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

Good afternoon, everyone. This is [indiscernible], the Treasurer of S-OIL. Thank you for your attention to S-OIL's Q1 earnings results. For this conference call, our CFO, J.W. Bang -- J.W. and IR team leader, and the Chief team members joined. First, I will take you through the highlights of our first quarter results. Thanks to recent strength in refining margin and international oil price, the company achieved record high operating profit of KRW 1.3 trillion in Q1 this year. Solid fundamental in refining business, which drove these performance, is likely to be maintained for the time being. In addition to ongoing geopolitical issues that affect the supply, there are other structural and mid- to long-term factors that support refining margins such as multiyear low inventory level, increasing demand on the back of ease restrictions on COVID-19, tight supply and demand driven by reduced investments in capacity addition and shutdown of obsolete facilities. The company is equipped with competitive facilities that can deliver outstanding performance by taking advantage of the strong market dynamics. High-premium ULSD takes more than 90% of overall diesel exports, and our completion of RUC and ODC project greatly enhanced company-wide complex margin by upgrading entire low-value HSFO residue. Based on positive industry outlook and improved competitiveness of the current business that resulted in larger income generation, S-OIL established its great initiatives to secure new growth engine in preparing for [indiscernible] 2030 and to respond to climate change and energy transition through a reduction in greenhouse gas emissions, expansion of a petrochemical business and entering into green energy business will make upward effort to deliver continued shareholder return. We'll get into more details with the following slides presented by [ J.W. and ] IR team leader. Thank you.

