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

Hello, everyone. I'm Keiichi Iwata, President of Sumitomo Chemical. Welcome, and thank you for joining our current priority management issues and business strategy meeting. I want to express my deepest appreciation to our investors for your continued support for and understanding of our business. This is today's agenda. First, I'm going to share with you our business performance and trends; and second, I'm going to talk about the progress we've made on our current corporate business plan, which will draw to a close at the end of this fiscal year; and lastly, I'll explain what we are doing to become carbon-neutral. We have a lot to cover today, and I'm going to walk you through the major points for each agenda item so that we can spend more time on Q&A. So let's get started. We announced our full year fiscal 2020 results on May 13. So let me just briefly explain about our fiscal 2021 forecast. Please go to Page 4. Here is the business environment that we find ourselves in for fiscal 2021, and it gives the basis for our forecast. The text in blue boxes are the ones that are favorable to our business and those in red boxes are ones that are unfavorable. They are both positive and negative developments, but overall, it is certain that the global economy will do better in 2021 than it did in 2020. That said, however, we believe that the global economy is only halfway to recovery in absolute terms. To the right, you see that the financial impact of the pandemic on our business amounted to approximately JPY 29 billion in fiscal 2020, and we do not foresee any major impact on our business for fiscal 2021. When it comes to the business environment that surround our major clients and their industries, overall conditions continue to get better for Petrochemicals & Plastics products, automobile production, demand for display materials and semiconductors and so forth. Demand for semiconductors, in particular, is expected to recover this year to the level seen in 2018 when the demand hit a record high or according to some latest projection, it could even exceed the levels of 2018. Also, the business environment for crop protection products looks promising in terms of planted acreage and weather conditions. The prices of methionine are going up as well in the April to June quarter this year. So all of this gives context to our financial forecast for fiscal 2021, which we show on Page 6. Based on our assumed exchange rate of JPY 110 to the U.S. dollar, and at an after price at JPY 47,000 per kiloliter, sales revenue is expected to make a bullish jump to reach JPY 2.610 trillion with a JPY 200 billion core operating income and a JPY 100 billion net income attributable to owners of the parent. This will be a significant upsurge in both revenue and profit from the previous year. Let me move on to the next slide to give you more details about the core operating income forecast. Here's the breakdown of the core operating income forecast and actuals by sector. For a closer apples-to-apples comparison, we're showing the variance between forecast and actuals using of fiscal '19 figures because the impact of the pandemic was significant in 2020. So we expect a very healthy turnaround in our Petrochemicals & Plastics, IT-related Chemicals and Health & Crop Sciences Sectors for fiscal '21 as compared to fiscal 2019. The expected turnaround in Petrochemicals & Plastics will be driven by a recovery in market prices. IT-related Chemicals will enjoy an increase in demand for display and semiconductor materials after having earned the highest-ever profit in its history in fiscal 2020 and is expected to do even better in fiscal '21. Health & Crop Sciences is going to benefit from a recovering shipment volumes of crop protection products in North America, rising market prices of methionine and an expected sales increase due to the consolidation of the South America subsidiaries we acquired from Nufarm. The expected core operating income of JPY 200 billion and net income of JPY 100 billion are both nice round numbers, but these are just coincidences. We have about JPY 1 trillion in equity capital, so a net income of JPY 100 billion means that our return on equity is 10%, and the return on investment is about 6% to 7%. So in terms of these financial metrics, we are at the level that we are supposed to as a mature company, and it took me 3 years since I took the helm of this company to get us where we are today. The next page is about dividend, shareholder returns. As I mentioned previously, the guiding principle that underpins our dividend policy used to be able to make stable dividend payments with the payout ratio target of about 30% for mid to long term. For fiscal '21, we are going to raise dividend by JPY 5 a share to pay JPY 20 a share on an annualized basis. Thanks to an expected huge improvement in earnings from the previous year. And just so you know, the payout ratio for fiscal '21 is going to be about 33%. As we have discussed, it is very likely that our earnings continue on a recovery track in fiscal '21, but we want to share with you 3 potential developments that are -- that we identify as risk factors at this moment. They are not described in the slide. The first and the biggest risk factor is the currency risk, the exchange rate. If the dollar weakens by just JPY 1 from our rate of JPY 110 per dollar, it will automatically eat away our core operating income by JPY 2.5 billion and our financial income by JPY 3.5 billion. The second risk factor is this ongoing pandemic. There seems to be an end in sight to the current pandemic in the west, thanks to mass vaccinations, but cases are still rising in a lot of developing countries, such as India and Malaysia. And possible researches said the virus, including new variants, is definitely a risk factor. The third potential development is a worsening conflict between the U.S. and China. Any company doing business globally, including Sumitomo Chemical, is sensitive to developments in the conflict, and we will continue to monitor the situation closely. Let's move on to Page 9 to discuss how much progress has been made on the current corporate business plan. And we want to look at this progress in terms of further improving our business portfolio that is making each business sector even more profitable, building a more robust financial structure by raising our debt-to-equity ratio to 0.7 or so and accelerating the development of next-generation businesses, including addressing our priority challenges. First of all, let's take a look at our core operating income from fiscal 2016 to 2021. In 2019, the first year of the current corporate business plan, our core operating income was about half of what it was in 2017 when we posted the highest-ever figure in the history of our company. From that point and at the beginning of 2020, we braced ourselves for the worst-case scenario where the number would plummet to just JPY 80 billion because of the pandemic. But we managed to put ourselves back on track for steady growth to be able to achieve JPY 200 billion for 2021, although it is still short of a pre-pandemic goal of JPY 280 billion. On the next slide is a brief summary of the major business challenges we identified as of fiscal 2019. Each sector of ours was faced with its own set of important and complicated challenges. For example, the commercial launch of Rabigh Phase II project and getting it off the ground to contribute to our earnings was one of the challenges for our Petrochemicals & Plastics sector. Our Health & Crop Sciences sector was tasked to establish a