Lotte Chemical Corporation (A011170) Earnings Call Transcript & Summary

Good afternoon. I'm Hoon Kim, Head of IR at Lotte Chemical. I'd like to thank everyone for taking an interest in our company despite your busy schedule. Without further ado, we now begin the 2022 second quarter earnings presentation conference call. After introducing the members of the senior management present today, we will walk you through the business results for Q2 of 2022 and the outlook for Q3 and then proceed to a Q&A session. So our news result and business outlook will be presented through simultaneous interpretation and the Q&A session will be conducted via consecutive interpretation. First of all, introduction of all of the senior management members in attendance today. First of all, Yong-Seok Kim, EVP of ESG Strategy Group; [ Minwoo Kim ], Director of Corporate Planning Division; Jeong-Won Kang, Director of Finance and Accounting Division are here with us. And [indiscernible] Director of Monomer Division, as well as Basic Chemicals, and [ Sung-Ho Yoon ] Director of Polymer Division is here with us. From LC Titan, I have Mr. Philip Kong, EVP of Corporate Planning is here and [ In-ku Park ] Director of Battery Division, and [ Hyun-Ok Kim ], Director of Batteries Material Division is also with us. Now, let me walk you through the business results of Q2. Sales in Q2 posted nearly KRW 5.511 trillion, down 1.3% Q-o-Q while operating profit posted KRW 21.4 billion in losses. In this quarter, the turnaround for Yeosu plant was conducted and consequent opportunity losses were reflected. Demand contracted on the back of rising feedstock prices and deteriorating external environment, resulting in declining sales Q-o-Q and an operating profit turned [ negative ]. EBITDA posted KRW 185.9 billion, accounting for 3.4% of sales and gains and valuation for equity method posted KRW 122.8 billion, up KRW 79.7 billion Q-o-Q. Now, let me explain about the financial highlights. As of the end of Q2 of 2022, assets posted KRW 23.872 trillion, up [ KRW 1,016,900,000,000 ] YTD. Cash equivalent assets stood at KRW 3.341 trillion, down KRW 1.145 billion YTD. Liabilities [indiscernible] and KRW 175.7 billion. Borrowings came to KRW 4,126,600,000,000. Equity posted KRW 15,696,300,000,000, up KRW 257 billion for the end of 2021. As of the end of Q1 of 2022, a debt ratio posted of 52.1% of 4.1% YTD, and net-debt ratio posted of 5.0%. Despite the difficult business environmental, Lotte Chemical is carrying out its investment activities as planned to ensure its future growth. And as such, on a YTD basis, cash equivalent asset was down approximately KRW 1 trillion. Despite this, however, a stable financial structure with a debt ratio of 52.1% is maintained. Next is the business result and outlook by business division. The sales for the Basic Chemicals business in Q2 of 2022 posted a KRW 3.453 trillion and operating profit posted minus KRW 8.4 billion in losses. In terms of market situation, despite healthy profitability of the aromatics of products, the feedstock prices for the olefin product increased. And along with continuous sluggish demand for the derivative products within the region, global feed demand also weakened on the back of concerns over inflation as well. This resulted in declining profitability of the Basic Chemicals business. Also starting from May, a turnaround took place in the Yeosu plant for a month and KRW 40 billion in opportunity loss was reflected. Now, let me move on to the outlook for Q3. As naphtha prices are showing a downward trend, now feedstock price is expected to be less of a burden. But because of the slowdown in global demand, we anticipate a challenging business environment to continue. Next is the Advanced Materials business. The Q2 sales for Advanced Materials posted KRW 1,234,600,000,0000 and operating profit posted KRW 71.4 billion achieving operating profit ratio of 5.8%. In terms of the market situation, downstream demand has plunged owing to inflation concerns. However, sales of high value added products have been maximized and PC products are spread improved on the back of downward stabilization of BPA prices. Thus, profitability improved over the previous quarter. Also along with the Basic Chemicals, Yeosu plans turnaround for the Advanced Materials as well turnaround for some of the PC facilities took place as such. KRW 16 billion in opportunity losses were reflecting. In the case of the third quarter because of the impact of inflation demand for a downstream products is expected to further decline such as household appliance, IT products. And as such, profitability is expected to decline modestly. Next, let's move on to the business results of the LT Titan. In Q2, the sales of LT Titan posted KRW 821.8 billion in operating profit versus minus KRW 60 billion in losses. Up until now, although lockdowns within the country has had dampened demand, in Malaysia it had been lifted. Because of the impact of lockdown across major cities in China, recovery of downstream demand is being delayed. And as the cost burden becomes aggravated, profitability has deteriorated significantly over the previous quarter. In the case of the third quarter, the cost burden may be reduced to a certain extent. However, due to the impact of external instability, customers are taking a wait and see attitude and as large scale capacity adds on or scheduled to hit the market in the Southeast Asian region, we expect the scope of improvement in profitability to be limited. Lastly, LC USA. Second quarter revenue of LC USA was KRW 178.4 billion, OP profit was KRW 3.8 billion and OP margin was 2.1%. Recently, natural gas exports from U.S. to Europe has increased unprecedentedly, which has led to a spike in SM prices, increasing our cost burden. Also demand for MEG in the U.S. has remained soft due to instability in the external environment which has negatively impacted the profitability of the U.S. business. Third quarter outlook for LT USA is that SM prices are expected to stabilize somewhat versus second quarter, but with geopolitical risk continuing SM prices are expected to remain strong. In the case of MEG, in addition to the oversupply and weak demand, product prices are likely to decline further in line with falling naphtha prices. So third quarter business environment is expected to remain challenging. Next is an update on our key investment projects. HPC which was in pilot production started commercial production from June 30, which will be reflected in the equity method gain and loss of Hyundai Chemical. C4 production capacity of Lotte GS Chem, which is the joint venture with GS Energy started commercial operation as of July 1, and we owned 51% of the project which is expected to show up on our consolidated P&L from third quarter. Lastly, an update on the additional investments related with the EV battery electrolyte organic solvent products announced last June. Lotte Chem has selected battery materials as a future new business and has been expanding related investments. In addition to the high purity EC and DMC that we were already pursuing, we plan to additionally produce 68,000 tons of EMC and the DEC products and have decided KRW 140 billion in investments to achieve this. The project is targeting mechanical completion during second half of 2024 and plans to produce products with our proprietary technology. The other projects are also on track without disruptions and so please, refer to the slide for the details. I would also like to provide an update on our shareholder return policy. Even though we had originally planned to carry out interim dividends from this year, we will not be able to do so. We ask for your understanding that the company will be switching back to an year-end dividend for this year. With uncertainties in the external economic environment increasing our second quarter results have fallen significantly below plan. And after comprehensively considering various factors including cash flow, the company has decided to not carry out an interim dividend. We ask for your understanding, while the second half is expected to be also quite challenging. We will focus on cost saving on existing equipment and increasing sales of competitive high margin products to maximize our profits. And for the year-end dividend, we plan to maintain our existing policy of 30% payout on a nonconsolidated P&L basis. The 3 year KRW 300 billion in buyback program is still valid and is expected to be carried out as planned within the 3 year period. We announced last week that the company will be doing a KRW 50 billion in buyback. This may be below your original expectations but we will do our best to deliver the 3 year KRW 300 billion buyback commitment starting from this year. We will continue to attentively listen to the feedback from our shareholders. Now that completes the review of second quarter results and third quarter outlook. And our EVP, Yong-Seok Kim will be actually going over some updates of our U.S. battery material business and the hydrogen business.

