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

[Interpreted] Yes. Good morning. This is [ Ji-yoo Lee ], Project Leader of SKI's IR team. Thank you for participating in this Q4 2020 SKI earnings session. Please note that the contents presented today have yet to undergo an independent auditor's review and could be subject to changes upon such review. The presentation today will be delivered by [ Yang-Sub Kim ], Head of Finance Division.

[Interpreted] Good morning. This is [ Yang-Sub Kim ], the Head of Finance Division at SK Innovation. I thank the shareholders and investors for taking interest in SKI. In today's session, we will first go over the management results of Q4 2020, followed by a Q&A session. To address your questions fully, we have here with us management and staff of SKI and its major subsidiaries. First, I will brief you on the company-wide sales and operating profit for the fourth quarter. EV battery sales continued to increase, thanks to stable operation of overseas plants. But due to global oil product demand decrease with continued influence from COVID-19 and regular maintenance of our chemical facility, our sales stood at 7.6 -- KRW 776 trillion, which is a decrease by KRW 630.3 billion over the previous quarter. With lackluster refinery market conditions and the mentioned regular maintenance, operating profit recorded a negative KRW 243.4 billion, which is a decrease by KRW 189.7 billion from the previous quarter. As for nonoperating loss, with declining exchange rate, there was a foreign exchange gain of KRW 100.8 billion, but regular maintenance of Sinopec SKU on petrochemical led to an equity method loss of KRW 25 billion. And with net interest loss of minus KRW 69.0 billion and minus KRW 35.0 billion asset impairment and petrochemical business, the operation loss was at minus KRW 31.5 billion. Now on to our financials. Tangible asset grew with increased investment spending, but the decrease of oil and refinery product price compared to last year led to decrease of inventory assets and receivables. Therefore, our assets decreased by KRW 1.08 trillion at KRW 38.4534 trillion at the year-end 2020. Our liability is at KRW 23.0091 trillion, which is an increase by KRW 1.6878 trillion compared to end of previous year. Our debt-to-equity ratio is at 149%, which is 32 percentage points higher compared to last year-end. The company's debt stands at KRW 13.6367 trillion, which is an increase by KRW 2.5057 trillion over the same period. And our net debt is at KRW 8.7254 trillion, which is an increase by KRW 2.1665 trillion over the end of last year. Now on to our business highlights for the fourth quarter. First, on refining market conditions. Fourth quarter international order price rose despite concerns over the spread of COVID-19 variant, thanks to dispelled uncertainties over the U.S. presidential election and expectations for the vaccine. Even with sluggish demand recovery with COVID-19, fourth quarter refining crack saw a modest improvement with continued operation cut of refineries and expectations for the vaccine. As for gasoline cracks, the business has entered the low season, but regional demand improvements from markets such as Indonesia remained stable. Diesel crack started weak at the beginning of the quarter with pressure from high inventory but saw some improvement with curbed export with major countries and inflow of financial capital with expectations for the vaccine. With winter demand and vaccine introduction, kero crack remained strong compared to the previous quarter. Now on our refining performance analysis for Q4. Refining margin, so slight improvement but with decreased inventory-related profit and volume, stood at KRW 192.5 billion, which is a decrease by KRW 231.1 billion Q-o-Q. Refining businesses inventory-related gains, reflecting lower of cost or market method, is at KRW 56.6 billion. With less influence from COVID-19 and pursuant demand pickup, we expect refining margin to show gradual movement in 2021. Next, on our Petrochemical business market conditions. Regional cracker trouble and delayed restart led to a continuation of tight supply. This, coupled with strong downstream demand from industries such as packaging and automotive, continued the strong spread for olefin in the fourth quarter. As for aromatics, closing demand recovery was delayed in the U.S. and Europe with another wave of COVID-19, leading to continued weak PX spread. Benzene spread improved significantly with downstream demand recovery and reduced production, both regional and internationally. Now on the company's fourth quarter Petrochemical results. There was volume decrease that followed the regular maintenance activities of our cracker and polymer facilities as well as weak PX market conditions but with margin improvements from olefin and benzene spread and decreased floating costs with