S-Oil Corporation (A010950) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to our first -- third quarter of 2021 earnings conference call. I am Cho Yong-kuk, the Treasurer of S-OIL CORPORATION. I would like to thank you for joining us for this conference call, and it is my pleasure to speak to you today. For today's conference call, Mr. Ko Gwang-cheol, IR team leader and other IR team members have prepared for the presentation with me. Prior to the presentation of the company's third quarter financial results and market environment by Mr. Ko, I would like to brief you on the company's performance for the third quarter and the blueprint for sustainable growth of our society and the company in the near future. In the third quarter, as COVID-19 vaccination rate has continued to increase, expectation for revitalizing economic activities has been growing. With these expectations, the company posted a quarterly operating profit of KRW 549 billion exceeding the market expectation like the second quarter. As a result, the company renewed the historical high operating income and income before tax for the first 9 months recording KRW 1.750 trillion and KRW 1.489 trillion, respectively. The company's noticeable performance in the third quarter showed that the negative elements incurred by the outbreak of the COVID-19 are being [ led ] faster than expected. In the third quarter, demand recovery for the refined products pushed Asian refining margin higher, which was fully realized into third quarter profits with a stable operation of major plants, including ODC at capacity or above and lube-base oil products consecutively renewed record high operating profit due to a strong demand for high-quality products and accounted for over half of the total operating profit. In order to fully capitalize on the robust margin level of lube base oil and polymer increasing demand, the company increased the operation rate of lube base oil and PO plant up to 101%, 116% of design capacities, respectively. As margins for gasoline and diesel have been increasing, the strong performance is expected to continue for the rest of the year. Moreover, recent price hike of natural gas will support the oil demand as a substitute for gas, which is expected to accelerate the margin increase for the refined products. Additionally, the company is developing the ESG management and the new business for the sustainable growth of the society and the company. Regarding the ESG management, the company has been conducting a project for establishing ESG framework with external specialists. By developing elements and initiatives during the project, the company will establish our road map for ESG activities. In respect to the new business, the company is planning to advance into the overall hydrogen area as one of our new growth engines. Especially the company signed an MOU with Samsung C&T in September to jointly develop hydrogen value chain and biofuel business. Besides, the company is planning to import low ammonia from Saudi Arabia and supply them to the market. In the third quarter of the year, the company achieved a notable performance despite the persistent pandemic situation. The company will continue to make an effort to secure the interest of all stakeholders and its sustainable growth. Thank you all for listening, and I would like to request your continued support and interest once again. Now I hand over to Mr. Ko. Mr. Ko, please.