Good afternoon. This is EVP, Yong-Seok Kim, Head of Lotte Chem's ESG Strategy Group. Thank you for joining our conference call each quarter. The recent conditions of the petrochemical industry has -- have been very challenging with higher feedstock costs, weak demand and oversupply. And this has led to our quarter-on-quarter results falling versus the previous quarter and second quarter. Third quarter and second half conditions are not likely to improve easily. Despite such instability in the business environment, Lotte Chem can continues to remain focused on improving operational efficiency and various cost reduction measures. And at the same time, we continue to work on improving our downstream portfolio by expanding new growth areas, such as solar power and rechargeable battery materials. And also increasing the share of high-end compounding products. Leveraging our stable financial ability, we are continuing to make investments into new green businesses that will enhance our future enterprise value, regardless of fluctuations in our short term business results. For example, last June, we established the U.S. holding company to the battery materials business in the U.S. and signed a joint venture agreement for the hydrogen business. Today, I would like to provide some updates on these new growth engines, which is the battery materials business and the hydrogen business. In the case of the battery material business, we believe that the growth opportunities in the U.S. and other overseas markets will be much larger than that in Korea, and so we plan to focus on the U.S. market. Of the KRW 5 trillion of revenue target for year 2030, about 60% is expected to come from the U.S. business. To pursue the business opportunity in the U.S. last June, Lotte Battery Materials USA was established as a 100% owned subsidiary to play the role as an investment holding company for the battery material business. Through Lotte Battery Materials USA, we will focus on securing the production capacity in the U.S. on time for all 4 major battery materials used in lithium-ion rechargeable batteries, and also make the necessary investments to gain an edge in battery-related new materials and technology. As a first step, Lotte Battery Materials USA established the Lotte Aluminum Materials USA as a joint venture with Lotte Aluminum last July. Lotte Aluminum Materials is a company that will produce lithium battery cathode foils and is 70% owned by us and 30% by Lotte Aluminum. This will be the first aluminum cathode oil production site to be built in the U.S. Construction is scheduled to start within this year and commercial production is scheduled by 2025. In addition to the cathode foil, Lotte Battery Materials USA also signed an MOU with Soelect in April to pursue a lithium-metal anode material business and is currently studying construction plants. The electrolyte organic solvent business is covered by an MOU with Seosan, under which we're looking into business opportunities in the U.S. Our basic approach to the battery materials is that Lotte will actively expand its existing material capabilities with speedy investments and materials that Lotte currently does not have, we will enter markets by working with various partners. We expect our battery material business in the U.S. to become more tangible soon and hope to share with you the details in the near future. Next is an update on the hydrogen business. Our goal is to generate KRW 5 trillion in revenue by 2030 with KRW 6 trillion in cumulative investment. The hydrogen ecosystem is still in the initial stage of development, and therefore is likely to take longer than battery material business to deliver visible results. Now that said, we're aiming to invest across the total value chain that covers supply, distribution and demand of hydrogen and to gain a leadership in the hydrogen industry in Korea. Now as [ fast forward ] in June, we signed a 3-party joint venture agreement with SK Gas and Air Liquide for hydrogen fuel cell power generation and refilling station business, and also signed a joint venture agreement with Air Liquide for hydrogen delivery transport business. The respective joint venture entities for both projects are expected to be established during the third quarter. Each project is planning to start initial business using the byproduct hydrogen capabilities and technology owned by Lotte Chem and the partners. In terms of each business, in the case of the hydrogen fuel cell power generation business, commercial operation is expected to start from year 2025. And we have plans of building 2 units within our Ulsan plant. The hydrogen filling station business aims to open 50 stations by year 2025 and 200 by 2030, mainly focusing on commercial vehicles. Initially the joint venture will establish 2 delivery sites; one in Ulsan and the other in Daesan and create a near distance hydrogen distribution network and later on expand to liquid hydrogen transportation when demand expands in the future. The hydrogen business is still in its very nascent stage when considering the entire roadmap. But these early projects are important as the foundation for clean hydrogen that we aim to produce in the long term. Based on these operations, we will achieve a goal of achieving the carbon reducing growth. Our dear investors, even in the second half, as we mentioned, the petrochem industry as well as the overall global economy is expected to face uncertainties and a challenging business environment. Under these circumstances, we will continue to move forward step-by-step to achieve our vision regardless of short-term business results and deliver greater enterprise value, as well as greater shareholder value in the long-term. Thank you again for your ongoing interest and support for Lotte Chem. Thank you.

