Sumitomo Chemical Company, Limited (4005) Earnings Call Transcript & Summary

Thank you for joining us in the Sumitomo Chemical conference call for the fiscal 2019 full year financial forecast and projected dividend. First, Mr. Sasaki, Executive Officer of Sumitomo Chemical, will explain the fiscal 2019 full year financial forecast and projected dividend. He will later be joined by Mr. Mito, Managing Executive Officer for Q&A. Before the presentation, let me give some reminders. In the presentation, future projections based on current forecast may be provided. Please be informed that they may involve risks and uncertainties. You are kindly advised that actual results may greatly differ from projections. Now let us start the conference call. Mr. Sasaki, you have the floor.

This is Sasaki from Sumitomo Chemical. Thank you for joining us in the conference call despite your busy schedules. I'd like to take this opportunity to extend our deep appreciation to investors and analysts for your understanding and support to our management. As we made a press release today on the revised fiscal 2019 full year financial forecast and projected dividend, I'd like to take you through the revisions. Later, I'll be joined by Mr. Mito, Managing Executive Officer, Health & Crop Sciences business to take your questions. Full year financial forecast for fiscal 2019 announced in October 21 last year remained unchanged for the third quarter earnings announced end of January. As of end of January, formation of a strategic alliance with Roivant Sciences in Pharmaceuticals business, led to higher selling, general and administrative expenses and R&D expenses, while fall in shipment of crop protection chemicals and cuts in methionine selling prices were seen in the Health & Crop Sciences segment, leading to decline in profit. In the meantime, third quarter core operating income in the Petrochemicals & Plastics business exceeded full year guidance. After carefully assessing the business environment since then, we decided to revise the full year financial forecast and projected dividend. Earnings results announced by our equity-method affiliate Petro Rabigh and business outlook of each business segments made it clear that we will fall short of full year projections announced earlier. For these reasons, we made a press release on the revisions to our financial forecast and projected dividend. On Slide #3, revised forecast is provided. The forecast of sales revenue has been revised from JPY 2.330 trillion to JPY 2.250 trillion, down 3.4%. Core operating income is revised down from JPY 160 billion to JPY 125 billion, down by 21.9%. Operating income on an IFRS basis is JPY 130 billion, down 23.5% from JPY 170 billion. Net income attributable to owners of the parent or net income was down 40% from JPY 50 billion to JPY 30 billion. Our forecast for both revenue and income has been revised downward from the previous forecast. On Slide 4, numbers for each business segment are presented. In almost all segments, forecast of core operating income has been revised downwardly from the previous announcement. For your information, we have factored in certain impacts of the spread of infection with new coronavirus. These numbers may change due to changes in situation going forward. But assuming that the current situation, including operating rate in late February would stay unchanged until the end of March, we have included an adverse impact of between JPY 4 billion and JPY 5 billion on core operating income. Operating income on an IFRS basis, and net income attributable to owners of the parent or net income for the term are forecast to be lower than the previous forecast, mainly due to lower core operating incomes. Lastly, I would like to explain Slide 5 on projected dividend. On October 21 of last year, we revised our projection to the effect of that year-end dividend was yet to be determined. As I said earlier, now the full year forecast is below our original plan and incomes are expected to be significantly lower from a year earlier. Though we are very sorry, we revised down our projected year-end dividend to JPY 6 per share. Adding to the interim dividend of JPY 11 per share, which has been already paid. The annual dividend shall be JPY 17 per share. It is our basic policy to consider comprehensively performance of each term, payout ratio and internal reserves necessary for future business development to continue stable dividend payment. This annual dividend of JPY 17 per share accounts for 93% of the net income, JPY 30 billion on the revised forecast. We believe this represents a very high payout ratio. And we would appreciate if you could understand that our focus is to continue stable dividends. This concludes my presentation on revised full year financial forecast and projected dividends. Now we would like to take questions from you.