[Interpreted] Good afternoon. I'm [ J.W. ], I'm the leader of IR team. Before we begin, please be noted that Q1 financial results are provisional and thus results are subject to change after external auditors' review. Let me start with the Q1 performance and outlook for the next quarter. Please refer to Page 5. In Q1, we delivered a KRW 9.287 trillion in revenue, up by 12% from previous quarter and margin selling prices. Operating income stood at KRW 1.332 trillion, increased by KRW 940.7 billion quarter-on-quarter. The highest quarterly record in company history was driven by income [indiscernible] refining business due to increasing international refining margin and oil price. For your reference, inventory gain from oil price increase recorded KRW 562.0 billion. Thanks to F/X gain in operating income, income before tax has climbed up by 207% quarter-on-quarter, [indiscernible] and KRW 1,195.9 billion. In finance and other income, FX loss was KRW 80.7 billion due to the rise in $1 rate by KRW 24.7 from the previous quarter. Next, financial status. Despite income growth driven by strong international refining margin, the increase in working capital on the back of oil price hikes and tax payment resulted in the reduction of a quarter end cash balance. Now net debt to equity ratio inched up to 65.6%, which is slightly higher compared to the end of last year, but still at a favorable level. In terms of profitability, annual ROE and ROCE post 48% and 37.3%, respectively, showing big increase. EBITDA was KRW 1.32 trillion. Moving on to performance and outlook for each business on the next slide. First, refining business. Q1 operating income of refining business stood at KRW 1,202.2 billion, recording KRW 974 billion of a quarter-on-quarter increase. Singapore refining margin surged to average $4.1 per barrel compared to $2.2 per barrel in the last quarter. Global inventory of each product remained at its lowest level for years due to tight supply-demand balance, which has worsened with Russia's invasion of Ukraine. In March, Singapore complex margin jumped up to $7.7. Widened diesel spread over Dubai led the rise in refining margin. Diesel spread over Dubai went up to [indiscernible] $21.7 per barrel in Q1 from $12.6 in Q4 last year. Strong fundamentals were maintained with a sharp drop in China's exports, increased regional import demand and multiyear low product inventory level. With this, the prior disruption of Russian diesel and intermediate products drove strength in spread. In Q2, regional refining margins are expected to stay firm supported by the demand increase with ease of pandemic restrictions. The -- price for diesel and gasoline is expected to go higher respectively to geopolitical supply pressure and seasonal factors such as Ramadan and the summer driving season. Moving on to petrochemical business. Petrochemical business in Q1 recorded a negative KRW 65.6 billion in operating income similar to last quarter. For Aromatics, PX spread in Q1 rebounded to $190 per ton despite the high increase of naphtha price. Thanks to run cut or shut down as less competitive PX plants amid spring seasonal demand for polyester. In Q2, PX spread is expected to widen from the previous quarter by tight supply due to scheduled maintenance, reduced facility run rate and adjusted product scheduled of the profitable gasoline. For olefin products, PP and the PO spread in Q1 narrowed due to feedstock propylene price increase. The startup of new capacity earlier this year and stronger lockdown in China weakened the demand. In Q2, PP and PO spread is expected to recover gradually with the demand rebound driven by reduced operation rates under narrowed margin and potential lifting of lockdown in China. Turning to lube-based oil business. Operating income of lube segment declined by KRW 31.5 billion quarter-on-quarter on raw material cost increase, but remained still at sound level, achieving KRW 195.3 billion. Let me get into more details. Underlying lube-base oil fundamentals remained firm amid the company's demand and tight supply, thanks to the scheduled maintenance and lowered run rate to increase the [indiscernible] of diesel while margin is high. The spread was slightly in decline due to feedstock price increase driven by the surge in oil and diesel price, which has no impact on company-wide income as it is reflected in refining business results. In the coming Q2, domestic refiners will shift yield from lube to middle distillates with prices are going up. Thus, [ LBO ] lube fundamental is positive backed by tighter supply and seasonal demand. Moreover, lube-based oil spread is expected to widen from Q1 as sales price, which lags feedstock price change, catches up under sound fundamentals. Now we would like to give update on our key businesses. First, the structural refining margin trends. Currently, multiple structural factors are supporting healthy fundamentals in regional refining industry. Russia's invasion of Ukraine disrupted supply while pushing our refining margin. caused by the conflict will ease. The business it does, refining margin is likely to stay strong for a long time due to various structural reasons. With lower utilization of obsolete refining facilities and [indiscernible] energy price in Europe, Asian refining margin is expected to benefit from European countries if they refuse their reliance on Russia. Demand for refining products remained healthy before conflict between Russia and Ukraine erupted. In particular, it is likely to take a long time to address the supply tightness due to global inventory of diesel and [ kero ], which is hovering at the lowest level in 5 years. Jet fuel demand is on a recovery track with reopening of the borders. Figures may differ slightly, but institutional outlook is that, that the demand for jet fuel has recovered to slightly higher than 70% of the pre-COVID level and some expected to recover to 90% level by late 2023, which will have positive impact on refining margin for the next couple of years. The following factors may have ongoing and will continue to have impact over the next 3 to 4 years until [ mid-2025 ]. The export of refining products from China is likely to be on the decline in the coming years due to the government's nationwide reduction in greenhouse gas emissions and improvement in energy efficiency according to outlook. In addition, [indiscernible] shutdown of [indiscernible] refineries as per quota reduction in refining products and national limits capacity addition are expected to reduce China's exports over the next couple of years. Lastly, demand growth in global petroleum products, driven by underinvestment in and the shutdown of refining facilities is expected to outpace net capacity addition for the next few years. Demand, which fell sharply due to COVID-19, is on a recovery trend and demand increase is projected to outpace the investments in new refining facility with global greenhouse gas reduction trends and energy transition. The [indiscernible] shows that demand will be up from 6.7 million B/D to 8.5 million B/D from 2022 to 2025, whereas net capacity addition, which is far defined at 3.5 million B/D. Next is profitability enhancement by RUC and ODC. The company's competitive facilities help us deliver greater performance and other refiners by making the most out of the strong refining margin, in particular, RUC and ODC project enables the company to upgrade low-value HSFO to high-value products such as gasoline. With this, we could see the significant uplift in total complex margin. This resulted in the improvement in total complex margin of this company to $4 per barrel based on annual performance. We would like to emphasize that RUC/ODC project significantly contributed to the company's income generation. Lastly, let me present the company's green initiatives. In order to transit to a sustainable future, the company is pushing for green initiatives as a long-term direction. The purpose is to develop business based on our unique capabilities to create competitive return on investment. First green initiative is decarbonation. The company aims to reduce carbon emissions by 35% by 2030 compared to the business as usual, and achieve net zero by 2050. To this end, we are upgrading carbon management system and the study of mid-to long-term road map for carbon reduction. Next initiative is growth in petrochemical. S-OIL plans to expand its petrochemical business to 25% from 12% by 2030 with second phase petrochemical project Shaheen, through which the production of high-value polymer downstream products, including polyethylene and polypropylene will go up. Last initiative is expansion into new energy business. In an effort to enter into hydrogen and biofuel business, the company signed an MOU with Saudi Aramco and the Samsung Construction & Trading and enhancing cooperation on low carbon and future energy business. For hydrogen business, S-OIL and Saudi Aramco will cooperate actively in establishing hydrogen infrastructure to bring competitive blue hydrogen and ammonia produced in Saudi Arabia, to Korea in order to store, distribute and utilize them and identify potential opportunities out of them. Additionally, transition of fuel for our consumption in hydrogen fuel is pushed in parallel with the supply of clean hydrogen and ammonia [indiscernible] the domestic power generation companies with partnership with Samsung Construction & Trading. Entering into bio-diesel business and hydrogen-added biofuel is another area for business expansion. Once you get the full results from these initiatives, we will provide the details to the market. With this, I would like to wrap up Q1 earnings results. Thank you. The Q&A session will begin shortly after a Korean presentation session is wrapped up. Please wait for a minute.

