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

[Interpreted] Good afternoon, everyone. This is [ Katy Kang ], the Treasurer of S-Oil. I'd like to extend my gratitude to our investors and analysts for your attention to S-Oil's Conference Call for Q2 Earnings Results. For this conference call, our CFO, JW Bang; IR Team Leader, [ JW Ahn ] and the team members joined. First, I will take you through the highlights of our second quarter results. S-Oil achieved KRW 1.72 trillion of operating income in Q2 2022, thanks to greatly improved profitability of all business segments, including refining, petrochemical and lube base oil. Quarter-on-quarter income increased significantly by 29%. Due to the recent outlook for global recession and the high oil price, there are concerns over sluggish demand. However, demand for refining products is resilient enough to recover to pre-pandemic level. As demand recovery for jet fuel is maintained at satisfactory level, global demand growth for oil is expected to hover above pre-pandemic level, this and the next year. Moreover, unprecedented strike in second quarter refining margin, we built the shortage of refining capacity that global refining industry faces. Larger-scale shutdown of refineries during the pandemic removed the supply glut in a short period while highly upgraded refining facilities were in operation at full capacity. As investment in refining facility requires large fund with loan payback period, recent energy transition trend is likely to discourage new investment, resulting in capacity shortage in the coming years. Based on the differentiated income generation capability and the favorable market environment, the company will strive to achieve new growth engine in the face of energy transition era in an effort to enhance the shareholder value in the short and the long term. [ JW Ahn ] will get into more details with the following slides. Thank you.

