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

[Interpreted] Good morning. I'm [ Ji-yoo Lee ], IR project leader at SK Innovation. Thank you for taking the time to join us today. Today, we will first present Q2 earnings release, which will then be followed by our presentation on battery and E&P business split-off disclosed early today. After the 2 presentations, we will have a Q&A session to entertain your questions. Without further ado, we would like to begin the earnings call for Q2 2021. 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 invite our CFO, Mr. Yang-Sub Kim, for the presentation.

[Interpreted] Good morning. I am Yang-Sub Kim, CFO at SK Innovation. At the outset, I would like to thank our shareholders and investors for your continued interest in the company. On the call with me today are executives from SK Innovation and its major subsidiaries to entertain your questions. With that, I will present to you SKI's -- SK Innovation's Q2 business results for 2021. First, let me go through the overall Q2 performance, including sales and operating profits. Rising crude oil prices and subsequent increase in petrochemical product prices as well as strong battery sales drove our revenue in Q2 by KRW 1,879.8 billion quarter-on-quarter to KRW 11,119.6 billion. Despite a drop in inventory-related gains, operating profit increased KRW 4 billion quarter-on-quarter to record KRW 506.5 billion, thanks to increased margins in petrochemicals and base oil and improved profitability of the battery business. Nonoperating profit increased KRW 1,171.7 billion quarter-on-quarter and came in at KRW 141.6 billion. To elaborate, FX-related gains recorded KRW 9.5 billion; derivative-related losses, KRW 108 billion; interest expenses, KRW 87 billion; equity metal valuation gains of KRW 288.5 billion, including Beijing SK Tower equity sell off. Next, let me go over the balance sheet. As of the end of Q2 2021, assets totaled KRW 45,930.3 billion, up by KRW 7,432.2 billion versus 2020 on the back of increased inventories and accounts receivable, resulting from rising oil and petrochemical product prices. Liabilities increased KRW 5,214.5 billion versus 2020 to post KRW 28,254.1 billion due to increased accounts payable and borrowings following oil price hike. The debt-to-equity ratio recorded 160%. Gross debt stood at KRW 8,022.8 billion, down by KRW 702.6 billion compared to 2020 despite increased CapEx, thanks to cash inflow following SKIET's IPO. Let me now move on to Q2 market overview and business results of each business. First is the refining market backdrop. Crude oil price in Q2 rose as concerns over oversupply eased with delayed Iranian nuclear deal and fueled by expectations for demand recovery with continued rollout of vaccines. Product crack in Q2 stayed strong despite increased output by refineries with our expectations on stronger demand as the U.S. and Europe expand vaccination campaigns. Gasoline crack also increased quarter-on-quarter, thanks to reduced inventory burden, the arrival of peak season and the U.S.-led gradual demand pickup. Diesel crack strengthened as demand bottomed out and investment appetite increased in the U.S. and Europe. Kero crack also climbed up backed by steady U.S. demand for air travel and impending lift in travel ban in Europe. Next, I will discuss our Q2 refinery business performance. Refinery operating profit fell despite strong crack in key products, including gasoline, kerosene and diesel due to weak FO crack, margin dip affected by weak dollar, reduced inventory-related gains from slowdown in crude's rally. As a result, operating profit dropped KRW 183 billion quarter-on-quarter and posted KRW 233.1 billion. Q2 inventory-related gains for the refining was KRW 243 billion, including LCM. Refining margin is projected to gradually improve in the second half as COVID-19 retreats and demand rebounds. Next, let me move to the petrochemical market. First, polymers. In Q2, supply increased as the region finished TAs and added new capacity. Moreover, the resurgence of COVID-19 cases in Asia hurt downstream demand. As a result, our PE spread remains flat while PP spread was weak. Aromatics, meanwhile, saw strong PX and benzene spreads quarter-on-quarter as downstream demand improved and the new downstream businesses came online. Next, I will talk about our Q2 performance of the business. Sales volume showed a slight drop following TAs in PX units, but strong aromatics spread and overall product margin increase helped petrochemical operating profit to rise KRW 49.6 billion quarter-on-quarter to record KRW 167.9 billion. In the second half, polymer products are projected to see their spreads soften compared to the first half despite modest growth in packaging demand and a rebound in automotive demand due to increased supply coming from capacity additions in the region. As for PX, the main aromatics spread is forecasted to be flat in the latter half, despite new PTA capacities scheduled to come online later this year as new PX facilities in the region, including [indiscernible] China, will balance out supply and demand. Next is on lubricants. Base oil supply continued to be tight with the arrival of the TA season and low refinery run rate. This led to a rise in sales prices in the region and an increase in base oil margin. As a result, the lubricants operating profit increased KRW 89.4 billion quarter-on-quarter to KRW 226.5 billion. In the second half, base oil supply will expand but also with the restocking demand. Also as the real economy picks up, the real demand is expected to become bullish, which will help limit the spread from falling. Next is E&P performance in Q2. Oil and gas prices rose in Q2. Nevertheless, E&P operating profit in the same period fell KRW 7.7 billion quarter-on-quarter to KRW 3.6 billion due to reduced sales volume and increased SG&A. Next, I will move on to the battery business. The battery business on its sales in Q2 jumped KRW 103.9 billion quarter-on-quarter to record KRW 630.2 billion backed by solid sales of new programs, including Hyundai Motor Company's IONIQ 5. Operating loss also improved by around KRW 78.8 billion quarter-on-quarter and posted minus KRW 97.9 billion, thanks to increased sales and early stabilization of a new plant in Yancheng, China that commenced production this year. Our plants in Yancheng and Huizhou, China started their commercial production in Q1 this year, besides No. 2 plants in Europe and the U.S. located in Hungary and Georgia, respectively, are under construction. And the [ Vermont ] plant in the U.S. is near completion and is preparing for commercial production in 2022. SK Innovation recently announced a launch -- to launch a JV with Ford to manufacture batteries in the U.S. The initial output will be around 