[Operator Instructions] The first question will be presented by Chun Woo-Je from Hanwha Investment & Securities.

I have a question with regards to what is written on Page 9 of the presentation deck about the new investments. So together with Lotte GS Chemicals, so you have plans for the first round of capacity add-ons and the second round of capacity add-ons. So, can you explain about what kind of impact this will have on increasing the sales and also whether this has any possibility of vertical integration as well? And my second question has to do with the facility expansion related to the next generation battery, the electrolyte organic solvent facility. So -- because I don't have a deep understanding about this area, does Lotte Chemical kind of strength or competitive edge, does it have in this area and to what kind of customers do you plan on selling these products?

So let me take the second question first. With regards to the electrolyte organic solvent, the facility. So this is one of the key 4 materials that goes into your electric vehicle, EV batteries. It is a component that is included in the electrolyte. Our key competitors in the electrolyte organic solvent area are Japanese or Chinese companies. However, the global supply chain is shifting towards the United States and the European companies and so it's becoming more difficult for the Chinese companies to enter into this area. In the case of our company Lotte Chemical with regard to the electrolyte organic solvent, we have a strong competitive edge. And compared to the Chinese competitors, we are more easily able to enter into this area. Key competitiveness that we have in the electrolyte organic solvent area is the fact that when it comes to the feedstock, the raw material that goes into producing this product, we have high purity EO, ethylene oxide and we have 100% vertical integration when it comes to this feedstock. And so, compared to our Chinese peers who have to procure all these feedstock from overseas and produce these our products, we have very strong cost competitiveness. So finally, with regards to the major customers for our electrolyte organic solvents within Korea, LG Energy Solution, SK On and Samsung SDI and also across the world, we have companies like Tesla, who are making inquiries into our products. The commercial production of our facility to produce these electrolyte organic solvents is expected to start in 2023 but already we are receiving many inquiries from both Korean battery companies, as well as global companies like Tesla. So really the outlook for this business has been very bright.