Thank you very much. We now would like to start Q&A session. First question is from Morgan Stanley MUFG Securities, Mr. Watabe.

First question is on dividend. JPY 11 as interim dividend and JPY 6 for year-end, assuming profit next fiscal year remains the same, will JPY 11 as interim dividend be the lower limit? Or could it go further down to JPY 6, JPY 6 interim and JPY 6 year-end. Can you elaborate on what you mean by stable dividend?

As mentioned earlier, the intent of dividend payout this year is to maintain stable dividend payments and, therefore, make the utmost returned to shareholders. As for next fiscal year and beyond, we cannot say anything definite at this moment. For 1 thing, a very high payout ratio cannot be sustained over many years. It will therefore depend largely on our profit and earnings forecast for next fiscal year. We are at a time when it is very difficult to say anything about next fiscal year. There are a number of elements of concern coupled with the unclear outlook regarding the new coronavirus, there are concerns that the spread of the virus could possibly slow down the world economy. It is, therefore, hard to say anything at this juncture.

Understood. My second question is on the new coronavirus that you briefly mentioned, can you give a breakdown of the JPY 4 billion to JPY 5 billion by segment or illustrate what sort of situation do you expect to continue? Forecast for the Health & Crop Sciences segment is a little north of JPY 16 billion in Q4, which is, in fact, better than Q4 last year. Can you please explain this? Is this because methionine prices have hit bottom and remain sluggish. Therefore, impact of methionine prices are perhaps not factored in or have crop protection chemicals picked up?

Regarding your question related to Health & Crop Sciences, Mr. Mito, Managing Executive Officer will later explain. As for the impact of the new Coronavirus at this moment, which I referred to earlier as JPY 4 billion to JPY 5 billion. Plants that were unable to resume operations after the Chinese New Year holidays have resumed operations as of end of February, although at low rates. Assuming that this situation will continue until the end of March, we are talking of an impact of JPY 4 billion to JPY 5 billion. By segment, IT-related chemicals business with high take-up of Chinese business, projections were revised down by JPY 3 billion, of which more than half or a close to 2/3 are associated to the new coronavirus. Petrochemicals & Plastics segment will also be affected. We have polypropylene compound plants. Fall in shipment volume and negative impact on selling prices are anticipated. Such impact could be seen in the Petrochemicals & Plastics segment. I would not totally deny the possibility of impact in other business segments. The total impact, therefore, is expected to be around JPY 4 billion to JPY 5 billion. Regarding the Health & Crop Sciences segment, let me ask Mr. Mito to reply.

This is Mito of the Health & Crop Sciences business segment. Thank you for the question. There are mainly 2 factors affecting the business performance of the segment this fiscal year. The North American business, which is a critical part of the segment, from winter to spring last year, experienced low-temperature, heavy rainfall and sustained flooding in certain parts of the country. Such poor weather conditions had a significant impact on our business. Second factor affecting the crop protection chemicals business is the intensified trade war between the United States and China. Shipment of soybeans, main crop in the United States to China, main customer, has declined drastically. These 2 factors, we believe have a significant impact on the North American business. To be more specific, the distributors or wholesalers of crop protection chemicals carry heavy inventory.

How will the high level of inventory impact shipment of crop protection chemicals, which will soon start with demand increase?

This is expected to have major impact on the crop protection chemicals business this fiscal year. As for the other pillar of the segment, methionine, as you know, suffered a sluggish sales prices. While prices are showing signs of recovery, harsh conditions continued throughout the fiscal year. Crop protection chemicals particularly in North America, and methionine will have significant impact on this year's results.

Comparing Q4 this year and last year, you seem to be expecting some improvement, what are your thoughts on this? This was my question.

Profit declined year-on-year up until Q3, but in Q4, there is some improvement.

Are you getting positive response?

My apologies.

Shipment is concentrated in the fourth quarter. But how the results look like for the full year, including markets other than North America? This is our line of thought.