60 gigawatt hour with the potential to expand up to an additional 180 gigawatt hour by 2030. Please refer to the appendix for a detailed CapEx plan by region. Despite recent semiconductor shortage in the auto industry, our battery business is projected to post sales of mid KRW 3 trillion level in 2021, in line with our earlier guidance. And when it comes to profitability, we expect the operating profit to surpass the breakeven point in 2022, reach a mid-single digit in 2023 and attain a high single-digit in 2025. Next, let's take a look at SKIET's Q2 performance. SKIET's Q2 operating profit recorded KRW 41.4 billion, up KRW 9.7 billion quarter-on-quarter, thanks to additional capacity and production stabilization in our Chinese plant. Furthermore, LIBS capacity additions are underway, and the total output will grow from 860 million square meters in late 2020 to 1.37 billion by the end of 2021. Our Chinese plant completed a Phase 2 expansion in April and commenced commercial production. Another global production hub, the Polish plant, is under construction as planned and will start production in Q3 this year. Please refer to the appendix for more detailed CapEx plans per region. This brings us to the end of our presentation on Q2 business results. We will continue our presentation on battery and E&P business split-off. CFO, Mr. Kim will continue to serve out a presenter. Afterwards, we will open the floor for questions for both topics, Q2 earnings and the separation. Amidst the rapidly changing business environment, both at home and abroad, we feel it is necessary to enhance management efficiency via fast decision-making and to effectively procure funds for investment. In this slide, we seek to split-off the battery and E&P units. Major countries, including the U.S., China and Europe, have strengthened their ecofriendly policies accelerating energy transition. Against this backdrop, our battery division is eying to expand capacity from the current 40 gigawatt hour to more than 500 gigawatt hour by 2030. And E&P also has undertaken various environmentally friendly projects to transition to a sustainable green business portfolio. By carving them out, the 2 new business entities, we'll be able to raise management efficiency for future growth, and if needed, secure diverse sources of investment funds, including strategic and financial investors. On the next page, I will explain to you the new corporate structure following the split-off. After the separation, SK Innovation will keep it stakes in the new battery and E&P entities as before, and cement its position as Korea's leading refiner/chemical company on one hand and continue its R&D initiatives for new projects such as battery metal recycling on the other. Next, I will elaborate on future growth strategies of the new battery business. The new battery subsidiary aims to join global top 3 battery makers by 2022 in terms of sales volume and has a plan to ramp up its global production capacity to more than 200 gigawatt hour by 2025 and to greater than 500 gigawatt hour by 2030. To turn this vision into a reality, the new battery company will strengthen the 6 dimensioned virtual cycle consisting of leading-edge product, customer trust, fastest growth, strong market position, solid financial figures and technology leadership. At the same time, it aims to leapfrog into a global top-tier battery company by expanding battery applications. SK Innovation succeeded in commercial production of 62 and 181 -- 811 NCM batteries for the first time in the world and leveraged such competitiveness to recently sign an MoU with Ford and secured an order backlog of around 1,000 gigawatt hour. Our operating profit is expected to reach the BEP in 2022 and gradually post higher profits from then onwards. Backed by this, we will strive for even better next-generation battery technologies to maintain our leadership as a global top-tier battery player. Next is on the new E&P business. The new E&P subsidiary aims to build a sustainable upstream business through digital transformation and technologies designed to cut carbon emissions. At the same time, it's fixed to redesign its portfolio to be pro green by embarking on new projects such as CCS. Today, the company is building a value chain linked with deep saline aquifers in Korea to crystal carbon and is exploring various government projects and overseas business opportunities to ensure sustainable growth. Next, I will share with you SK Innovation's mid- to long-term growth strategies after separation. SK Innovation, the surviving entity, will perform its role as a green portfolio designer and developer in line with its vision Carbon to Green. This year, SK Innovation reinvented and reinforced its R&D arm with environment- and future-oriented projects in mind. Furthermore, we will actively leverage external competencies through open innovation in CBC to ensure speedy and successful technological development. SK Innovation will also explore additional growth options in the area of green energy and materials such as battery metal recycle and turn them into business opportunities to establish a virtual cycle of value creation. Next, I will briefly touch upon one of SK Innovation's growth pillars, the BMR business. As was presented at DSK's Story Day event on July 1, SK Innovation developed a proprietary technology to recover lithium hydroxide, utilizing its long-sensing refinery technologies. Lithium extracted using this technology is not only cost competitive, but also emits 40% to 70% less CO2 compared to conventional methods. SK Innovation plans to build a demo plant by early 2022 for battery metal recycle and start commercial operation by early 2025. We will grow this into a promising business generating EBITDA of more than KRW 300 billion. Next is the SK Innovation's mid- to long-term road map. Under the vision, Carbon to Green, SK Innovation's existing businesses will develop green business models such as CCUS and plastic recycling to strengthen their top-tier leadership and contribute to enhancing SK Innovation's corporate value. Next is on split-off timeline. With a target to achieve a split-off on October 1, SK Innovation plans to convene an extraordinary meeting of shareholders on September 16 at SUPEX Hall on the third floor of SK Innovation's headquarters. SK Innovation will maintain its leadership in other existing businesses, following the split-off and commit to further raise its corporate value by exploring new business opportunities. Thank you. Please refer to the attachment for post split-off financial statements. This brings us to the end of the presentation and the topic of split-off. Now we will open the floor for questions. [Operator Instructions] Also note that the Q&A session will be translated consecutively.