regular maintenance, our operating profit saw an improvement by KRW 7.2 billion at minus KRW 46.2 billion. Now on the market outlook for olefin in 2021. Supply increase is expected in the first half with the restart of troubled facilities and volume from capacities coming online, but there would also be a strong downstream demand with global economy recovering. As for market conditions for a representative aromatic product, the PX, with eased influence from COVID-19 and concern from polyester change supply/demand recovery and with the scheduled large-scale PTA expansion, the market condition is expected to gradually improve. And on a yearly average, PX spread is expected to show some improvement over the previous year. Now on to our fourth quarter Lubricants results. Despite the low season, with reduced operations of refiners and decreased base oil supply, margin improved. With expectations for the vaccine and customers wanting to build inventory, sales volume increased. The operating profit from this business stood at KRW 125.3 billion, which is an increase by KRW 54.7 billion Q-o-Q. Now on the market condition outlook for base oil in 2021. Global economy recovery will lead to strong demand. With strengthened environment regulations, including tougher fuel efficiency and new low viscosity requirements, there will be added demand for group 3 products leading to gradual market condition improvement. Now on company's Q4 E&P business results. With the company's decision to withdraw from Peru and North America, the operating results from the said assets were treated as accounting for discontinued business. Sales numbers decreased slightly over the previous quarter, but with decrease in depreciation and cost, operating profit improved Q-o-Q at KRW 1.6 billion. Now on Q4 Battery business results. Sales from Battery business increased KRW 11.2 billion Q-o-Q at KRW 497.2 billion. Even with declining foreign currency exchange rate, this result was possible mainly due to volume increase with commercial production from Hungary #1 plant commencing in 2020 and sales volume increased from China Changzhou plant. Even with early stabilization of overseas plants and pursue on profitability improvement and increased sales, the initial cost increase of overseas locations slated for commercial production in 2021 led to an operational loss of minus KRW 108.9 billion, which is around KRW 10 billion increase from the previous quarter. Hungary plant #1 and Changzhou plant in China has begun commercial production in 2020. Number 2 plant in Hungary and plants #1 and 2 in Georgia, U.S. are under construction. Plants in Yancheng and Huizhou are readying themselves for commercial production starting Q1 2021. For detailed facility expansion plans for different regions, please refer to the appendix. The quarterly sales and OP margins for the Battery business is rapidly improving with procured orders and glitch-less efficient operation of overseas plants. Our sales number is fast-growing, and operating loss is decreasing according to schedule. There is gradual improvement that would get us to the target of reaching operating profit breakeven point in 2022. Now on to our I/E material business for Q4. LiBS sales increased in Q4, but the changes in the exchange rate and the initial fixed cost pressure with the new facility operation of the China subsidiaries, the OP for this business decreased KRW 4.6 billion Q-o-Q at KRW 25.3 billion. The company continues to add new LiBS capacity. Our production capacity stood at 870 million square meters at the end of this last year, and the number will be increased to 1.37 billion square meters by the end of this year. The new line in China that will be completed is expected to go into commercial production in the second quarter. The Polish plant construction is on schedule and is slated to commence commercial production in Q3 of this year. For detailed regional expansion plan, please refer to the appendix. Lastly, on dividends. With worsened results in 2020 due to the ongoing pandemic and with increased investments to new growth businesses, the company is unable to pay out end-of-term dividends. Please understand that this is an inevitable decision made for the improvement of our financials. Our exposure to Battery and I/E material businesses that require continuous reinvestment is increasing. COVID-19 and other external factors add to profit and loss volatility. And with this backdrop, the company is reviewing our mid- to long-term shareholder return policy. Once the company reaches a decision, we will share the information with our shareholders and investors through disclosures and other measures. Thank you. This concludes the presentation. Now we will move on to the Q&A session. Before posing your question, please state your affiliation and your name. And the Q&A will be translated consecutively.

