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

[Interpreted] Good morning, everyone. This is [ KD Bang ], the Treasurer of S-Oil. I'd like to spend my gratitude to our investors and analysts for your attention to S-Oil's conference call for Q3 earnings results. For this conference call, our CFO, JW Bang; IR team leader, JW Ann; and team members joined. First, I will take you through the highlights of our third quarter results. S-Oil achieved KRW 511.7 billion of operating income in Q3 2022, despite reduced income in refining business due to downward correction in international oil price and refining margin, income contribution from non-refining business, including lube and chemical increase. Thanks to diversified lube and petrochemical products portfolio, the company could generate a stable income amid widened short-term volatility in the market. As for short-term market outlook, refining margin is highly likely to go up in Q4. Diesel and kerosene demand for winter hitting purpose in Northern Hemisphere is expected to grow amid low global inventory levels, which have fallen far below the 5-year low. Thus, inventory level will be very insufficient to support the market. If demand for heating fuel goes up higher than average level in the winter or tight energy supply occurring throughout the year in Europe region continues. Moreover, [ with the ] pandemic-driven restrictions seems to have a positive impact on demand recovery during the coming Q4 and next year. Overseas travelers visiting Southeast Asian countries where restrictions have eased all year are on the rise. Recently, Japan, Taiwan and Hong Kong are also easing current measures. If China's lockdown measures alleviate in the coming months, though we are not able to specify exact timing, overall demand recovery for Chinese refining products will contribute to the rise in refining margins. Long-term supply-demand outlook released by major energy research institutions says that prolonged global refining facility shortage may continue by around 2030. The projection is based on demand growth for petroleum products that is likely to be maintained despite energy transition and the worries of a global recession. But net capacity expansion is expected to lag far behind due to less investment in refining facility and shutdown of obsolete facilities. JW Ann will get into more details with the following slides.