[Interpreted] Good afternoon. I'm [ JW Ahn ], the leader of IR team. Before we begin, please be noted that Q2 financial results are provisional, and thus, results are subject to change after external auditor's review. Let me start with the second quarter performance and outlook for the next quarter. Please refer to Page 5. In the second quarter, the company's revenue jumped to KRW 11,442.4 billion, up by 23% from the previous quarter, thanks to sales price increase driven by [indiscernible] international oil price. Operating income stood at KRW 1,722 billion, up by KRW 390 billion from the previous quarter. Despite KRW 200 billion of a quarter-on-quarter reduction in inventory-related gains, strong international refining margin drove 20% of quarter-on-quarter income growth in refining business. Petrochemical business shown [indiscernible] and the income of lube base oil business climbed up by 32% from the previous quarter. For your reference, inventory-related gain on the back of oil price increase is KRW 357.9 billion. For finance and other income, FX loss was KRW 271 billion due to increased won-dollar rate. Income before tax was up by 17% quarter-on-quarter, posting KRW 1,399.4 billion on the back of improved operating income. Next, financial status. Despite increased working capital driven by oil price hike, cash balance in second quarter-end was maintained at a similar level with the first quarter-end due mainly to increased income with a strong margin. Additionally, increasing equity on the back of rise in retained earnings, reduced the debt-to-equity ratio from the first quarter-end to 57.5% at a favorable level. In terms of profitability, annual ROE and ROCE recorded 48.5% and 38.2%, respectively, at high level, thanks to enhanced operating income. EBITDA recorded KRW 1,533 billion. Moving on to the performance and outlook for each business on the next slide. First, refining business. Second quarter operating income of refining business stood at KRW 1,444.1 billion, posting a 20% quarter-on-quarter increase. Singapore refining margins skyrocketed to average $20.8 per barrel compared to $4.1 in the last quarter. This unprecedented hike was driven by limited supply that failed to keep up with robust demand as diesel inventory hit a 14-year low with globally low inventories of other refining products. Supply was reduced due to embargo imposed on Russian fuel and intermediary products and lowered export quota of China based on its energy security policy. However, the demand remained healthy, thanks to eased COVID-related restrictions of countries around the world. Overall rise in second quarter refining margin was largely led by widening the spread of transportation fuel such as gasoline, diesel and jet fuel. Gasoline and diesel spread over Dubai crude increased to average $29.8 and $51.6, respectively, in the second quarter from $15 and $21.7 in the previous quarter. Extremely tight supply on the back of low inventory and the prolonged war between Russia and Ukraine drove down the unprecedented rise. Next, outlook for the third quarter. In the third quarter, refining margin, which hit the highest is in downward correction from July and appears to stay volatile for the time being. But magnitude of the recent fall appears to be slightly excessive compared to market fundamentals. The margin is projected to remain high above previous level after going through a short-term correction as tight supply in the global refining market persist. Lower end of the chart shows Singapore margin. 5-year average margin stayed around $2.5 per barrel except for 2020 when the pandemic hit and the previous high was around $5 per barrel. Up to date, average Singapore margins still remains above the previous level at $10.5. Among products, diesel is projected to lead to the strength in refining margin. Diesel spread is maintained at high level with $30 to $40 in July, though it was corrected downwards compared to the unusual high mark in second quarter. Inventory pile up of diesel and kerosene for heating purpose in the winter is likely to put upward pressure in diesel spreads. Moving on to petrochemical businesses. Petrochemical business in the second quarter swung back to profit compared to the first quarter, recorded KRW 18 billion in operating income amid slow demand due to China's lockdown. For Aromatics, PX spread in Q2 widened significantly from the previous quarter to $388 per ton. The steep hike is owing to the tight supply of refining product and the growth in gasoline blending demand for intermediary products such as Toluene and MX in the face of summer driving season, while supply was limited due to unplanned outage and scheduled T&I of several regional refineries. PX spread in the third quarter appears to stay healthy in the summer months due to demand for gasoline blending, but fluctuate more toward the quarter-end with the start-up of new capacity in China. For olefin products, demand for PP and PO in the second quarter was bearish with lockdowns in China to contain the spread of the pandemic. PP spread slightly widened quarter-on-quarter as PP facilities in China reduced the throughput due to profit decrease, while PO spread inched down due to the start-up of new facilities. In Q3, PP and PO spread are projected to improve gradually with easing trend of pandemic restrictions and a stimulus package of China. Turning to lube base oil business. Operating income of lube base oil business was up from the previous quarter by 32%, posting KRW 258.9 billion. For market dynamics in the second quarter, lube base oil fundamental improved on the back of solid demand aided by driving season and tight supply driven by reduced operation rate of LBO facilities to increase the yield of diesel amid strong margin. Lube base oil spread was under rise with a strong fundamental as product prices catch up with big stock price hike in the previous quarter. In the coming third quarter, stable demand is expected to continue through the second half and LBO fundamental is likely to stay firm as several refiners are likely to limit the supply due to scheduled maintenance and ongoing war between Russia and the Ukraine. Moreover, LBO spread is projected to sustain current level amid sound fundamentals or widened as feedstock prices stabilizes lower recently. Now we would like to give updates on our key business. Refer to Page 11, please. First, demand recovery of refined products. With recent oil price hike and the worries over recession, international crude and futures market became more volatile, causing concerns over global demand slowdown. However, demand for refined products is showing resilience with post-pandemic demand normalization under easing restrictions, strong seasonal upswing in the summer and the winter months and globally unprecedented level of mitigation measures for international oil price surge. Global oil demand growth outlook for this year, made by major financial institutions stays between 2.2 million B/D and 3.5 million B/D, exceeding pre-pandemic average of 1.3 million B/D. Demand outlook for 2023 is also higher than pre-pandemic level. Growth and the recovery momentum of global oil demand continued through the year at a bit slower speed. The upward trend of this next year is mostly driven by jet fuel demand, which is on a recovery track decoupled from oil price owing to the rebound of air travel demand. In 2022 and 2023, 2 million B/D of just fuel and kerosene demand is projected to be added to global market compared to the previous year. For gasoline and diesel, governments around the world, excluding the U.S., are controlling consumer price in an unprecedented form the jet tax cut. As institute analyze that around 50% of gasoline and 70% of diesel volumes sold in the world are subject to mitigation measures in the form of a price ceiling or tax cut. Thus, consumers are less -- feeling less pain with a restricted increase in oil price, mainly contributing to the global recovery of oil demand. Next, refining facility shortage. The collapse of demand and the refining margin during the pandemic led to the shutdown of refining facilities with a 3 million B/D capacity in the last 2 years. The pandemic accelerated massive refinery rationalization, which usually takes much longer. Refining industry evaluates that this contributed to the healthy recovery of supply-demand balance in a relatively short period. In addition, global demand growth is expected to outpace net capacity expansion for the coming years with less investment in refining facilities. Including this year, net capacity expansion of a total 4.1 million B/D is anticipated until 2024, while demand growth outlook ranges from 5.6 million B/D to 8.2 million B/D. It usually takes from 10 months at minimum to 2 years of maximum for a new facility to run at full capacity after the start of commercial operation. Thus, the impact of the supply from new facilities, which are scheduled to enter the market for the next 3 years, appears to be gradually seen. According to the industry outlook, plans for massive capacity expansion is rarely found after 2024 on the back of the global greenhouse gas reduction and energy transition. Investment in refining facilities is shrinking as it requires massive funding as a long payback period. That is why the industry views the long-term supply glut as less stress. As the industry is influenced by seasonal swings in demand and volatile annual supply volume due to regular maintenance, wider fluctuation in refining margin may appear frequently with unbalanced supply demand in the short-term temporarily. However, I would like to emphasize that refiners are positioned to benefit from margin strength in a stable manner compared to the previous cycle under current market environment. Last is the profitability of enhancement, profitability enhancement by RUC and ODC. The company is equipped with facility competitiveness that enables us to deliver greater performance than other refiners by making the most out of the strong refining margin. However, the company's RUC and ODC strongly improved the margin generation capability. In the second quarter, the price of High-sulfur fuel oil or HSFO, which is the [ fixed tug ] of RUC and ODC plummeted, while gasoline margin remained high. This has significantly widened the profitability of RUC and ODC. In July, HSFO spread over crude plunged to minus $30, sending net refining margin down to negative range. Less competitive regional refiners with simple complex is getting pressured to reduce run rate under current margin structure. But the company like S-Oil is maintaining refining margin at a healthy level despite recent downward correction in the market as its highly complex facilities are upgrading entire HSFO volume, taking advantage of sound upgrading margin. With our highly competitive facility, the company will generate exceptional and a stable performance continuously. With this, I'd like to wrap up the second quarter earnings results. Thank you.

