SK Innovation Co., Ltd. (A096770) Earnings Call Transcript & Summary

[Interpreted] Good morning. I am [ Wi Han Lee ], IRP at SK Innovation. Thank you for taking time to join SK Innovation's Second Quarter 2020 Earnings. Today's presentation has yet to be reviewed by our external auditor. So the results are subject to change based on such review. Now I will hand it over to the CFO, Mr. Myung-Young Lee.

[Interpreted] Good morning. This is Myung-Young Lee, CFO of SK Innovation. I would like to thank our shareholders and investors for your continuous interest in the company. Today, I will present our second quarter 2020 performance, after which we will have a Q&A session. On the call with me today are executives from SK Innovation and its major subsidiaries to answer your questions. First, let me go over the second quarter full company performance including sales and operating profit. To talk about the top line, a decline in crude prices triggered by COVID-19, and a decrease in petroleum product prices and sales volume caused sales to decrease KRW 3.9634 trillion quarter-on-quarter to KRW 7.1996 trillion. Turning to operating profit. Against a still sluggish backdrop, less inventory-related losses and lower Middle East OSP resulted in a quarter-on-quarter increase of KRW 1.3355 trillion to end with a operating loss of KRW 439.7 billion. Nonoperating side. Tax-related gains of KRW 25.1 billion. Product derivative-related gains of KRW 34.4 billion, interest expenses of KRW 77.3 billion, equity method losses of KRW 34.6 billion led to nonoperating losses improving KRW 231.3 billion versus the first quarter to KRW 40.7 billion. Next, let me go over the balance sheet. As of the end of the first half, total assets stood at KRW 39.2647 trillion, a decline of KRW 261.4 billion versus 2019 end. Tangible assets increased as capital expenditure grew, but the fudge in crude led to a decrease in inventory assets. Total liabilities was KRW 23.4323 trillion, an increase of KRW 2.1158 trillion versus last year as debt increased. Debt/equity ratio was 31% point higher at 148%. In addition, gross debt stood at KRW 15.0176 trillion, up by KRW 3.8866 trillion versus the end of last year and net debt grew KRW 2.215 trillion to KRW 8.7739 trillion during the same period. Next, let me discuss the refining market overview. In the second quarter, to first talk about the overall petroleum market and refining market, fuel prices softened in the beginning due to concerns about the spread of COVID-19, but recovered during the second quarter because of less concerns about the oversupply as the OPEC+ stuck with the agreed production cuts and stronger hopes for a recovery in refining demand as economies around the world reopened. Second quarter petroleum product crack levels weakened quarter-on-quarter as low demand continued on the back of the spread of the coronavirus [indiscernible] crack cell with the COVID-19 pandemic, but is recovering gradually as lockdown measures are lifted. Diesel oversupply continued as exports dropped from lackluster non-regional demand, while refiners increased the yield in light of weak gasoline and debt levels. As a result, diesel crack softened versus [indiscernible] crack was also weak due to a decrease in demand, stemming from travel restrictions and entry bans. However, as the OSP on Middle East crude was lowered significantly, margin of Asian refiners who import a large portion from the Middle East [ declined ] versus the previous quarter. Next, I will discuss the second quarter performance on the [indiscernible] plus the operating profit for the refinery business, even though the overall market was weak, operating profit improved by KRW 1.2031 trillion quarter-on-quarter because of a decline in Middle East OSP, that are lagging margins due to the crude rebound plus inventory-related losses versus the first quarter leading to a operating loss of KRW 432.9 billion. Second quarter refining inventory-related losses, including LCM, aftermarket application was KRW 187.4 billion. Second half refining margins are expected to improve as refining demand increases from a gradual recovery in the global economy, driven by economic stimulus measures around the globe. Now let me go over the petrochemical market. Second quarter olefin supply decreased because of turnaround conducted by regional NCCs and FCCs, while downstream demand increased, adding to a stronger olefin product spreads quarter-over-quarter. On the aromatic side, though regional PX capacity went into planned maintenance, unexpected shutdowns of Chinese PTA led to capacity in an oversupply in PX. As a result, quarter-over-quarter, aromatic spreads were softer. Next, let me talk about the second quarter performance of the business on the next [indiscernible]. The petrochemical operating income, olefin and aromatics spreads moved in opposite directions, resulting in a minor contribution from the margin effect. However, a decrease in inventory losses and a drop in variable cost due to a decrease in utility costs led to a KRW 158 billion increase quarter-on-quarter to KRW 68.2 billion. The second half olefin spreads are expected to turn soft, even though demand is expected to recover from an improved COVID-19 backdrop because of an increase of supply from new capacity additions globally. Looking at the PX market, the flagship of aromatics, demand expected to gradually recover as downstream demand recovers due to a more stable COVID-19 trend and economic stimulus measures from governments. Next, let me move on to lubricants. To talk about lubricant operating profit, base oil sales volume decreased significantly, mainly in the U.S. and Europe market as global auto OEMs were shut down due to COVID-19, but margins improved because of a fall in cost. As a result, the second quarter operating profit increased KRW 8.5 billion quarter-over-quarter to KRW 37.4 billion. Going into the second half, the base oil market is expected to recover moderately from stronger demand amid a more stable coronavirus environment. Signs of demand recovery have been noted across all regions. Moving on, I will go over the second quarter E&P business performance. E&P business generated operating profit of KRW 11.8 billion, KRW 33.5 billion less quarter-over-quarter because of a decrease in complex selling prices and drop in sales volume as demand dried off because of COVID-19. Next, let me move on to the battery business. The company saw an increase in sales volume as overseas factory that started commercial production this year stabilized earlier than expected. However, one-off SG&A to build a global business system led to operating losses totaling KRW 113.8 billion, an increase of KRW 8.9 billion versus the previous quarter. To meet customer demand, the company completed production facilities in China and Hungary at the end of last year and started commercial production in the first half to sell to market. In addition, we are currently building a number 2 plant in Hungary and our first facility in Georgia, USA. To meet additional orders from the U.S., we are planning to build a second production facility in this location. Next, let me move on to the I/E Materials business. Operating profit for I/E materials posted KRW 43.7 billion, up KRW 16.7 billion versus the first quarter due to an increase in LiBS sales volume for EVs. The company continues to increase production capacity for LiBS. In the fourth quarter of 2019, 2 additional lines in Jeungpyeong started commercial productions, taking total production capacity from 360 million to 530 million square meters. We are also on schedule with the construction of our global production hubs in China and Poland. Lastly, I would like to mention that the company will not be paying out interim dividends this year due to weaker performance and CapEx required for our new business. Please understand that this is an inevitable situation to improve our financial profile. The business environment is challenging due to COVID-19, but we will continue to exert our efforts to enhance our corporate value and overcome this crisis through continued innovation and fundamental [ transformation ]. This is the end of our presentation. We will now start the Q&A session. Before asking your question, we will ask you to state your name and affiliation. In addition, please note that the Q&A session will be [indiscernible]