[Interpreted] Good morning. I am JW Ann, the leader of IR team. Before we begin, please be noted that Q3 financial results are provisional, and thus, results are subject to change after external auditor's review. Let me start with Q3 performance and outlook for the next quarter. Please refer to Page 5, Q3 financial results. In Q3, the company's revenues stood at KRW 11,122.6 billion, similar to the previous quarter, as decreasing international oil price which affects the sales price was offset by $1 rate increase. Operating income recorded KRW 511.7 billion, down by KRW 1.2 trillion from the previous quarter, due mainly to a reduction in the operating income of refining business. The trend was driven by inventory-related gains, which dropped more than KRW 500 billion quarter-on-quarter on the back of oil price reduction as well as downward correction in refining margin. However, the company's operating income remained healthy, thanks to improved quarter-on-quarter profit in petrochemical business and record high quarterly operating income in lube business. For finance and other income, FX loss was KRW 520 billion due to the increase in $1 rate. However, it will be offset by FX impact on operating income throughout the year. Next, financial status. Cash balance in Q3 end stood at KRW 856 billion, reduced from the previous quarter due to the repayment of debt and payout of interim dividend despite slight decrease in working capital, driven by lowered oil price. Net debt-to-equity ratio in Q3 end slightly edged up quarter-on-quarter, recording 62.5% due to slight reduction in equity as a result of the dividend payout, but it is still maintained at a healthy level. In terms of our profitability, ROE based on annual rate was maintained at 32.8% and ROCE at 26.1% at high level. EBITDA recorded KRW 112 billion. Moving on to performance and outlook for each business on next slide. First, refining business. Q3 operating income for refining segment fell from the previous quarter to KRW 78.8 billion. The downward trend is driven by gasoline demand for summer driving season, which was a lower than pre-pandemic level, and news regarding additional issuance of export [ product ] from China in mid-September. Accordingly, average Singapore refining margin in Q3 went through significant downward correction, recording [ $7.9 ] per barrel after [ exceeding ] $20.8 in Q2. Moreover, the average price of [indiscernible] in June dropped to $91 from $113 per barrel on concerns over global recession, which resulted in inventory-related loss which is a one-off loss. As for Q4 outlook, regional refining margin is projected to improve by augmenting winter seasonal demand. Overall, global demand for fuel products goes up in winter for heating purpose in Northern Hemisphere by 1.3 million BD, higher than year-round below on average, which is subject to slight change after -- which is subject to slight change based on temperature. Usually, stockpiling of a product for winter season starts from October. Recently, inventories of diesel and kerosene in major regions such as U.S., Europe and Asia have plunged to their lowest level since 2005. Despite maximized production of diesel to take advantage of steep hike in margin after March, global refineries failed to build up inventory. This is mainly due to electricity shortage in Europe and [ Southern ] China in the summer and recent French refinery strikes. The low level inventory of diesel is likely to support its spread in refining margins. However, there may be sporadic volatilities based on the timing and range of China's possible export increase and EU's scheduled imposition of sanctions against refining product from Russia. We'll provide more details in the later part of the presentation. Moving on to petrochemical business. Operating income of petrochemical business in Q3 recorded KRW 66.1 billion, up by KRW 38 billion from the previous quarter. For Aromatics, PX spread in Q3 remained unchanged compared to Q2 recording $375. Spread remained healthy, supported by the discount of naphtha price amid tight supply on the back of operation cuts and scheduled maintenance of regional facilities. PX spread in Q4 is expected to soften slightly due to scheduled start-up of new capacity. But alternative demand for aromatics intermediary products for gasoline blending is likely to be sustained, and the spread is projected to be supported by continued weak feedstock naphtha price. For olefin downstream products. Demand for PP and PO remained bearish with the continued zero COVID policy in China from Q2. Especially, yield spread weakened slightly affected by supply increase due to the start-up of a new facility in China at the end of June. As for the outlook on PP and PO demand in the coming Q4, demand growth in consumer goods at the end of the year is likely to improve global market fundaments. Fuel spread is projected to recover gradually with the regular maintenance of some regional facilities. Turning to lube base oil business. Operating income of LBO business was up from the previous quarter by 46% to KRW 376.7 billion. For market [ assignments ] in Q3, demand dwindled after summer peak season, but market fundamentals remained healthy, supported by tight supply due to scheduled maintenance. LBO spread widened considerably with lower deficit costs and the decline in oil price amidst healthy fundamentals. In the coming Q4, seasonally weak demand is expected, but underlying supply-demand balance is healthy as global LBO capacity is extremely needed. Additionally, supply is estimated to be limited with adjusted operation rate of LBO facilities to raise the throughput of diesel though the spread is projected to stay high in this winter. Accordingly, LBO spread may edge down slightly from the near record level in Q3 that's estimated to be maintained at a healthy level. Now let me update major business results of the company. Please refer to Page 11. In September 30, Chinese Ministry of Commerce issued 13.25 million tons of extra light oil export products, which include gasoline, diesel and jet fuel. With this Asian refining margins fell sharply, entire quota up to [ 18 ] 2022, which is 37.25 million tons, similar with the 37.61 million tons of last year. For your reference, total quota for this year is 34% less than its [indiscernible] of 56 million tons in 2020. Though there was nothing official on a prior date of the quota, it seemed impossible to use total allotment within this year, considering export infrastructure. The industry estimates that it will be allowed to use the quotas until Q1 or first half of the next year for some refineries. Raised export quota of China will make short-term supply increase in the risk is inevitable, but uncertainty still remains with the actual timing and additional volume of exports that will be released by Chinese refiners. Moreover, a larger portion of additional Chinese export volume in the market may be offset by reduced restrictions of Russian refining product with time lines. Major execution outlook shows that EU's sanction against Russian refining product, which is scheduled to be effective on 5th of February will cut the run rate of Russian refiners. Please refer to the chart on your right for the forecast released by various institutions. Unlike crude, 0.6 million to 0.7 million BDF diesel are exported to EU from Russia. If the sanction becomes effective, Russia should see importers that replace EU countries. The biggest Russian crude importer, India and China, both do not need the diesel imports as they are diesel exporters. Thus, Russian refiners will have hard time to find out other importers for its diesel, which is expected eventually to bring above reduction in operation rates. After the disruption of Russian-Ukraine war in February, sanctions imposed on Russia by Western countries voluntarily continued to -- contributed to a sharp decline in the [indiscernible] of Russian refineries, which pushed our refining margin significantly. In this plan, temporary growth in export volume of Chinese refining product by Q1 next year is projected to offset in large amounts with time lines by reduced supply from Russia. From a long-term perspective, there is no reasonable ground to conclude that the Chinese government totally shifted its documented policy to restrict exports of refining products. There is still a chance to ease that restriction policy only temporarily due to slowing Chinese economy, triggered by zero COVID policy and weak demand for refining products. This means there will be less need to boost exports if China changes its lockdown policy and its domestic demand picks up. Next, refining facility shortage. Larger scale rationalization of older refining facilities during the pandemic and investments dampened by greenhouse gas reduction initiatives and energy transition have raised major institutions outlook from early this year, thus shortage of refining facilities will get worse and last long. According to their outlook, cumulative global oil demand growth from 2020 when global oil demand is [indiscernible] due to pandemic until 2030 is estimated in the range of between 5.3 million BD and 7.1 million BD. However, net capacity addition is [ 30.6 ] million BD during the same period, including 1.7 million BD to 3.5 million BD in excess demand based on estimation. As demand growth is likely to outpace net capacity expansion with highly maintained run rate of competitive facilities, refining margin is expected to stay at a high level for the time being. Given periods required for design and construction of new facilities, to pass the shortages projected to be prolonged. As a result, high cycle of refining industry is expected to continue for years to at least late [ 2020 ]. With this, I'd like to wrap up Q3 earnings results. Thank you.