True, if you compare fourth quarter this year and last year, there is a possibility of a slight improvement. But business performance, including the third quarter, especially for North America is tough compared to last year. Challenging, if you include North America, but numbers are improving. Although, this could get long. So thank you.

Next question, UBS Securities, Mr. Miyamoto.

This is Miyamoto, UBS. My first question is on Petrochemicals & Plastics segment. Looking at Petro Rabigh's earnings, I can understand the severe conditions. I think you've factored in JPY 21.5 billion in decrease in profits from Q3 to Q4. Can you tell me more about this? For Rabigh, I think fall in profit is about JPY 7 billion to JPY 8 billion. Can you share with us in more detail regarding cracker utilizations in Japan, in Singapore and MMA and polyolefin conditions?

Regarding Petrochemicals & Plastics segment. Petro Rabigh announced their earnings. And while they account for a large part, there are others where we expect significant drops. The biggest factor is deterioration in market conditions, MMA and caprolactam, considerably down. Those are factored in. Your question was on utilization. Singapore is operating decently. Polyolefin operations are slightly down. In the meantime, in MMA, utilization is substantially down in some plants, and we are assuming a decrease. Negative impact in terms of volume. As we said, this is against the backdrop of slowdown of the Chinese economy, some impact from the new coronavirus is also factored in. Regarding MMA, market conditions have now turned sour in the last 3 months. And for caprolactam, we see some improvement as of late.

Is the profit significantly down because of lower utilization rate?

Lower utilization is 1 aspect. We were -- how should I say this, expecting the U.S.-China trade tensions to alleviate in terms of prices and impact on the Chinese economy, but that is not the case.

Drop in utilization and volume is having a large impact vis-à-vis the third quarter. Is that a fair way to put it?

Yes, I believe so.

I see. My next question is on Energy & Functional Materials segment. Comparing Q3 and revised forecast for Q4 shows a close to JPY 4 billion drop in profit from JPY 5.1 billion to JPY 1.4 billion. At the time of Q3 earnings, Sepracor business was explained to be down for temporary factors and highly likely to recover, is it unlikely to recover? What is the overall impact of macroeconomic situation? Please explain Q4 revised forecast in comparison with Q3.

First of all, on Sepracor. It is true we explained just a month ago that there is some inventory adjustment in the third quarter and that we aim to achieve the same as last year on a full year basis. This, however, is quite tough, as we see it now. That has been revised. Tanaka Chemical Corporation, our subsidiary in the cathode materials business has revised down their earnings forecast. More time than expected was necessary in addressing customers' specification changes. Coupled with greater-than-expected slowdown of the Chinese economy has led to larger-than-anticipated drop in shipment volume. These are new issues. And we had to revise our forecast.

Regarding cathode materials, such impact is seen more in Q4 than in Q3? And business conditions are more severe?

We see a little bit of that for cathode materials. Third quarter was not that good. While a little more recovery was expected in the fourth quarter. Recovery is not seen as anticipated. It is very sluggish.

Separators and cathode materials had a tough Q3 and tough situation continuing into Q4. I still cannot get why JPY 3.4 billion fall in profit vis-à-vis Q3, resorcinol periodic maintenance shutdown may account for about JPY 1 billion, but what else could drive profits down?

As you mentioned, there is periodic maintenance shutdown for resorcinol. And as we have planned in Chiba and Oita, we have a situation where we have back-to-back periodic maintenance shutdowns. Those are the factors. And the magnitude is as you described. The rest of the impact comes from others, mainly separators and cathode materials.

I see. Q4 is expected to be more challenging than Q3?

Yes, you can put it that way. Are you satisfied Mr. Miyamoto?

Yes.

We would like to take the next question. Mr. Takeuchi of SMBC Nikko Securities.