I'm Yong-Seok Kim the Director Of Hydrogen Energy Division. And let me take the question about the Lotte GS Chemical. So this year, the sales is expected to reach around KRW 150 billion to KRW 200 billion in terms of operating profit margin or 4% level is expected. With regards to vertical integration, we will continue to review this possibility together with Lotte GS Chemical.

The next question will be presented by Parsley Ong from JPMorgan.

My first question is on Slide 10 of your presentation. I think in the past, Lotte Chem had this target 2030 vision for about KRW 10 trillion green chemical revenue of which for Lotte Group and for which Lotte Chem would have maybe KRW 6.5 trillion. And under that, the mobility of Battery materials division would have less than KRW 2 trillion revenue by 2030. But on Slide 10, you now have Lotte Battery Materials revenue KRW 5 trillion by 2030. Does that mean you have increased your business plan or revenue target? Or is some of that KRW 5 trillion actually equity method income contribution, and so your original target has not actually changed? For example, I see headlines that a Lotte is -- might be trying to buy a stake in Iljin Materials. So if we have let's say, a 10% stake in Iljin Materials, are we counting 100% of Iljin Materials revenue under copper foil to get that KRW 5 trillion? So basically, I want to see if there has been any upward revision in your mid to long-term business strategy for Battery Materials. And the second question is on your ESS business. I see here that you are partnering with Standard Energy and if you look at some articles online, Standard Energy appears to be planning to do vanadium ion battery ESS solution for ship. Is that the business plan? And could you share with us -- because I see that you're also doing vanadium battery electrolyte, et cetera. So could you share with us what kind of potential you see in this market and your mid to long-term expectations on revenue, returns, op margin, et cetera?

My name is [ Minwoo Kim ], I'm the Director of Corporate Planning Division. With regards to your first question about whether the equity method calculation has been reflected in the KRW 5 trillion targets for the Green 2030 goals? Well, if you look at the accounting methods and if you look at, on the other side the actual business size and how meaningful to what kind of magnitude the business will be grown in the future, these are 2 different issues. And at the moment, I'm not in a position to actually answer your question of whether the equity method will be reflected in the calculations of this goal or not. With regards to the potential investments that we are considering, due diligence process is underway but nothing has been finalized in terms of the actual investment. And so in relation to that issue of whether it will have an effect of upward adjustment of our sales or targets is not something that we're considering at this point. I just want to add that that with regards to the 2030 strategy that we have announced to the market, the material that you have referred to, that is included in the possible business areas that we can expand into. But at the moment, this is not linked to any upward adjustment of our future revenue goals.

So my name is [ In-ku Park ]. I'm the Director Of Battery Material Division. Let me -- I'll take your second question about the Standard Energy collaboration. In the case of vanadium battery compared to the lithium-ion battery, it is much safer in terms of the potential for fires and it has much more longer battery life and so, it's very suitable for our urban based ESS solutions. So, in the case of Standard Energy, this is a startup company that develops and produces the vanadium batteries for ESS batteries. And in this year, a Lotte Chemical has taken out a 15% stake in this company. That aside a from taking out as 15% stake in Standard Energy for the vanadium ESS batteries, we are looking into various other options for collaborating with Standard Energy to expand in this area. And as a first step for this project, in the month of June of this year at the Hi-Mart, which is a hypermarket in Korea at the Apgujeong branch of Hi-Mart. We have started a demonstration project for ultra-fast charging station for vanadium battery based ESS. So after undertaking this demonstration project for a year, we intend to expand the business of ultra-fast charging stations in Korea. And after the trial is over, we also intend to expand into overseas markets as well. And also, we are building a pilot plant to produce electrolyte, which is a key ingredient for producing vanadium batteries. And our plan is to complete the construction within the first half of 2023.

Currently, there are no participants with questions. [Operator Instructions] The next question will be presented by Jin-Myung Lee from Shinhan Investment.

So I have 2 questions. The first question has to do with your comments about increase of share of high value-added products in the second half as well as going into the next year. And so by business division, can you inform as to the share of the high value-added products in the overall product portfolio and the profitability of these product groups? And also, can you inform as to your CapEx plans by business position going into the second half of the year?