[Interpreted] The first question will be given by [indiscernible].

[Interpreted] This is [indiscernible] from KB Securities, and I have 2 questions. First is about the petrochemical business. As you announced, in Q1 this business incurred a loss. Could you break down into the olefin and aromatics business in terms of the profit and loss? And for the second question, this is about the guidance for the second quarter. Assuming that oil price will stay at a very high level, around $100 by the end of June. What do you expect the sales revenues and operating income to be?

[Interpreted] So to answer your first question about the profitability of the olefin and aromatics business and the Chemical segment, when we make the disclosure, we do not break down the profitability of the olefin and aromatics business, respectively. However, it is obvious that both saw a decrease in the profitability, mainly owing to an increase in the raw material prices, mostly [indiscernible]. So to answer your question about the guidance for the second quarter. As you know, the current oil price is moving in around $100. And most of the institutions made a forecast that oil price will move in the range of $95 to as high as $110 until the end of the year. And as for the outlook on the refining margin, even when the war in Ukraine comes to an end, the Western countries embargo against Russia may last for a longer period of time. And there's also the expectation that many countries in the West will lower their import of Russian fuel products in order to lessen their reliance on the Russian energy. So given the fact that although it's difficult for us to specify, when given, the nature of the political factors, we expect the bullish refining margin and the bullish momentum to last for a considerable period of time given the fact that the supply will be interrupted from Russia. And the seasonal demand increase, especially in the summer season as demand increases for gasoline and the demand recovery when China lift up the lockdown and the gradual increase in the demand for jet fuel when countries around the world open their borders, will also push up the refining margin and keep it at a high level.

[Interpreted] This is from [indiscernible].

[Interpreted] So I have 2 questions about the inventory valuation gains of [ KRW 552 billion ]. Could you just break this down into the business segment? And my second question is about the shareholder return on the dividend policy specifically, you said that the refining margin is expected to be at a strong level until the end of the year and the refining business, product business posted a very good performance in Q1, which gives people that the 2022 performance throughout the year to outperform that of 2021. Is this a positive signal for the company's overall dividend policy as part of the shareholder return?

[Interpreted] So to answer your first question on the inventory valuation gains by business segment, it is KRW 450 billion for the refining business, KRW 65 billion for the petrochemical and KRW 45 billion for lube-based oil business.

[Interpreted] This is the CFO, Ju-Wan Bang of S-OIL. To answer your question about the dividend, our dividend policy is based on the principle of making sure that our net income of the current year is fairly and reasonably allocated between the investment funding for the company's future growth and company's financial health to ensure that it stays at a healthy level and the shareholder return. So in line with this dividend policy, at the end of last year, we made a disclosure that our dividend payout ratio for 2021 and 2022 will be at 30% or higher of net income of the current year. And this pipeline remains unchanged. As you have mentioned earlier, [indiscernible] recorded the highest quarterly operating income in Q1, which also raised coping expectations for the overall performance throughout 2022. So given the situation, we believe there could be a possibility of a higher dividend per share to the shareholders this year even when there is no increase in the dividend payout ratio. As per the dividend payout ratio itself, it is subject to the decision by the Board of Directors. So we cannot tell you specifically about it because it is a decision made by the Board. But for now, I can tell you that our overall guidelines and the dividend policy remains the same.

[Interpreted] The following question is by Kyoung Jae Song from Hanwha Financial Investments.