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

I have 3 questions. The first question is on your refining division. So recently, refining margins have fallen quite sharply and there are headlines about some of your peer refiners considering altering their yields or cutting runs or lowering the utilization rate. So could you give us an update on S-Oil situation and your third quarter and fourth quarter utilization rate plan? The second question is on your mid- to long-term strategy. Could you give us an update on the Shaheen project? For example, your current expected CapEx, capacity, types of downstream products, expected return, et cetera. And therefore, can you also tell us your 2022 to 2025 free cash flow and dividend outlook? And the third question is, could you give us some color on the amount of opportunity cost for maintenance that you booked in second quarter as well as the one-off costs from the fire at the Ulsan plant that happened in May?

[Interpreted] So to answer your first question on the refining margin, which has tumbled recently and our outlook on our throughput rate. Well, as I said in my presentation at the outset, there is some downward correction in the refining margin. However, I would like to note the fact that the company's complex refining margin stays at a healthy level, and therefore, we do not have any plans to adjust or as we could at the moment. So as for the refining margin outlook, as you know, the margin has seen some downward correction in July. The average throughout the second quarter of the Singapore complex margin was $21, but it has tumbled to $10.50 in July. I would like to note that the Singapore average complex margin in the last 5 years, excluding 2020, when the COVID hit was $2.5 and throughout those periods, the highest was $5 to $5.50, which was marked in the second half of 2017. So if we compare ourselves with the margin in the last 5 years, excluding 2020, I still believe that the July average is quite high and healthy. Well, as for the latest tumble in the refining margin, I do think that it's exceedingly high compared to the market fundamentals. So after the standard correction, we expect to see some rebound both from the supply and the demand side. First, on the supply side, there is a deep negative in the hydroskimming margin, which will force the less competitive refineries to downward -- to adjust downward their throughput. Also we expect to see some turnarounds, some turnaround and inspection towards the second half of the year, which will also bring down some throughput in the refineries across the world, which will inevitably adjust the supply side. On the demand side, as we all know, the gasoline price in the international market has peaked in July and started to come down. However, as we all know, the gasoline price is quite elastic, which means the reduced gasoline price will be reflected in the retail fuel price and support the demand. Also, in the third and fourth quarters since there is seasonal high demand for the refined products due to the cold winter, there will be demand to stockpile the inventory. So this will be the favorable factors supporting the demand side.