[Interpreted] [Operator Instructions] The first question will be presented by Young-chan Baek from KB Securities.

[Interpreted] I would like to ask 2 questions. The first question that I would like to ask is about your order book for the battery business. If you include the overall orders that you have through the JV with Ford, I do believe that currently, your order book stands at over 1,000 gigawatt hours, which is a very robust order book. If you could provide the breakdown of that, that would be appreciated. And in addition to that, for the orders for the next 2 to 3 years in terms of the overall outlook of the orders that you expect, if you could share some detail about that, that also would be appreciated. The second question that I would like to ask is a very simple question. It seems to be that at the SK Innovation level, if you look at the overall equity gains that you have, equity valuation gains, that there is some gains from a sale at the China entity that you have or the Beijing entity. Could you share that, please?

[Interpreted] So this is Yoon Hyung-jo. I am the Head of the Battery Business Support Office. And maybe I can address your 2 questions related to the battery business about our order book, and also the forecast that we have going forward. So in terms of the orders that we currently have, they represent orders from existing customers such as Hyundai-Kia Motors, Ford and also Daimler. But also include efforts that have been made to win orders from other OEMs. So if we currently look at the order book outstanding, it represents 1,000 gigawatt hours. And if you convert that into revenue numbers, that would represent KRW 130 trillion. In addition, there were some uncertainties related to the business. However, because that has been alleviated, with the ongoing discussions that we have about other orders, we do believe that in the not-too-far future, those will also be realized. In addition, if we look at the overall growth within the EV market, it is accelerating. And also with regards to the orders that we are winning, we are trying to make sure that the order book growth is at pace that outspeeds the overall market growth.

Yes, this is [indiscernible] the Head of the Finance 3 Office. And maybe I can share with you the details about the sale of the Beijing tower. To share with you the details, at SK China in June, there was a sale of Beijing tower. The total sales amount represented KRW 1.6 trillion. According to our ownership in that overall asset and according to the equity valuation gains that we have represented, the overall gains to the company was KRW 230 billion.