[Interpreted] So I have 2 questions. First is about the refining margin. The refining margin is so very good, but there is also the market concerns about the spike in the OSP. So reflecting the OSP residue, tell us, is the company's internal margin, reflecting the increase in the OSP has a room for an increase in second quarter vis-à-vis the first quarter. My second question has to do with the decrease in delivery flow in the gasoline production in order to maximize the diesel production, which is in shortage in the market for now. If this situation persists, is there a chance for the -- is there a chance for the -- for some adjustments in the yield of diesel?

[Interpreted] So to answer your first question, as you know, the product spread of the rebound products versus the crude oil has been widened to a very high level. And actually, the refining -- the cost of refining margin and the OSP increases beyond the spread that we're seeing in the market. We believe that the temporary spike of delayed OSP reflects some -- the current hike in the refining margin. If we compare the situation right after the war in Ukraine versus in March, the international oil market and the oil prices have slightly cooled down to the period right after the war. And as a result of that, we expect the OSP to be adjusted downward. At the same time, in the second quarter and in the second half of the year, we expect to see the refining margin to stay at a healthy level. So we believe the spike in delayed OSP and its impact on the company's overall business performance will be limited and will not last for a long time. To answer your second question, as you know, the diesel market is super bullish. And to take advantage of it, we are doing some internal profit optimization to maximize the yield -- the production yield of both kerosene and diesel. As for import of diesel, there are limitations in doing so, given the fact that the supply disruption caused by the war in Ukraine and the sanctions against Russia has led to the price increase. So our policy for now is to do the internal product optimization to maximize the company's production yield of diesel and kerosene. As you know, [indiscernible], which is the feedstock lube-based oil, can be converted for the diesel production. And actually, a lot of the global refining companies around the world are lowering the running rate of lube-based oil plants in order to maximize their production of supplies. I believe the situation will lead to -- will be a factor in widening the spread for lube-based oil in the future. And as for diesel, you have some issues in both supply and demand. On the demand side, we expect to see some increase in demand for gasoline because of the Ramadan season and the summer driving season. [indiscernible] to believe that Japanese spread will remain at a solid level. For lube-based oil, most of our lube-based oil production is focused on the high premium on high-value line like the Group II and Group III. So for us, lowering their production and converting them to diesel, does not really serve the company's economics. And as for gasoline, recently the supply has been very low, which gives a very good economics for gasoline, which is why we have made a decision to lower the production of naphtha, and instead raise the production of gasoline.

[Interpreted] the following question is by [indiscernible] from Hanwha Investment & Securities.

[Interpreted] This is [indiscernible] from Hanwha Investment & Securities. I have 3 questions. First is about the exports of Russian crude oil and fuel products. What is your estimation of their product or -- their exports during the economic sanctions and how much do you expect to see them drop? Second is about the lockdown in China. Maybe this will have an impact on the demand of gasoline or contrary is China decides to import more volume from Russia and then sell it to the export market, this could have an adverse impact on the overall market [indiscernible]? What is your view on this? Third question is about the company's net zero target in 2050. I doubt the hydrogen and the bio-diesel business only could help the company achieve your net zero target by 2050. So could you elaborate more on how you are going to achieve this target and specifically from which [indiscernible] business?