Thank you, Mr. Cho, and let me add my welcome to all of you joining today. Before starting, I'd like to draw your attention to our cautionary statement. Third quarter financial results are provisional. And the results are subject to change after external auditor's review. Also, over the course of this conference call, we will make forward-looking statements that is based on our current expectations, assumptions, estimates and projections. We caution you not to place undue reliance on any forward-looking statements which may involve risks and uncertainties. Now I will begin the presentation of our third quarter financial results on Slide 4. We delivered KRW 7.1 trillion in revenue or 6% quarter-on-quarter on the rising selling prices. Selling prices increased by around 10% quarter-on-quarter in tandem with high-quality crude oil prices, whereas sales volume declined by 3% as the product shipment late September was affected by passing typhoons in the region and port congestion in China. Operating income was KRW 549 billion, posting strong performance for 3 quarters in a row and offsetting all-time high of operating income for the first 9 months. Such a good performance was driven by more widened margins in light and middle distillate products and consistent high margins in lube base oil. Inventory-related gain from crude oil price hike reduced KRW 88 billion from KRW 139 billion in the previous quarter due to relatively mild rise in crude oil prices in third quarter. Below operating income line, the sharp depreciation of Korean won versus U.S. dollar incurred FX loss of KRW 157 billion. As a result, third quarter pretax income was KRW 473 billion, decreased by KRW 76 billion compared to last quarter. Moving on to the next slide, our financial status. Mainly due to increase in working capital requirements, current cash balance decreased to KRW 0.7 trillion, while net debt balance increased to KRW 5 trillion, but balance sheet maintained its robustness. Net debt-to-equity ratio recorded 76%, whereas debt equity ratio lowered to 88% from 91% a quarter ago. ROE and ROCE posted 23% and 17%, respectively. EBITDA in third quarter was KRW 602 billion. Moving on to third quarter performance of each business on Slide 6. In refining business, sales revenue increased 7.7% quarter-on-quarter. Operating income recorded KRW 185 billion, 21% expansion from the previous quarter. The rebound in regional demand margin led to profit improvement following full operation of refining plants. Inventory related gains reduced to KRW 72 billion in the third quarter. Petrochemical segment saw operating income decrease to KRW 75 billion down 44% quarter-on-quarter with operating profit margin ratio of 6%. Product spread over naphtha narrowed quarter-on-quarter as the demand strength was weakened amid resurgence of coronavirus variants in Asia. On the other hand, lube business renewed record high profit again around the previous quarter, posting operating income of KRW 288 billion, thanks to strong demand for high-quality products. Turning to the capital expenditure and refinery operations. In the third quarter, KRW 74 billion was put into capital expenditure. Most of the fund went to minor projects and construction as planned. The remaining budget will be mostly used in first quarter. Depreciation for the corresponding period was KRW 444 billion. Looking at plant operations in third quarter, there was no maintenance and the whole units except para-xylene one were steadily operated at capacity or above. Especially PP&PO plant, which is called RUC, was running at 115%, following 109% in the second quarter to capitalize on favorable market situations to maximum. Whereas PX facilities were operated at around 90%. So the operation to adjust a month of PX plant, the company instead increased the production of gasoline that has higher margins. In the fourth quarter, we do not have any maintenance planned either. Next, let me explain third quarter market environment and fourth quarter market outlook by each business on Slide 8. Singapore refining complex margin rebounded to minus $0.6 per barrel from minus $2.2 in the previous quarter. Continuous demand recovery fast reduced the global inventories to multiyear low pushing on refining margins. In the first quarter, regional refining margin is expected to go higher. Increase in border reopening and COVID-19 restriction lifting across the globe will lead to stronger demand recovery. And inventory build-up demand will be added ahead of winter season. Furthermore, some consumers will switch to oil product as alternative to natural gas and coal with supply goes in short these days. Moving on to polymer and petrochemical sectors. PO spread over naphtha remained [indiscernible], $1,352 per ton due to firm demand, even though it narrowed quarter-on-quarter affected by the rising naphtha price. PP spread also softened recording $443 per ton on average as the demand was slowed by spread of coronavirus variants in the region, while new capacity operation increased supply. In the fourth quarter, PO spread will continue to be bullish supported by tight market fundamentals. PP spread is expected to maintain robust level as the demand would be returning due to stabilization of COVID-19 cases in the region. Potential upside would be restrained by supply increase from new capacities. Turning to aromatics, next slide. PX spreads dropped quarter-on-quarter to $225 per ton on average caused by spread of Delta variant and operation cut in downstream plants in China in spite of start-up of new PTA plant. Benzene spread retreated from second quarter high level posting $318 per ton and supply increased from new capacities and import reduction from U.S. after Hurricane Ida. Looking ahead, PX spread will continue to be pressured by lower run rate of downstream plant in China. But shutdown or operation cuts from uneconomical PX plant would somewhat offset this downward pressure. Benzene spread is also expected to be affected by operation cut in derivative sectors in China. However, it will be maintained at a health level by low inventory and operation of new styrene monomer plants in China. Lastly, looking at lube base oil market on Slide 11. Lube base oil spread over high-sulfur fuel oils resulted downward to $73 per barrel from second quarter record high level because of restart of major plants after maintenance. However, Group III spread was widened by strong demand for high-quality products. In the coming fourth quarter, lube base oil spread is forecasted to stay high supported by demand and robustness for high-quality products, although easing supply tightness would act as pressure along with hike of feedstock prices. That concludes my prepared presentation. Thank you for listening. Now we would be happy to take your questions.

[Operator Instructions] The first question will be given by Parsley Ong from JPMorgan.

So my first question is on dividend. If you look at your earnings for this year, we are on track to probably get record high OP. And for the last 3 years, we've had pretty poor dividend, given weak earnings. And over the last 15 years, generally in -- profit of this level would indicate a higher payout ratio. Do you think a 50% to 60% payout ratio is possible? And also, could you share what's your CapEx outlook for 2022? Second question is on your new business opportunities. Could you tell us a bit more about fuel cell innovation and your key targets over the next 5 years? For example, when do you expect an actual product to market? When do you expect first revenue, et cetera?