[Interpreted] So this is S-Oil CFO, JW Bang. To answer your second question about the company's mid- to long-term strategy. So in response to the changing dynamics in the global oil market, we have this long-term growth strategy whereby we will increase the production ratio of the petrochemical products to 25% out of the company's total production. So to meet this goal, we are preparing on the so-called Shaheen project, whereby we are going to use the crude oil and the low value off-gas and naphtha in order to produce petrochemical products. So our goal for getting the -- for making the financial investment decision for this project is in the second half of this year. And at the moment, we are in the course of finalizing the front-end engineering design. So if everything goes well, the project will be completed in 2026, which will [indiscernible] the petrochemical upward cycle and go into commercial production from the second half of 2026. And I believe this Shaheen project will be very competitive in terms of both economics and investment because the low value off-gas and naphtha that we're getting from our existing refinery, we will be selling into the steam cracker that we are going to build nearby our existing refinery. And also, we plan to share the utilities and the storage facilities with the existing -- between the existing refinery and the new steam cracker and the downstream facilities. And once we -- the Board of Directors makes the final investment decision, the details around it will be communicated and shared with the market in greater detail. For your third question, first of all, I would like to express on behalf of the company, our deep regrets to the fact that there was an incident, a fire incident in the #2 alkylation unit in May and that cost fatality. As was disclosed to the investors, the affected plant has been suspended of work. However, for the other nearby facilities, they have been suspended of work temporarily but have returned to normal operations. So right now, the government authorities have issued the order of suspension of order to the #2 alkylation unit, and we are fully cooperating and collaborating with government authorities. So in doing so, we will also find out the real cause of the incident and also come out with the measures to restore this unit and make sure that there is no repeat of such an incident. And we're also making plans to get the government authorities of approval to uplift the work suspension order. And as for the opportunity loss and the size of damage, we are at the -- taking the procedures to estimate the property loss and the business interruption loss at the moment. But we do not expect to see a big financial loss arising from the incident. For the 60 days of exclusion period and the KRW 2.5 million deductibles, other than this, the rest will be compensated in accordance with the insurance policy.

[Interpreted] The following question is by Lee Jin Ho from Mirae Asset Securities.

[Interpreted] I am Jin Ho from Mirae Asset Securities. This is a question about the company's dividend guidelines. As Mr. CFO mentioned, it sounds like the Shaheen project is a very big scale project. With this in the planning stage, is the company's dividend guideline of 30% still valid?

[Interpreted] So the company's dividend policy is to make a balance between our preparation for the future growth and future investments and the company's healthy financial structure and the shareholder return. So based on this belief, we have maintained our dividend policy of keeping the dividend payout ratio at 30% of the net income in 2021 and 2022. So this is the guideline as far as our dividend policy is concerned and this remains valid. So after the financial investment decision for Shaheen project, I believe most of the CapEx will fall from 2024 and onwards. However, as you know, the company has been performing well from last year and we also expect to see a very good cycle in the refining business. Therefore, with a very stable financial structure, we'll be able to keep our dividend payout ratio while at the same time enhancing the shareholder values. So to summarize, despite the Shaheen project, we believe we'll be able to maintain our dividend policy guideline of keeping the dividend payout ratio at the same level as in the previous years.