So let me take the first question. I'm [ Sung-Ho Yoon ], the Director of Polymer Division. In the Polymer division, the share of high value-added products or PE and PP takes up more than 50% of our strategic product portfolio. And in times like these when the market situation is very challenging, we intend to continue to increase the sales of these high value-added products going forward. Among the high value-added products, so there's a EVA for the solar power usage and also there's PPA for food packaging, top polymer. And compared to the commoditized products, there is a difference about 5% in terms of profitability. With regards to the Advanced Materials business, with regards to share of the high value-added products. In terms of the ABS, the high value-added products is more than 98% of the total portfolio. And according to our standards, these are not commoditized products, and these are products that are customized to the requirements of the customer. And in terms of the polymer products, about 60% in terms of sales, it is composed of high value-added products in terms of volume or the high value-added product takes up 50%.

I'm Yong-Seok Kim. I am the EVP of ESG Strategy Group. Let me take a question about the CapEx. On an annual basis, the CapEx for the year 2022 is a total of KRW 3 trillion and KRW 1 trillion of CapEx has already been executed for the first half and KRW 2 trillion in addition is planned for the second half. So if you look into more details, the equity investment took up KRW 900 billion in the first half. And in the second half, KRW 1.100 trillion is scheduled to be expended. And also for new investment in the first half of the year, KRW 100 billion and in the second half of the year KRW 550 billion is scheduled. The rest -- the remaining KRW 600 billion is for ordinary investment.

The next question will be presented by Dong Jin Kang from Hyundai Motor Securities. The next question will be presented by Parsley Ong from JPMorgan.

I have 2 follow-up questions on your Battery Materials division and one on your normal Chemicals division. So for your Battery Materials division, you mentioned you're building lithium material capacity in the U.S. Could you share with us what kind of capacity and CapEx you're looking at? Second question is a follow-up question on your vanadium battery. Could you share with us, if possible, the rough energy density and watt-hours per kg for your vanadium battery? And how do you compare this versus sodium-ion and LFP batteries? And then the third question is on your Chemicals business, could you update us on your third quarter and fourth quarter maintenance as well as rent cut plans?

I am [ In-ku Park ] I'm the Director of Battery Material Division. Let me take the question about our lithium-ion battery material facility that we're pursuing in the United States. So with regards to lithium-ion battery materials in the United States as has already been announced, we have decided to pursue the cathode foil business as well as the organic solvent business. But aside from these business areas as well, we're also considering other business areas as well. With regards to the cathode foil business in the United States, has been already announced that together with Lotte Aluminum, we have created a JV, a joint venture company with equity shareholdings being split 7:3 between Lotte Chemical and Lotte Aluminum. And we are making preparations to start commercial production from 2025. With regards to the organic solvents business, as has already been announced that we are pursuing a JV with Seosan, and we are reviewing the possibility of building organic solvent facility in the United States after 2026. With regards to the U.S. cathode foil our plants, the CapEx is on a yearly basis 36,000 tons per year and under normal operation rates the sales is expected to come to KRW 300 billion. In the case of vanadium battery, how it's energy density compares to other competing products? Well, when vanadium battery is compared to the lithium-ion batteries, it's annuity density is 1/3 lower than the lithium-ion batteries. But in terms of a fire accident safety, it's much more superior and it has longer battery life. And so it is a product that is highly suitable for ESS applications.

So let me take the question about the turnaround that is scheduled for the third quarter as well as the fourth quarter. Well, there is no such a turnaround that is scheduled for Korea. But in the case of Malaysia, LC Titan for some of the PPP lines, our turnaround is scheduled. With regards to your question about the rent cut. So for Korea in the third quarter, crackers, we intend to maintain an operation rate of 85% to 90%. So there will be some production cuts. And for SM and EG, it will be around 70% to 75% operation rate, but nothing has been decided for the fourth quarter yet in terms of the rent cut.

So let me take your question about the long cut from the Advanced Material side. There is no turnaround that is planned for the second half. And in terms of the adjusting the operation rate given, the volume of inventory that has been built. And also given the challenging business environment, we intend to adjust the operation rate to around 70% level.

So with this, we would like to end the earnings presentation for Q2 of 2022 for Lotte Chemical. If you have any further questions, please contact us at the IR team of Lotte Chemical. We'll see you again at the third quarter. Thank you. [Statements in English on this transcript were spoken by an interpreter present on the live call.]