for the more mass products or the "volume zone" of the market, we do recognize that there is a need and demand for manganese chemistry. And we think that, that is something that we will be able to address from 2024. However, that have been said, that market timing or how the market actually plays out going forward, we do think it would depend upon how lithium prices trend going forward because the overall competitiveness of manganese could differ according to where lithium prices sit. So as a result of that, we're also looking at high -- low nickel, but high voltage, low nickel chemistries and materials that we would be able to produce. So not only are we looking and trying to address the premium market, but we're also developing a wide range of materials to address the more mass market or volume zone within the market. So maybe to address the petrochemical question that you have had with regard to the overall naphtha market and our sourcing capabilities. For the sourcing of naphtha, from a very long period back, we have been able to diversify our sourcing -- the sources to which we purchase to ensure that we are able to mitigate any supply risk that we may have. So currently, in terms of regions, not only do we source from Korea, but we also source from the Middle East, from India and also Africa. In addition to that, if you look at the contract format, we are continuously increasing the amount of direct purchases or direct imports that we have. Not only are we making efforts on that side, but at the same time, for the capacity that we actually hold, we are trying to ensure that the feedstock that is used not only can it use naphtha, but we're also increasing the portion that can also use LPG because we do see the change in the overall market prices. So as of now, around 1/4 of the capacity can be convert -- has been converted to be able to use LPG if necessary. So we continue to compare the LPG prices versus the naphtha prices and flexibly adjust the mix according to the situation. And to address your question about what the naphtha lagging effect was in the first quarter, unfortunately, we won't be able to share with you specific numbers. It did have a healthy contribution. However, in the second quarter, we do think that the same lagging effect will have a negative impact on the overall performance.

[Foreign Language] [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]