[Interpreted] So to answer your first question on the company's dividend for this year. As you know, the company has maintained a fairly high dividend payout ratio in the past years. However, we had to lower our payout ratio to around 30% in the last 2 or 3 years because of the poor performance. As I have made myself clear in the past in our conference calls, this is subject to a resolution by the Board and therefore, the 2021 year-end dividend will also be determined by the Board in March next year. As for the company's dividend policy, we make the policy, and we strike to balance -- we aim to strike a balance between the investments that we need to make for the future and the soundness of the company's financial structure and the shareholder return. So all these 3 factors are taken into account in determining the company's dividend for that particular year. So again, the year-end dividend will be determined by the Board next year and the direction whether the payout ratio will go down or up, it's something that is very hard to say at the moment because it is not up to -- it is up to the Board's decision. And as for the dividend guideline, we have maintained it for the past 2 years on keeping our payout ratio at 30% or above. And whether we are going to make some adjustments in this number will also be made at the end of the year based on our communications with the Board. And once a decision is made, we will definitely communicate this with the market. As for the fuel cell innovation, in March this year, we secured 20% of the equity ownership of this company with an investment of KRW 8.2 billion. And whether we are going to invest further into the company will be subject to the FDIs, the plans to invest around KRW 100 billion until 2027 in order to enhance its production capacity to 100 megawatts. And so this will be the factor that we'll look into in determining our decisions for future investments. And our outlook for 2022 CapEx is KRW 600 billion.

The following question is by Kyoung Jae Song from Hanwha Financial Investment.

[Interpreted] This is from Hanwha Securities. I have 3 questions. I'm hearing news of the Chinese refinery facilities being regulated. Could you share some of the highlights of what's going on in China? And what is S-OIL's thought around this? Second is about the EBITDA of RUC and ODC. 3 years ago, you communicated to the market that the EBITDA expected from the RUC and ODC is around KRW 600 billion. But these days, the PO margin is very good, the gasoline spread is also favorable. So is there any chance that there will be -- the RUC and ODC will make a higher contribution to the company in terms of income creation? And third is about your plans to purchase blue ammonia from Saudi Aramco. If this is done, how much will this contribute? I mean, how much sales revenue and income do you expect to generate from this business?

[Interpreted] So on your first question about the Chinese government regulating the refinery facilities in the country, I think this is targeting mostly the so-called cheaper refineries, the medium and the small size ones. The first was in the middle of June this year, where the Chinese government started to impose consumption tax to light cycle oil and bitumen, which are used as the blending stock. This was aimed at keeping the cheaper refineries from playing around the loopholes to enhance their market share in the domestic market. And also the Chinese government imposed a crude import quota. They allocate a quote -- import quota to the teapot refinery. And every year, the quota has been on a rising trend. But this year compared to 2020, the import quota to the teapot refineries has actually gone down, and the market does not expect to see any increase in the quarter during the remaining period of the year. So all these factors combined to move the teapot refineries to actually lower their throughput rate. So this decrease in the crude import quota has actually eased the competition among the state-run Chinese refiners and the domestic market. And this resulted in these state-run companies actually cutting, slashing their export volume in the region. As a result of that, the China's third quarter export volume has actually been slashed by more than 40% compared to the second quarter, resulting in a tighter supply for -- tighter supply of fuel products in the regional market across Asia. And as for the income contribution by the RUC and ODC. Well, the company does not break down the income contribution by unit. But if we compare the product spread versus -- the actual product spread versus the plan, some of them are underperforming the plan and some outperforming the plan. But for the propylene oxide, it is far outperforming the plan. And for gasoline, it is close to the plan in terms of the spread. And from the fourth quarter of last year, we have seen the income contribution by RUC and ODC outperforming the plan and even more so for 2021. Again, [ RUC and ODC ] is outperforming the plan and [Technical Difficulty] in the last 2 years since we started up the RUC. Our design capacity for RUC is 76,000 bp, but we raised the capacity [Technical Difficulty] market situation. The PO plan, the design is 300,000 tons, but we've raised it to 330,000 tons or up to 340,000 tons, which is above the designed capacity. So this favorable spread and the actual increase in the design capacity, I mean us producing more than the design capacity is anticipated to generate more than KRW 200 billion every quarter in terms of the EBITDA. And as for your third question on the blue ammonia, well, as I have said at the very outset, we have signed a partnership with Samsung Constructions & Trading to build a hydrogen value chain, which includes the blue ammonia and the biofuel business. And this is one of our plans to cut down on carbon emissions. However, this is only in the planning stages. It is -- and therefore, still is too premature and early to share with you what the business size will be, what is going to be the time line, and what will be the impact on contribution in terms of -- contribution to the company in terms of the income creation. But once we get a more clearer picture, we will definitely communicate this to the market.

The following question is by Oscar Yee from Citi Bank.

My first question is related to your cost of hydrogen. My understanding is that you have been using some LNG feedstock to probably make hydrogen. Could you share us roughly on an annual basis, how much LNG do you consume per year? And I remember that you also previously have signed a long-term contract, right, on the LNG supply. So currently, do you still need to purchase from the spot market on that? Second question is just a bit on the numbers. Could you share us what is the sort of a positive FX impact from the won depreciation in 3Q on the OP side?