[Interpreted] So to answer your first question, I believe after the sanctions against Russia, the European countries import of Russian diesel accounted for almost 10% of their total import before the war in Ukraine. So as long as the supply interruption persists arising from [indiscernible], we expect to see the refining margins for both kerosene and diesel to remain at a high level. As for [indiscernible] that some of the Russian crude oil may be flowing into India or China? There are some moves around this in the pricing, but it is difficult for us to elaborate on the impact of this inflow into some of the Asian countries, including India and China. But even if the war comes to an end, it's difficult for us to forecast that the Western countries embargo against Russia will be eased immediately. Actually, most of -- the view in general is that it will take a longer period of time before the sanctions against Russia lifted, which lead us to forecast that the supply disruption caused by the embargo and the war in Ukraine will last for quite a period of time. So the lockdown in China is having a negative impact on the demand for crude and fuel products at the moment, but we don't think this will last for a long period of time. Actually, the -- depending on the policy direction by the Chinese government, because of their policy direction, actually, their exports of fuel products is on a decline. And this will have a positive impact on the fundamentals of regional refining industry in the mid- to long-term. We believe that demand from China, however, is quite critical. But what matters more is the export volume coming out of China, and this is a bigger factor affecting the refining margin in Asia. This year, the Chinese government cut their export quota of gasoline, diesel and jet fuel by 56% in the first half of this year. And we do know that the demand in China has come down because of the lockdown to some level, but this will now have an impact in the general sense, and we believe it will be more offset by the T&Is and the decrease in the overall throughput of the Chinese refinery and their decision to self-fill the inventory as part of the energy securities and other factors affecting the overall market fundamentals in Asia. So to answer your third question on how we are going to achieve a net zero by 2050, I would like to tell you that the company is actively engaged to the global effort to reduce greenhouse gas emissions and the government's -- the Korean government' carbon neutrality policy. And in line with this, the company has established the road map to reduce carbon emissions, and we are making plans to act on that. And in the next long term, we are going to first execute the items, the business items that allow us to secure the economics on our own, for example, improving the energy efficiency of the refinery in general, introducing the low-carbon scheme and collecting and capturing carbon dixoide from the process production stage and selling them. So these are the action items that we will put into action first and foremost. And we're also reviewing other indirect way to minimize the emissions of carbon caused by the use of power. For example, we are considering the power generation using the gas turbine and the fuel cell. In the long term, we are also exploring various other solutions, such as hydrogen, replacing to alternatives and greenfield to just hydrogen and also resorting to carbon capture. But in order to achieve our net zero for 2050, we do know that a lot of technological evolutions and advancements have to be made in relation to various parts of green and ecofriendly kind of resources. This answers your question.

[Interpreted] Currently, there are no participants with questions. [Operator Instructions] The following question is given by [indiscernible] from Shinyoung Securities.

[Interpreted] So this is [indiscernible] from Shinyoung Securities. First, the PX margin is quite bearish these days and the PO margin, which we see a very strong and also come down substantially. What is your data on the PO on expansion and the volume itself? And when do you expect the PX market environment should improve. And as for your thoughts on increasing the yield of diesel and kerosene over lube-based oils, could you give us the specific numbers on the production yield?

[Interpreted] So about the PO expansion volume, our forecast is about 800,000 ton a year, which is [ both ] to the demand level. So as for the PO market, in the short term, there are still uncertainties in terms of the end users in China, I mean, the uncertainties in terms of their production and the sales volume because, as you know, China is still in the lockdown in order to keep the COVID-19 pandemic at a zero level. So for the time being, they will look for the overall direction of the market. So -- but if the Chinese government decides to [ abrupt these ] actions as the COVID situation eases with respect to demand for diesel -- or the demand for PO to recover, particularly in the automobile and the construction sector and the overall market sentiment to increase. And as for the PX market in Asia, given the oversupply caused by the new facility addition coming to the market and the bearish demand in China caused by the lockdown, we expect to see quite a long period of time before the PX business returns to the up cycle. So with the reduced running rate in order to minimize the negative impact on the profitability, we expect and be moved by the refiners and the petrochemical companies to increase the production yield of gasoline spread with respect to the overall spread for PX in the second quarter to increase and would -- along with the increase in market fundamentals. In the third and the fourth quarter of this year, when the new capacity additions in China increases the overall supply, there are some market fluctuations and the volatility. However, with the ease in COVID situation in China in the future, we expect to see some demand increase and also some restructuring of the less competitive refineries and also the T&I that could have a better -- that could positively impact the result the demand for PX in the second half of the year. Well, I understand that some companies that produce a high volume of Group I lube-based oil, are cutting back on their Group I lube-based oil and instead raising the production of diesel, high-margin diesel these days, but it is difficult for us to gauge how much of that volume is processed. As for S-OIL, more than 90% of our lube-based oil is the high-margin Group II and Group III. And I understand that part of the Group I has converted to diesel to produce more diesel by adjusting the production nodes in the refinery. But even this Group I is a very small volume. That's the end of my answer.

Currently, there are no participants with question. [Operator Instructions]

[indiscernible] This is treasurer [indiscernible]. I think our time for the Q1 earnings release is up. But if you have further questions or need more detailed answer, please feel free to contact the IR team, and we'd be more than happy to give you our thoughts and our answers. Once again, I would like to thank all the investors and the analysts for joining us, and have a good day. Thank you. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]