This is Takeuchi of Nikko. My first question is about IT-related chemicals. Operating income for the fourth quarter is forecast to increase from the third quarter, taking into all the positive and negative factors. As you explained, about JPY 2 billion is taken into account as the impact of coronavirus. If we added back, though I don't know whether it is appropriate to do so. But operating income for the fourth quarter can be above JPY 7 billion, which is commensurate with that of Q1 or Q2. If we compare Q3 and Q4, can we say that it is getting better? Could you please explain Q-on-Q changes for polarizing film and touchscreen panel?

Yes, from Q3 to Q4, there seems to be a slight increase. During the third quarter, there were movements that had not been seen before. In a sense, such as inventory adjustments, that is Q3 results were much lower than the usual level. We believe that there were extraordinary factors in Q3 such as model changeover. Therefore, it is getting better compared to that. However, the JPY 5 billion you mentioned is rather lower than the level recorded in the first or second quarter. As the fourth quarter is an off-season, so we struggle in products like polarizing film, on top of which there is a negative impact of coronavirus. I think this is how we should look at it. On the other hand, for touchscreen panel, although we may have mentioned this at the earnings call for the third quarter. We expected an increase from the third quarter in film type touchscreen panel, in particular, because it was the timing, right after the customers' model changeover, when a full-fledged ramp up in sales is expected, and we thought shipment would increase. In principle, we believe that -- we believe that part will remain, and I believe this is how the expected increase from Q3 to Q4 could be accounted for. I hope I answered your question?

Understood. Then, can I say that profit increase in touchscreen panel rather than polarizing film is a main driver for increase on Q-on-Q?

Yes, that is correct.

My second question is about methionine. Though it has not yet recovered fully, some recovery has been seen in the market prices. Could you briefly explain the background and its sustainability into the next fiscal year?

Although it is quite difficult to predict the market prices for methionine, regarding the recent rise in prices, as you know, at the end of last year, one of the largest manufacturer, Adisseo, declared force majeure due to disruption of logistics posed by the striking French railway system. We believe that prices have recovered due to this, mainly in Europe. Going forward, as Adisseo lifted force majeure about a week ago. We do not think there will be a direct impact of that. But we anticipate some impact on supply and demand due to the slight decrease in major suppliers' inventories. It is also difficult to predict whether the coronavirus issue may have positive or negative impact on prices. But given the disruption in logistics. We have heard some customers have concerns about shortage of supply. So we believe that the recovery trend in prices will continue towards next year.

I believe you have made a decision to stop obsolete equipment, but can I assume that the remaining equipment, including the newly built-up plant has continued to be fully operated and the products are solder fully?

Yes. For the plant, which has been beefed up. It has continued to be operated at almost 100%. Have your questions been answered, Mr. Takeuchi?

Yes.

Now I would like to invite next questions. Mr. Watabe of Morgan Stanley MUFG Securities.

I am sorry to ask for the second time. I would like to ask about Health & Crop Sciences. Could you provide us with the latest information on North American market, it has been affected by bad weather over the last 2 years, which led to inventory pile up and maybe by floods as well. Could you give us an update? Could you also give me an update on new farms, Latin American business and any movements related to its consolidation, which I believe will start from the next fiscal year?

As for the current situation in North America, as I said earlier, the inventory has stayed at a high level due to bad weather last year and the U.S.-China trade friction. That is 1 thing. More specifically, we have also obtained information that sell-through from distributors to retailers is not advancing as expected, not only for us but for other major companies. Therefore, as I explained earlier, recovery in shipment has been slow in fiscal year 2019. On the other hand, planting for crops this year, such as soybean and corn will start soon. And if the weather doesn't turn unusual and given media report about the partial agreement on tariffs and U.S.-China trade friction. We believe that we will see a significant recovery in the acreage that had seen sharp drop since last year. Accordingly, we expect that our agrochemical business will see a recovery in fiscal year 2020. With a recovery in sell-through of distribution stock. Regarding new farms, Latin American business. Last fall, we reached an agreement on acquisition. And currently, it is being reviewed by the competition law authorities. We are working in earnest to get approval in early course. For crop protection products business in Brazil, which is slightly different from North America, it had been affected by droughts in Brazil. But weather has improved steadily and the Brazilian crop protection market itself has got back on track for expansion. For us, the sales of our main herbicide product, flumioxazin are increasing. And we will aim to increase shipment of herbicides, further in the next fiscal year under the new company. As regards to contribution to profit it may be too early to discuss this, but we are currently developing a new agent for soybean rust, which is the largest segment in the Brazilian crop protection market. We are aiming to launch this thing around 2021. And after the launch, we believe that the synergy of this acquisition will be maximized.