[Interpreted] Well, previously, we used enough feedstock, but because of some cost issues, we signed a long-term LNG purchase contract a few years ago. As for the hydrogen cost and the total portion, we still don't -- we don't have the exact numbers. And for the LNG long-term purchase agreement, since we have this long-term purchase agreement, I don't think we are purchasing in the spot market. But once we have the numbers, we'll share that with you. In third quarter, the FX went up. So there was some FX loss incurred in the nonoperating side. But the other hand, there was some positive FX impact in the operating side in terms of the operating income. But I don't have the specific numbers, the specific impact of the financial exchange on the operating income in terms of the numbers. I don't think it's big, but I'll try to get it and I can share with you later.

The following question is by Baek Young-chan from KB Securities.

[Interpreted] I have 3 questions. The oil price is on a rising trend. What is your outlook for next year? Second is about the inventory-related gains and loss. Based on the lower cost method, what is the inventory gains or loss in the fuel business. And third is about your new investments. You mentioned the FCI and the blue ammonia, but I think this is rather contradictory with the Shaheen Project. So what is your take on the Shaheen Project?

[Interpreted] On your first question about the oil price outlook, well, it's very difficult to make an outlook. But given the fact that we are having a tight supply and the fact that the demand is expected to keep recovering as the COVID-19 [indiscernible], we expect the oil price to remain rather bullish. And as you know, all the talks around the ESG and the carbon emission reductions are actually putting some constraints on new investments to create more supply. And few institutions are forecasting a new supply to come to the market. In the demand side, the global economy is on a recovery track. And even so the current demand is not up to 100% of the prepandemic levels, which leads us to expect the demand to keep rising in the fourth quarter and through the early part of next year. And as a result of that, we expect to see the oil price to stay rather bullish for the next few months at least. And for the lower cost method on the inventory side, well, since the oil price is not very volatile in the third quarter, I think the impact was almost 0. And for the Shaheen Project, well, the basic design and concept of this project is to produce much less fuel products and instead produce more petrochemicals. And at the same time, this will not rely on the conventional way of producing the petrochemical products, which is a naphtha cracker. And instead, we'll do so with the energy-efficient TC2C to produce more petrochemicals. So I cannot say that this will be a net-zero new plant. However, since we will be producing less fuel products out of the new plants, out of the Shaheen and produce more petrochemicals, there will be a big slash in terms of the carbon emissions. And at the same time, the energy use will be very efficient. The total energy consumption will be much less than the conventional plants. So overall, I think this project will contribute to the company's efforts to become cleaner and emit less carbon.

The following question is by Chun Woo-Je from Hanwha Investment Securities.

[Interpreted] So I have 3 questions on the lube base oil. It's very strong these days on the demand side. Is it because the demand from -- for the vehicles and the airplanes is going up? Or is it from the supply side as some of the lube base oil producers in Korea and around the world have adjusted their yield? Second is about the PO. It has very spread these days. What do you -- where do you think that some strong PO spread is coming from? And what is your outlook? And third is about the CDU plant. I was told that there was an expansion plan that was delayed. Any updates about the CDU plant expansion plan?

[Interpreted] So to answer your first question on the lube base oil profitability. As you know, the spread peaked in the second quarter. And in the third quarter, the overall supply tightness eased as plants lowered their throughput or had to shut down because of maintenance all came back starting from the end of the second quarter. As a result of that, the spread in the third quarter slightly softened compared to the second quarter. However, the demand for the premium lube base oil was still very high in the third quarter. And as a result of that, the company's income from the lube base oil business was actually higher in third quarter compared to the second quarter. And we expect the demand for premium lube base oil to continue to go up because of the overall increase in the global mobility and also the premium lube base oil is considered as a green product and countries around the world, especially the advanced ones are imposing very tight regulations on the vehicle emission gas. So all these factors are all in favor of the premium lube base oil. On your second question about the PO. As you know, the PO spread is very high these days. It's largely due to the very tight market fundamentals, and we expect this to last for a while. And as for the PO, if you look at the propylene oxide downstream, which is mostly the consumables like the materials for construction and architecture of the car interiors or the home appliances, like the refrigerator, the demand for these consumables are going up, particularly in Asia as the Asian people's income level is going up and their consumption pattern is becoming more westernized. So as a result of that, the demand is high, but we're not seeing as much expansion as to your plans, which is causing some tightness on the supply side. As for the CDU plant, I think it's not rather than -- this year. We are seeing some plans for expansion in 2022. And the low -- unprofitable CDUs, they have been shutting down. We're seeing that this year, and we expect to see this coming in 2022 as well.

Currently, there are no participant question. [Operator Instructions].

[Interpreted] Well, it looks like there are no more questions and reaching almost an hour. We would like to conclude the conference call for the third quarter earnings. Once again, thank you very much for your participation, and we look forward to meeting you again in the fourth quarter and in good health. Thank you very much. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]