[Foreign Language] [Operator Instructions] [Interpreted] The first question will be presented by Hyunryul Cho from Samsung Securities.

Yes. I will give you the translations to the 2 questions first.

[Interpreted] First, I would like to know your guidance for your battery sales in years '21 and '22. I believe that you are more or less on mark with your 2020 goals, but I would like to know your guidance for your Battery business in years '21 and '22, if that's possible. And you've talked about reaching a breakeven point with your Battery business in year 2022. Could you please be more specific as to when in 2022? And now on the second question, which is on your investment in Hungary. You've talked about your capacity, and you've mentioned that you could go beyond the mentioned figure of 125 gigawatt hours. And could you please be more specific on your numbers? And I would like to more -- know more about your commercial production plans. You've mentioned Q1, but when is the data more specifically?

[Interpreted] Yes. This is Yoon Hyung-jo or Hyung-jo Yoon, the Head of Battery Strategy and Planning Office, providing you the answer. As you have noted, our sales numbers recorded KRW 1.6 trillion, and compared to year '19, that's about 2.3x higher number. And despite the worsened external conditions with COVID-19, we were able to achieve this result. And as you would have heard from the presentation, we have begun commercial production at Hungary #1 plant and also our plant in China Changzhou. And I believe that the results from China's Huizhou factory and Yancheng factory will be included in the numbers for 2021. And Yancheng, we are readying ourselves with commercial production that would bring us 10 gigawatt hours. So well, we will be adding on 2 new sites in China. And with that, including the domestic sites, we would be operating, on a global basis, 5 sites worldwide, and that would give us 40 gigawatt hours. Yes. We will be continuing our efforts to add on new capacity in year 2021, and we have more volume going to our OEMs and was mentioned in our last earnings release session. Well, I believe that this year's numbers will be around mid-KRW 3 trillion to even a higher number. And that would be twice the number that we have recorded in year 2020. And by year 2022, our numbers would go as high as KRW 5 trillion. So we have begun our commercial operation of our global sites last year, and those sites are quite stable in their operations. We will be, as was mentioned, be adding on new capacity with our new sites. And with that, I believe there are loss, we see a decrease by about 30%. And we aim to turn to a positive number when it comes to our EBITDA. And as mentioned during the presentation, we do have a reach to -- we do have a goal to reach breakeven point in terms of our operating profit in 2022, and we could even go beyond BEP. And we do maintain our mid- to long-term view with the growing battery market. And with the growing OEM market and with our overseas sites in good operation, I believe that we will be able to reach a mid-KRW 5 trillion number in 2022. And by year 2025, I believe that we could reach a high single-digit profit number. And now if I may address your second question. We have our operation domestically in Seosan and we've begun commercial operation in Hungary plant #1 and also in China Changzhou plant. And this year, we will see commercial operation commence in Huizhou and Yancheng. So Huizhou, it has become a joint venture of our company as of the end of last year. And Yancheng, as was mentioned during my previous answer, it's readying itself for commercial production slated for Q1. So we'd be adding on 2 more sites from China. And as was mentioned, including our Korean Seosan site, that will be, on a global basis, 5 sites. And at the end of this year, year 2021, that will produce about 40 gigawatt hours. So we have 2 sites currently on -- in construction in Hungary, that's #2 and #3 plants. And the #2 plant will begin commercial operation in 2022. And as was announced yesterday, our #3 site in Hungary will begin commercial operation in '24. So the major locations when it comes to our business are Europe, China and the U.S. and we are adding on new manufacturing capacities in these regions. And our goal is to get to 85 gigawatts hours by year 2023 and as high as 125 gigawatt hours by year 2025.

[Foreign Language] The next question will be presented by Parsley Ong from JPMorgan.

This is Parsley Ong from JPMorgan. First question is on the EV Battery division. You have a negative 19% OP margin in fourth quarter, which is a slight improvement versus third quarter. Could you let us know if the current lawsuit expense related to the ongoing lawsuit of LG Chem, is that included in the current EV battery OP margin? And if so, what is the actual -- the true OP margin, all gross profit margin currently for the EV Battery division? And how will we get to your breakeven point over the next 2 years? Could you give us some color on that? The second question is with regard to your order backlog. Could you give us an update on that front? [Interpreted]

[Interpreted] Yes. This is Hyung-jo Yoon, from the Head of Battery Strategy and Business Office again addressing your question. Well, the numbers that you see for OP, it's reflecting our lawsuit cost 100%. So it may be larger than what it actually is. But on the upside, if the lawsuit is tidied over, then you will see much better improvement when it comes to our OP numbers. And please do understand that I'm not at liberty to disclose the actual numbers related to our lawsuit. And if I may move on to your second -- the BEP-related question. Well, as was mentioned, we do have a target to reach our BEP -- OP BEP in year 2022. And as was mentioned, we do have a good plan to roll out our international commercial production. And with that, we would be having and enjoying an economy of scale, and we would also work on our cost side, which will get us to our target. And if I may address your second question, which is on our backlog. We work with many global auto OEMs, including Daimler and Chanda Motor Company and Kia Motor Company. But other than those names, we are also working with other global auto OEMs on their various programs. So our backlog as of today stands at 550-gigawatt hours. And in terms of sales, if I may translate that to numbers, that's equivalent to -- of KRW 70 trillion. And this backlog does not reflect the current negotiation ongoing with our OEM clients. And once such agreements are made, we will be making sure to update you with our new backlog numbers in our next conference call.

[Foreign Language] The next question will be presented by Jae Sung Yoon from Hana Financial Investment.

Yes. I will give you the translations to the 2 questions.