Understood. My second question is about the variance between core operating income and IFRS-based operating income. In this fiscal year, changes in the fair value concerning contingent consideration had a positive impact. But on an underlying basis, and for modeling the next fiscal year onwards, how much nonrecurring loss do you expect?

The variance between core operating income and IFRS operating income was just JPY 5 billion based on the revised forecast. Regarding the positive impact, it usually should be negative, for manufacturers like us, loss on variation of fixed assets occurs every year to a certain degree, and the impact is typically negative. But for this fiscal year, there were larger gains on contingent consideration. Thus, the impact was positive. Without such factors, according to my feeling, nonrecurring item may usually carry between minus JPY 5 billion to minus JPY 10 billion a year. Thank you. Mr. Watabe, was it okay for you?

Yes.

We would like to move on to next questions. Mr. Kimura of Nomura Asset Management, please have the floor.

I have 1 question. In December last year, investors meeting for the current priority management issues and the business strategy was held, where you provided your thoughts on potential upside and downside from the medium-term plan for each segment. And now we have more visibility for the results for this fiscal year. I understand that we needed to exclude the impact of coronavirus. But could you talk about any positive or negative changes from what you discussed in December? If there's seem to be any structural or major changes since then? Please update us on those.

I think you are referring to the Investors meeting led by President, Iwata, which was held in December. For your question about any major changes since then. First, at the meeting, we explained that assumptions for business environment we had at the beginning of the year have not held true. And that there had been changes in business environment. For example, we stated several changes that the U.S.-China trade friction might be prolonged. The awareness of the environmental issues may be raised and so forth. For a specific business, I think we mentioned that market prices of methionine had been declining. For any changes since then, I think we are moving towards a positive direction because we have at last seen some signs of rising in market prices of methionine, which, I believe, is positive. Having said that, we have a great concern about the impact of coronavirus, and its potential impact was included in the revised forecast to a certain degree. But I think more recently, we have a concern about whether it can be contained at that level. For us to continue our business, we may have to make emergency responses going forward regarding coronavirus issue. But setting aside this, in principle, we should continue to be mindful of and work on the challenges that we had discussed in December, and that we will not deviate from doing so. Mr. Kimura, are you satisfied?

Yes.

Thank you.

There seems to be no further questions. We would like to end the Q&A session. Before closing, I would like to invite Mr. Sasaki of Sumitomo Chemical Company Limited, to say a few words.

Thank you very much for taking part in our conference call today. I touched upon this earlier. In addition to the U.S.-China trade friction since last year, there is a concern that the new coronavirus and the spread of the infection may stall the global economy, and it is anticipated that we may be required to address the situation in various ways. And uncertainty may increase in terms of visibility of our business in the future. Under these circumstances, what we should do from a medium to long-term perspective will stay unchanged. We believe it is the most important for us to make utmost efforts in addressing the challenges set forth under the corporate business plan. I would like to seek your continued understanding and support. Thank you very much for your attendance today.

Thank you very much. The recording of this conference call will be available for 3 months from today in archive on the Sumitomo Chemical's website. It can be played at any time during the period. Now we would like to end this conference call. I would like to thank you again for your attendance.