[Foreign Language] The first question will be given by [ Young-chan Baek ] from KB Securities.

[Interpreted] This is from KB Securities. And I have 3 questions to S-Oil versus we saw the PS margin increasing in Q2 and Q3. However, S-Oil's on PX run rate was in the range between 70% to 80%. Could you explain why? Number two is about the CDU run rate in Q3. It was 92%. Is this because of the maintenance of the #1 of the FCC? Or is it because of the declined margin of some products? Number three is about the U.S. government policy to give subsidies to buy jet fuel. With regard to this, I would like to know what S-Oil is doing in terms of R&D into the biofuel? And how much of your jet fuel is going to the United States in terms of the sales revenue portion?

[Interpreted] For your first question, in Q3, we had the regular maintenance for the PX plans, which been concluded at the end of Q3. And as a result of that, are the PX plant utilization rate in Q3 was lower than that in the first half of the year. So with regard to your second question about whether the regular maintenance of FCC and the reduced margin in the market affected the relatively low utilization rate of the CDU. To answer this question, the number one FCC started the regular maintenance in September 15, and it ended recently, which inevitably affected the utilization rate of the CDU. And as for the margin, we are going to optimize the operation rate for the refining petrochemical and lube oil products in order to make the most out of the market -- margin situation. So now that the #1 RFCC regular maintenance is over, we -- the CDU utilization rate will go up and to the maximum level in order make the most out of the Q4 margin. I think the third question has to do with the sustainable air fuel or SAS, which has been included in United States IRA at where the SAS will be subject to tax credit in order to nurture and cost the future growth of the SAS market. At the moment, the cost of the SAS production is 3x higher than that of jet fuel, which means that even though there is a tax incentive and credit for the SAS, the cost is too hard for it to have an economic and also the volume of SAS is very, very small compared to jet fuel because of a small amount of waste vegetable oil and the animal oil that is used as a feedstock for producing SAS. So in order for the SAS, you have any medium in terms of the market on size and the economics, it's going to take a long time. But do you still think that there will be a demand for this in the long term, and it will definitely have some marketing progress over the long term, which is why we are constantly monitoring the evolutions and developments in the market situation, and we're also in the middle of the study to [indiscernible] a proper business model for SAS. As per our contribution, I mean our representation of the jet fuel to the United States market, we are selling 30% of S-Oil jet fuel goes to the United States.

[Interpreted] The following question is by Parsley Ong from JPMorgan.

I have 3 questions. The first question is on FX. If I look at your net profit...

[Foreign Language]

Can you hear me now? Hello? Can you hear me?

Yes.

I have 3 questions. The first question is on FX. If I look at your net income, then could you clarify what caused the nonoperating FX loss? Was there any trading loss in there? And also, how much was the FX benefit on the operating profit side in third quarter? And what is your expectation going forward? The second question is, can you confirm that post your schedule maintenance in third quarter, your utilization rate in fourth quarter will be close to 100% for all units, including your CDU and PX units? And then the third question is on your debt. As you mentioned during the presentation, your net debt to equity has been rising. Could you share with us what is your borrowing cost now? And what kind of borrowing costs are you expecting for the Shaheen Project and your overall borrowing cost expectations for 2023?