[Interpreted] So first is on the scheduled IPO or planned IPO of SKIET. Do you have any actual data for the contemplated IPO? And what is the strength of SKIET over its peers? And the second question is related to your CapEx funding plans. I do believe that you have plans to sell down your stake at SK Lubricants. So including this sell-down option, what kind of other measures do you have to fund your CapEx requirements?

This is Head of Finance Division, Mr. Kim Yang-Sub addressing your first question on the IPO schedule of SKIET. Yes. To improve the value of our I/E Materials business, we are thinking of going public with our SKIET business. But please do understand that nothing -- the details have yet to be ironed out. And due to regulation reasons, I'm not at liberty to disclose you on the detail. And once the time line is set, we would be communicating this information to you through our disclosures and other measures.

[Interpreted] So this [ Tak-sun Oh ], Head of Corporate Support Office, addressing your second question, the merit of SKIET, the battery separator business. Well, I could firstly cite our facility capacity is 50% higher than our peers. A single line gives us 84 million square meters, and this is a better improvement over our peers by 50% to 100%. The second merit I would like to cite is our safety. Well, batteries nowadays, they're going for more higher nickel content. And our separator films, they're really thin in nature, but our products were never involved in any fire incidents. Next forte is our global presence. Many of our OEM clients run to the supply chains to be near their location. And if you look at our supply chain, it's where our clients are.

[Interpreted] Yes. This is Yang-Sub Kim, the Head of Finance Division, addressing your question on CapEx funding. Well, as you are well aware of, with our expansions with our Battery business and I/E materials business, there is a big need for CapEx. And the company will do its best to maintain the financial quality. So we want to maintain our net debt within a KRW 10 trillion level. So we are looking into various options that we could use such as divesting our noncore assets and an IPO of our subsidiary, SKIET. Through these measures, we'll be funding our CapEx requirement and at the same time, be ensuring financial stability of the company in this year as well.

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

[Interpreted] Yes. I have 2 questions. First is on your refining margin. I do believe that there is a slow improvement when it comes to refining margin. But having said that, I believe the inventory level is something we could take note of. And I would like to know the regional inventory status. So my second question is on your plans to bring in-house your cathode businesses and other material-related businesses? Do you have any plans to bring it in-house?

[Interpreted] So this is Dong-yeol Lee, Head of Corporate Planning Office. I would first like to talk about the inventory trend. Well, the OPEC+ countries have decreased their production. And compared to the peak numbers in 2022, we are seeing some changes. But what you would like to note here is the middle products, including gas oil and jet oil. Because of the slow demand in aviation industry and other industries, we do see some issues here. And when it comes to gasoline and fuel oil, it's back to the level that we have witnessed in 1919. And with ease in COVID-19 situation, I believe, on a global basis, the inventory level will go see a downward movement.

[Interpreted] So this is Hyung-jo Yoon, Head of Battery Strategy and Business Office, addressing your second question. As you're well aware, we have brought in-house the separator business, and we are currently outsourcing our requirements for cathode and other materials. But as our production capacity grows, we do feel the need to have a more secure procurement and secure supply of the needed materials. So we do feel the need to bring some of the work in-house, and we are looking at various options. Well, high-nickel cathode is in high demand, and we've used our own technology in commercializing the battery technology, and we have outsourced this. But the security level related to this technology is on par with what we manage in-house. So as was mentioned, we are looking at various options, including bringing some of the work in-house. But please understand that I am in no position to address this question in detail at this given point in time. Once things become more concrete, we will be disclosing the information to you.

[Foreign Language] The next question will be presented by Oscar Yee from Citi.

I actually have a few questions. First, I think on the Lubricants side. Given your big refinery in year-end cut, is your Lube division seeing a reduced feedstock supply to run your free base oil plant? And maybe could you give us some idea about the current utilization level of your base oil plant? Second question is related to the batteries. Could I ask you, given now you have 3 plants in China, could you share with us -- are you able to sell the output for all these 3 plants within China or you actually plan to ship out some of your products from these 3 Chinese plants to the overseas OEMs? And roughly, what sort of export percentage would that be? Third question is I remember earlier, you talked about -- you already included the lawsuit case cost in your battery OP, right? Am I correct in that? And I know you cannot disclose the exact cost, but could I ask you, if you strip out this sort of like lawsuit costs, are you able to reach EBITDA breakeven last year in 2020, not on the EBIT, but on the EBITDA side? [Interpreted]

[Interpreted] Yes. This is [ Ho-jeong Won ], Head of Corporate Planning and Development Office. I will first take your lubricant question. So as you rightly noted, the global refiners are decreasing their output. But despite this fact, we have no trouble getting our feedstock. As for our overseas operation, we do get a stable flow of feedstock from our joint venture partners. And we have various or multiple sources for our feedstock. So there is no trouble in operating our Ulsan operation.