[Operator Instructions] [Interpreted] The first question will be presented by Jae Sung Yoon from Hana Financial Investment.

[Interpreted] Thank you for the presentation. I would like to ask you 3 questions. First question, could you first provide us with an update on what the current sales process for your Peru block is for your E&P business? And when will be the timing for us to see the impact of performance from that block removed from your quarterly business performance? Second question, we've seen a quite steep rise in your net debt level. And I believe that, that had impacted your dividend payout policy. What other dividend policy changes should we expect as we go forward? I would expect that since you would need to continuously invest in your battery business, do you also have any plans to sell off any of your assets or your current business division? Third question relates to your battery business. Could you share with us what your mid- to long-term capacity plan is and what your guidance for your top line and operating profit is for that business?

[Interpreted] I am the Head of E&P planning office, [indiscernible], responding to your first question. With regards to the E&P business, our Peru block due to the COVID-19 pandemic, which led to the lockdown, the government approval process has been facing some difficulties. We will do our best to gain that approval from the government authorities as soon as possible and we are currently cooperating with the buyer, the operator, so that we can meet our original target of ending this whole process by end of September. In terms of the P&L from Peru block being removed from our overall performance, the timing will be that when this deal close is most likely end of September.

[Interpreted] I will respond to your second question on our financial structure, our dividend payout policy and also relate -- which all relates to our investment. Now first of all, if you look at the cumulative operating loss level for the first half of the year, it is quite significant. So it's too early for us to share with you any color on the dividend plan going forward. However, as we enter into the second half of the year, we will closely monitor what the market backdrop is and also identify any turnaround in the market backdrop and -- which will enable us to make certain changes to the policy. And so when that second half comes, we will be able to communicate with you and provide you with more information. Due to the COVID-19 pandemic, the market fluctuations and changes have been quite serious, which had actually contributed to the prolongation of our operating profit losses. We expect that for the time being, for the year, we expect our financial structure to turn for the worse. So we expect that, that will have certain impact on our dividend payout. However, the more, I guess, fundamental changes to our dividend payout policy, we will be able to communicate that with you at a latter point in time. And in order to recover from the operating profit losses as well as any undermining of our financial structure, we are at this point reviewing various different options. So first of all, in terms of the expenditure, after next year, what we are currently looking at is to have a more conservative approach to CapEx spending. So we're in the process of changing the -- adjusting the CapEx-related plans for the second half of the year. And also, the Peru sale -- Peru block sales proceeds, we expect that we would be able to receive that within this year. And as you would have probably seen through the news articles for our SK IET, which is our I/E business, we are currently in preparation for listing that entity. So a -- so we believe that by the first half of next year, we will be able to complete that listing process. And if so, that will have a positive impact on our financial standing.