[Interpreted] The following question is by Nikhil Bhandari from Goldman Sachs.

Congratulations on a great set of results. My question is on the balance sheet and gearing. So I mean, last year, we had company generating KRW 2.4 trillion EBITDA and the gearing decline from 88%, net debt-to-equity to 56%. This year, in the first half, the EBITDA generation is almost close to over KRW 3 trillion, but the balance sheet, the gearing is still flattish at the end of first half versus end of last year. It seems like the working capital has increased meaningfully and your accounts receivable and inventory has gone up a lot more than the payable days. Can you give us some guide on how we expect the balance sheet getting to change into the year-end? That would be very helpful. And the second question is, I'm a little surprised with your comment on diesel spreads to soften ahead of seasonal heating demand in winter. Can you elaborate that? Because I was thinking with gas so tight, diesel may have higher bid going into the heating season as an alternate heating fuels. I'm just curious to understand why you think diesel spreads will soften ahead of the seasonal heating demand in winter?

[Interpreted] So as is presented in our presentation, the company's EBITDA in the first half of this year has gone up significantly. But at the same time, we'd like to emphasize the fact that the oil price has made a significant jump compared to the end of last year. So despite our great earnings, this has served -- has put a strain on our cash and it has been a burden on our cash flow, has put a strain on our cash burden. So however, since the equity went up, we were able to keep the gearing rate or the debt-to-equity ratio at below 70%. And assuming that the oil price will remain at the current level, we expect the gearing ratio to stay at the level that we saw at the end of the first half of the year. And regarding the increase in the working capital, as my colleague mentioned, it was largely due to the oil price increase. But I would also like to take note of the fact that there was the tax payment, which was deferred by the Korean government last year. So that amounted to KRW 800 billion, which was a cash out from the company. And also in June, we had less crude oil lifting because of the turnaround and inspection and the maintenance, which brought down the shipper's credit, but this is only a one-off event, and we expect to see this burden to ease in the second half of the year. As for the diesel spread, it hit an all-time high of $63 in June. And then since then it softened to about $30 to $40 level in July. However, if you look at the 5 -- past 5-year average, excluding 2020, it marked at around $12 to $13, which means the July level is still very high. And as for the diesel demand, usually, the demand tends to soften, particularly in Southeast Asia and South Asia, where there is a monsoon season in the summer. So overall, it's quite slow. However, towards the end of the year and the winter season, there is a demand to stockpile diesel, which will possibly support the diesel spread. And from geographical perspective, there are still uncertainties around the Russian gas supplied to the European continent. So unless this risk is dissolved, I think there is also a possibility of strong demand picking up for the middle distillates, which are diesel and -- which were diesel and kerosene. So on the supply side, we -- there is an outlook of a downward pressure on the spread as some of the regional refineries will start up their facilities or in the third and fourth quarter. Also, however, there is a global trend around inspections of refineries in the fall season, which could normalize some of the excess that we put that is existing in the market. And according to the market intelligence that we obtained in the middle of July, it is said that the physical delivery of Russian crude oil -- the Russian diesel could be sanctioned and could be banned from the ICE market from the end of -- from the IT trading market from the end of November. This is for the diesel futures. This will come in advance of the European continent's full sanctions on importing Russian diesel, which will fall in February next year. So if this happens, this could create some demand for stockpiling of the non-Russian diesel. So even if there is some downward correction in the spread, there is the market forecast that the diesel spread in 2023 and 2024 will still be higher than the average in the past 5 years. That's all I have.

[Interpreted] The following question is by Lee Jin-Myung from Shinhan Financial Investment.

[Interpreted] This is from Shinhan Financial Investment. First is about the oil price. Oil price seems to be coming down slightly. What is your outlook for the second half of the year and the whole year of 2023 and also your outlook on the OSP in the second half of the year where OSP is picking up these days? As for the inventory in Q2, could you break it down between -- by business segments?