[Interpreted] The next question will be presented by Hyunryul Cho from Samsung Securities.

[Interpreted] There are 3 questions that I would like to ask you. First is related to your overall battery business. You did discuss and mentioned the JV that you have with Ford. Because it is in the initial stages, maybe it's too early to share a lot of details. But with regards capacity in the beginning, when do you think commercial operations of that capacity would be able to start? And when do you think that the 60 gigawatt hours would be able to be fully utilized? So if you have any details that you can share with us, that would be appreciated. The second question that I would like to ask is about your overall petrochemical business. It seems to be in the second quarter that the overall benzene and PX market was very strong. If we look at the PX margin levels, it seems to be that it's similar to that of the mid of last year, which was a very good time. So the question that I would like to ask is about the PX market outlook for the second half of the year and also for next year. If you have any views that you could share with us, that would be appreciated. The third question that I would like to ask you is about the overall split-off that you will be conducting. After the split-off for the remaining company, you did say that it would be engaging in the Battery Materials Recycling business, or the BMR business, and that as a result of that, you do expect it to generate an EBITDA of around KRW 300 billion. However, in addition to the BMR business, are there any other growth strategies that this entity would be engaging upon? And in addition to that, if you could share some more details about the BMR business, that would also be appreciated.

[Interpreted] So this is Yoon Hyung-jo, the Head of the Battery Business Support Office, and maybe I can address your first question. In May of this year, we did sign an MoU with Ford about the establishment of Blue Oval SK joint venture. So right now, we are in continuous discussions about the location of the site, also how the JV will be operating and other details related to the business plan. So for the overall JV factory, the overall commercial operations right now, we are targeting 2025, and preparing accordingly. In addition, the initial capacity is slated to be 60 gigawatt hours. And with regards to further expansion, it would depend upon the OEMs' sales plan. In addition, in May, Ford did announce that it is planning to convert around 40% of its overall production of global automobiles to EVs by 2030. And for that, it would require around 40 -- 240 gigawatt hours in battery supply per year. So when taking into consideration our cooperation and our partnership with Ford, in addition to the currently 60 gigawatt hours, which are under discussion, we do believe that there is a potential for a further opportunity of around 180 gigawatt hours. So that would be our expectations, but nothing has been finalized as of yet. So please understand this is an ongoing discussion as of the current time. So we would not be able to share more details with you. But once the details do become finalized, we will try to share that with you through other communication events.

[Interpreted] This is [indiscernible] and I am the Head of the Planning Office for SKGC. So if we look at the overall PX market, because of the improvements that we see in COVID related to the vaccination distribution and also the general economy improving, we do see more demand coming from the polyester market. And as a result of that, the PX spread on a Y-o-Y basis has improved significantly. And if we look at the second half outlook for the PX spread in the second half, there is new capacity of 3.3 million tons that will be coming in on the PTA side in July. In addition, an [indiscernible] PC on the PX side is also going to be -- also has started operations of 2.2 million tons since the end of July. So as a result, if we look at the overall PX demand dynamics in terms of the supply and demand, we do think that will balance out. So going into the second half of the year, we think that the PX spread levels will be similar to the current levels. And if we look at benzene in the second quarter, the overall spread levels improved significantly because we did have a very strong downstream demand. In addition to that, on the supply side, there were various troubles, and also there were turnarounds that were conducted. However, going into the second half of the year, the turnaround will be completed. Added to that, there are new plants that are going online, which will increase supply. So as a result of that, we do believe the spread levels will moderately lower to a lower level than the current level.

[Interpreted] So this is [ Kim Cha Chung ] the Head of the Corporate Strategy and Development Division at SKI, and maybe I can talk about the remaining company's overall growth strategies and the BMR strategy that we have for the future. So as we mentioned during the July 1 Story Day, for SK Innovation going forward, we do have a green anchoring strategy, at which in the center will be the overall battery business as our anchor, and we do want to expand the value chain surrounding that into new growth -- new businesses. So currently, as I mentioned before, for these new business areas, we do have a BMR business that we have identified. However, in addition to that, in the battery materials area and also into the next-generation batteries areas, we continue to look for opportunities that we would be able to develop in those areas. And in addition to that, we also are interested in new green areas for future growth drivers. So we look at various options that we have higher. Next, to talk about the BMR business in more detail, as the overall battery business accelerated, we do believe that from the standpoint of battery material feed that the importance of recycling is something that will continue to grow going forward. So what the actual battery materials recycling business represents is that it would be focused on the overall scrap material that we are generating from battery production. And also the overall waste batteries that we would see after 2025, in which the market will fully take off. So those would be the feeds that we would be looking at for this overall business. So through those batteries, we would be looking to attract not only the lithium but also the NCM materials that we would be able to enjoy. So in terms of the technology that is required to be engaged in this business, for the NCM components, the actual technology to extract that is something that has already been commercialized. However, for this business model, at the core of it is whether you would be able to extract the lithium. For SK Innovation right now, we do have the technological competitiveness to be able to extract highly pure lithium in an early manner. So using this differentiated technology in this area and also the strong battery presence that we have within the battery market, we are planning to build various production facilities for this BMR business in -- to cater to the China, U.S. and European markets. So taking this overall plan into consideration, and looking at the overall scrap volume and also waste battery volume that we are expecting going forward, the overall capacity that this business would represent in 2025 is expected to be around 260,000 tons.