[Interpreted] I am the Head of Battery Business support office. I am [ Yoon Hung Jo ], responding to your question about battery on our mid- to long-term capacity plan. From 2020, our Hungary number one plant and China's Changzhou plant has started the operation. Our company has secured a production base in key strategic geographies, and therefore, by the end of this year, our capacity for -- on an annual production volume basis is going to expand to 20 gigawatt hours. On top of that, we're in the process of building out the second European plant and number 1 and number 2 plant in the United States. Once these other production bases are completed by year 2023, we will see the capacity expand on an annual production volume base, that is 271 gigawatt hours. Our objective is to, by year 2025, to have an annual volume capacity of 100 gigawatt hours. Going forward, when we have more detailed plans, we will come back and communicate that with you. Responding to your question on our top line guidance and operating profit guidance. Our revenue target on an annual basis, that target still stands with regards to what we have previously communicated to you via the first earnings conference call. With the spread of the COVID-19 pandemic, some of the OEMs have adjusted their required volume. And therefore, we inevitably had to reduce our original target of KRW 2 trillion, which was set up in the early year 2020 and have reduced that by 10%. Currently, our supply agreement with the OEM still stand, but due to some of the halt in the plant on the back of COVID-19, there has been some adjustment in the overall 2020 volume. In terms of the operating profit guidance, we are continuously sticking to our initial target that we set at the beginning of the year. As we previously mentioned, there is still going to be certain costs that will be incurred because of the fact that the plant construction is at its early phase. And so we do expect that in terms of the annual profit, there could be a slight year-on-year decline, but our company before the COVID-19 pandemic became prevalent on a global basis, we have really kicked off our contingency business management system, and we have developed various different countermeasures responding to different types of scenarios, and we are very closely monitoring the situation. And also, in terms of our overseas plant, we are endeavoring to increase the yield of our production lines and also to optimize the basic cost structure. Although there are prevalent uncertainties, we are going to do our best to make sure that the impact is minimized.

[Interpreted] The next question will be presented by Woo Ho Noh from Meritz.

[Interpreted] I would like to ask 4 questions. First, this morning, I saw a news article on the acquisition of Innometry. Can you provide some more background information regarding this news? Second question is, what is your plan to expand into the ESS business? Third question is one of your customers, Hyundai-Kia Motors, assuming that their EV vehicles are going to see more increase in its sales, what is your profit guidance, any changes to your profit guidance for 2021 and any strategies related to that? And also what is your policy to defend the battery prices?

[Interpreted] This is the CFO. I would like to respond to your question about this morning's article in Innometry. Basically, this is something that is not being led by SK Innovation. I think it is something that is being pursued by one of the affiliates. So I think it will be inappropriate for me to provide you with any additional information at this point. We will come back to you later on.

[Interpreted] Responding to your second question on the green new deal policy really supporting the expansion of the ESS business. Basically, this green new deal, a deal policy has been announced and -- by many different global countries around the world in order to stimulate the overall economy. For our company, even before the COVID-19 pandemic, we had very closely been interested in following the overall trend and -- global and environmentally friendly trend worldwide. And also, in order to provide, I guess, more happy life to our customers and our consumer base, we have also announced Green Balance 2030 initiative as well. Although, for us, our ESS business is only at its beginning stage. Together with the EV and the battery business, ESS will become 1 important pillar of such businesses going forward. We are, therefore, very closely monitoring the market situation, and we do have plans, and we are making preparations to further expand our ESS business. Responding to your third question about our -- that regards one of our customers on the E-GMP project, which we won last year. With regards to this program volume, we will start with mass production and supply starting the fourth quarter of the year. And in order to meet that mass production schedule, we are currently satisfying all the milestones, important milestones that we have set. So we are doing our utmost so that we can live up to the commitment and promise that we have given our OEM customer. With winning of this program, basically, the overall volume had increased, and that really is already reflected in the P&L guidance that we have formally communicated. And with regards to this program and our order strategy-related aspects, there are no particular changes. It is same as before. Responding to your first question, in order to have cost competitiveness, as I said previously, we are putting in various different types of efforts. For instance, we want to secure and gain investment economics and also make sure that in terms of the process-related expenses, we also have economics retained on that as well. So all of this is going to contribute to us having cost competitiveness and -- which will follow our efforts on that. In terms of winning orders and increasing our capacities, our principle is for us to first win an order and then go through capacity addition process. That principle still stands.

[Interpreted] The next question will be presented by Min-seok Won from HI Investment & Securities.

[Interpreted] There are 2 questions that I would like to ask you. First, you said that for your separator business that you would be looking to list this business in the first half of next year, could you actually share what the progress is in terms of that overall preparations? And in addition to that, for this overall business, could you share some guidance for the performance for this year and also next year? Secondly, I would like to ask about your overall turnaround plans that you have. Looking at this quarter, it seems to me that the overall utilization of your CDU and RFCC have been dampened because of turnarounds. Going into the third quarter and fourth quarter, what are your expectations about the utilization during those quarters? And for your PX facilities also, could you provide some color about the overall utilization?