[Interpreted] Yes. This is Yoon, Head of Battery Strategy and Planning Office once again. As you've mentioned, we do have 3 sites in China. Most of the products produced in those sites are bound for global OEMs, and we do take out some of our products from China to be exported. And some products are bound for Chinese OEMs as well. And well, our operating profit numbers for year 2020, as was mentioned, does include the lawsuits -- lawsuit-related costs or fees. And well, if we were to carve out that lawsuit-related costs, it would improve our OP significantly but not enough to reach a BEP on an EBITDA basis.

[Foreign Language] The next question will be presented by Nikhil Bhandari from Goldman Sachs.

Yes. I got a few questions. Firstly, I noticed that your net debt improved from third quarter from KRW 9.6 trillion to about KRW 8.7 trillion this quarter. Considering the cash flow generation from refining and petchem business wasn't as robust even in this quarter, just trying to understand why that improved. And also, can you give us some color on what was your actual CapEx spend for year 2020? And what is the outlook on CapEx and breakdown for 2021? The other question I had is just around the litigation of ITC with LG Chem. The next, I think, hearing is on 10th of February. In a worst case, if the de facto decision goes through, what could be the implication? Can you talk about scenario? What are the options SKI has after that in a worst case? And what could be the impact to the business? And lastly, you mentioned that China, your factory, you do produce some battery that you export as well. Can you share some -- what is the cost of transporting battery in terms of freight, say, from China to Europe or U.S. market? And are there any kind of import tariffs that are additional costs for getting the battery from China to the markets like Europe and U.S.? [Interpreted]

[Interpreted] Yes. This is [ Kim Yang-Sub ], Head of Finance Division, who will be addressing your first and second question. So you've asked the question how we were able to lower our net debt number. Well, first, we've made some adjustments when it comes to our operation rates. And second, we either engaged in various securitization measures in order to improve our numbers. Yes. If I may give you an example of how we've securitized. Well, we have our holdings in Daehan Oil Pipeline Corporation, and we earned some gain on capital reduction amounting to KRW 41 billion. Now on to your second question. So our CapEx for year 2020 as a whole stood at KRW 4.4 trillion executed. And if I may give you some color on our CapEx execution for year 2021. We have the orders already received and new orders to come in for our Battery business. So we would have to continue our investment activities in this area. So our CapEx requirements will be similar to what we have witnessed last year, standing somewhere between KRW 4 trillion to KRW 4.5 trillion. And of the mentioned CapEx number, about 70% will go to LiBS and our Battery business.

[Interpreted] So this is Mr. Yoon Hyung-jo or Head of Battery Strategy and Planning Office again. I will be addressing the questions 3 and 4. So first, I would like to ask for your understanding. I cannot give you any details on the currently ongoing lawsuit. So as you've noted, we will be getting a final decision on February 10. Well, in the final decision, new findings will be reflected, the values that were not there in the initial determinations, such as the existence of trade secret -- infringement of such trade secret and an impairment that comes from infringement of such trade secrets. And we can never predict the outcome of such legal lawsuits. But in all cases, we are doing our best to minimize the impact that goes to the company, to the clients and the Korean battery industry as a whole. So even if the ITC shared the rule in favor for SKI, well, we do have some more steps ahead of us, including the Federal court cases and other related legal issues. But having said that, we would try our best to improve the industry and benefit the shareholders and our clients and also to see a take-off of the K battery industry to benefit the whole economic ecosystem and the nation as a whole. And we would engage in various dialogues and measures to reach an amicable agreement, including, perhaps, a settlement. Now on to your fourth question, export out of China. Well, as was mentioned, products that were made in China goes to various global OEMs, and the contract agreement differs according to our different clients. And who should bear the burden of any costs that are incurred, it's all dependent on the individual contracts. So I cannot really give you a detailed number or percentage of product that goes to Europe or the U.S. As was mentioned, everything is dependent on the contracts, actual agreements reached with the auto OEMs. And according to those contracts and agreements, we plan and operate and produce our batteries. And as of cost burdening, as was mentioned, we go for the optimal option as is slated or mentioned in the agreement.

[Interpreted] This will conclude the Q&A session, and this is the conclusion for Q4 2020 earnings release. Thank you. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]