[Interpreted] So as for the oil price, it has a big impact on the macro economy as an indicator. And lately, we're seeing a lot of volatility in the oil futures market. So as a company, we do not make -- we do not make some forecast or give any outlook on the oil price. However, as you know, the Dubai benchmark averaged at $113 in June. And if you look at the latest outlook by the institutions in the market, it is in between the range of $100 to $110. Well, with volatility in the oil futures market still remaining high, I know that there are some concerns of the oil price softening. However, if you look at the real market, the physical market, there are still some issues on the supply side. Well, there are some outlooks that the supply shortage issues will keep coming out in the market as we move towards the end of the year. This is for a number of reasons. First of all, the oil producers, particularly in the Middle East, they're still very limited in how much more they can produce a raise in the output. And there's also the news that the U.S. government, which is tapping into the strategic controlling reserves of around 1 million barrels a day, which started in April, they are going to close it at the end of October this year. And also, there is a news that the European continent will impose a full ban on the seaborne imported Russian crude oil from the end of December this year. So if you look at all these factors, I think the supply issues around the market will still remain. Well, as for the OSP, which is the Saudi crude, it is the policy by the seller not to share their OSP setting logic with the market or with the buyer. As you know, the OSP has been building up recently for a number of reasons versus the war in Ukraine and also there is some supply interruptions from Libya because of the political unrest and also the refining margin in Q2 has skyrocketed, knowing the fact that the margin in Q2 has gone up substantially high compared to Q1, I think a higher OSP is a natural course of action. As for the OSP increase, it will be reflected in the company's July and August lifting and it will be reflected -- and as a result of that, it will be reflected in the company's Q3 performance. As you know, the refining margin has gone down in July. However, the complex margin of the company is still very strong. And even the downward correction of the company's complex margin compared to the refining margin in the market is quite moderate. So even if the OSP is up, we have -- our outlook is that we'll be able to maintain a fairly strong profitability. If you look at the structure whereby the OSP is set, it reflects mostly the time spread of the Dubai benchmark, which is extracting the price of the near-month -- which is extracting the price from the near-month to the price of the far month. So given the fact that the time spread makes the correction between the difference in how the Saudi crude oil and the Dubai crude oil price is set, I don't think this itself is a factor that causes the refining margin to go down. If you look at the July and August average time spread, it is $1 higher than the previous month. And this gives the possibility that the OSP could go up slightly more in the future. However, given the fact that the refining margin in the market has recently gone down, the time spread increase may not be fully reflected in the OSP in the future. And if you look -- if we break down the valuation gains in Q2 by business segment, it's KRW 390 billion in the refining business segment minus KRW 12 billion in petrochemical and KRW 28 billion in the lube base oil business. If you look at the whole half year, including Q1 and Q2, it's a total of KRW 970 billion across the 3 business segments. But if you break it down, it's KRW 840 billion for the refining business, KRW 54 billion for the petrochemical and KRW 72 billion for the lube base oil business. This answers your question.

[Interpreted] The following question is by [ Desmond Low ] from Citi.

This is Oscar here actually. I just had one very little question since most of the questions already have been asked. And thanks for the very detailed explanation on the OSP. Could I just ask you for your 2Q operating profit? How much of that is the positive FX impact from the won weakness?

Sorry, but could you repeat your question? I could not hear as well.

Sorry, my question is what is the positive FX impact on your OP size from weaker won?

[Interpreted] So as for the FX impact on the operating side, in Q2, the FX gains on the operating side, operating income side was KRW 275 billion. However, we sustained a similar amount of FX loss on the nonoperating side. This is -- so this indicates that we were able to hedge our FX risk according to our FX policies. So if you look at the income before tax some, I would say that there is a good neutralization between the operating income and the nonoperating side. The schedule time is up. So allow me to close the conference call for the Q2 earnings. I would like to thank you all for joining us. And if you have any further questions or inquiries, please feel free to contact IR team. Thank you very much.

[Interpreted] This concludes the fiscal year 2022 second quarter earnings resulted by S-Oil. Thank you for the participation. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]