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

[Interpreted] There are 3 questions that I would like to you. First is that if you look at the overall split-off that you're expecting for the battery business and also the investment plans that you have, I do believe that the split-off is an exercise that you are having to prepare for an upcoming IPO. If there is an IPO in the future, how much dilution in ownership should we expect in terms of the overall size? And with regards to your overall plans, is there anything that you could share with us, that would be appreciated? The second question that I would like to ask is about the overall future direction of the company. If you look at the recent actions that the company has engaged upon for the SKIET business, you did conduct an IPO. For the E&P business, you have been selling assets. For the lubricants business, you have sold some ownership, and it seems to be that also for the pet chem side of the business, you are engaging in a sale there also. So the question that I would like to follow up with is on the refinery side, do you have any plans to maybe sell some assets there or sell any ownership there? The third question that I would like to ask you is that in light of the overall sales that you are conducting of ownership in various entities that you have, for the remaining company after the split-off, how is that company going to finance and fund the overall requirements that it has? What plans would it have there? And in addition to that, for the existing shareholders of SK Innovation, what do you think we should focus on in terms of the value as an investor for continuously investing into this company?

[Interpreted] So this is the CFO, Kim Yang-Sub and maybe I can address your first question about a possible IPO. As you are aware, one of the purposes of the current split-off that we want to have for the battery business is to ensure that in the future when we need to do so that we can raise the appropriate financing for investments that are needed in a timely manner. However, that has been said, in terms of the actual size or method or how we want to go about and actually raising that financing or funding, nothing has been determined yet. However, that have been said, I do believe that outside of equity financing, there are various ways that we can actually raise the financing that we require. For example, we would have our own operating cash flow that we would be able to from the business. There would also be the part of investment or CapEx that would be burned by any JV partners that we have. Also, there are incentives from the various governments that are provided for our various operational locations and also raising debt would be another option. So that have been said, any equity financing that would include an IPO would only take place after certain preconditions have been satisfied such as us actually being able to realize the performance that we want. So when those actual requisites would be satisfied is something that we would have to see based upon a wide range of considerations, including the necessary resources that are needed and also the market environment going forward. So as a result of that, as of the current time, please understand that there's not a lot of detail that we would be able to share with you. However, once we do have more details and more concrete views, then we will make sure that we have an opportunity to share that with you.

[Interpreted] So this is [ Kim Cha Chun, ] the Head of the Corporate Strategy and Development Division. And maybe I can take your second question. So to ensure that we can continue to secure the resources that we require for future growth, SK Innovation continues to review and execute various options that we see for -- in the areas, for example, options, including joint venture partnerships, equity sales or ownership sales and IPOs. And this is not only to funnel or drive the overall future growth but also to decrease our overall carbon exposure and to make sure that we secure the sustainability of our individual businesses. So for the refinery business also this would apply. So going forward, based upon the overall market backdrop and the business model innovation that we're able to engage upon, we would look at various options to use the equity that we have, whether it be through a JV or partnering. So all options are open. So after the overall split-off of the battery and E&P business for SK Innovation, as the holding company for all of these businesses, we will continue to engage upon actions that would increase the overall portfolio our businesses and execute such actions accordingly. So what is most important is to be able to continuously generate value for the SK Innovation company in itself. So as a result of that, for future growth areas, we will continue to identify new business opportunities and commercialize them so we can continue on this momentum. So as just mentioned, by continuously increasing the value of our existing portfolio and identifying new growth areas, we do want to continue to enhance the overall firm value and corporate value of our company and continue to give a reason for investors to invest into the company.