footprint in a growing crop protection market, and our Pharmaceuticals sector was above all frustrated with the delay in the development of post-Latuda products. However, for each of those challenges, a number of achievements have been made across the sectors over the past couple of years. So I want to share with you exactly what has been achieved by each sector. Please take a look at Page 13 for our Petrochemicals & Plastics sector. In the table on the lower half of the slide, we put from left to right, the prioritized challenges, which we identified when we developed the current corporate business plan, major progress to date and the future challenges. I'm here to give you more details about the licensing business and a rapid project in the subsequent slides. As for reducing environmental impact, our focus has been on developing new technologies, chemical recycling technology, in particular, and a series of projects has already been launched. More recently, we created a new function called Business Development Office for circular system for plastics back in April this year, and it is an organization that leaves and inspires our efforts to bring to life the fruits of our research more quickly. Our licensing business within Petrochemicals & Plastics sector centers around our production technologies listed on the left side of the slide, and we're putting more resources to this business. Our vapor-phase process of caprolactam production technology at the bottom is the latest candidate for our list of the technologies, and we believe this is very promising. In fact, we were awarded a prestigious Okochi Memorial Production Price for this technology in 2007. One of its unique hallmarks is that it produces no ammonium sulfide. We are currently in discussions with a number of potential licensees and our aim is to create a stable revenue stream from this licensing business by expanding licensees as well as sales of our catalysts that come with it. One of the things I want to talk about the Rabigh Phase II project is that the completion guarantee of the $5.2 billion project financing was terminated in September last year, substantial mitigating financial risks in the future. Although its earnings suffered a major setback due to the periodical maintenance shutdown last year, dragging down the group's entire results, its January to March quarterly results for fiscal '21 are very good as the operations remain stable for Phase 1 and Phase II and the crude oil prices are recovering. The fact that refining margins remain subdued is a concern though. Another thing I want to share with you with regards to Rabigh Project is about the situation of the project financing. Please take a look at Page 16. As the chart suggests, the borrowings for Phase 1 will be paid down by December this year, and that will allow us to focus on paying down the Phase 2 debt after that. Let's move on to talk about our Energy & Functional Materials sector. The following 3 sectors are the ones that we have been investing heavily, including strategic M&As for the past few years. So we prepared and included an additional slide, which describes details about our investment and a commercialization schedule for each of the 3 sectors. Here on this slide, the first thing I want to pick up is our Synthetic Rubber business, which is found in the middle of the slide. The description about this business in the slide is short of specifics. So let me point out that market reaction to the new great product which is a perfect example of the technological synergy between us and Zeon will be the key to the success of our Solution SBR business going forward. And it takes a little bit more time to assess that. Another product of our Synthetic Rubber business is, of course, EPDM. We have been trying many things to turn around this EPDM business, but the business outlook continues to be negative and challenging in medium to long term. So we are carefully exploring the best option for this business when that is the most acceptable to our customers and market. On the next page, Page 18, is the summary of major investment and M&A deals that we signed and are currently ongoing. From left to right, brief descriptions of the deals, the amount of money invested and the time frame where we should see a return on investment. For this sector, we are investing heavily in deals that concern battery materials. For instance, we invested JPY 15 billion to increase Tanaka Chemicals production capacity. And today, the production capacity at Tanaka Chemical is about 50,000 to 55,000 tons a year. The utilization rate was about 40% on average throughout fiscal 2020. So we expect to see the actual return on investment during the next corporate business plan period that is between 2022 and 2024. The bottom 2 rows show the deals made by our subsidiaries. And again, we should be able to see the actual return on investment sometime after 2022. Please take a look at Page 19. We consider super engineering plastics to be key materials for the 5G network in case that is connected autonomous shared in services. The LCP in particular, is a very promising now very much sought-after material for its high frequency characteristics and suitability for high-speed data communication or as an alternative to metal components of automobiles. These emerging applications aside, our LCPs are still the most widely used in the world and we are producing at full capacity. So in order to meet the rise in demand for LCPs, we're now considering to increase our production capacity, and we hope to put the plan together and start the site selection process by the end of this fiscal year. IT-related Chemicals sector is the one and only sector that reached and exceeded its profit target we had set in the current corporate business plan earlier than expected. I'm going to talk about our display materials business in the later slide. As for the semiconductor materials business, we are confident that we've made wise and successful investments, especially in the areas of processing chemicals and photoresists. I will share with you more detail on that in the next slide. And going forward, we will, of course, be focused on the ways to develop EUV photoresist. Please take a look at Page 21. This is the summary of major investment and M&A deals for IT-related chemicals sector. The acquisitions of a Chinese polarizing film manufacturer and the Sanritz helped us cope with increased demand for Internet devices as people spend more time at home last year. Sales of our semiconductor chemicals in China have almost tripled in just 2 years since 2018. Today, our semiconductor chemicals business generates about JPY 17 billion to JPY 20 billion a year in revenue. When it comes to increasing our photoresist production capacity, the main focus has been on immersion ArF photoresists. And as I mentioned earlier, we are literally in the midst of the race to develop EUV photoresist. I want to add a few more details about how we are going to make our display materials business more competitive. Take a look at Page 22. One thing we are particularly focused on is increase the use of our own proprietary materials for our key products to make us more competitively aggressive. Here are a couple of examples on the left side of the slide. The other is increase the use of our polarizing film for automotive applications. Take a look at the right side of the slide for more details. We acquired Sanritz back in 2019, and we are enjoying the benefits of synergy between the 2 companies as described in the slide. At the same time, we are also building up our defenses, if you will, by optimizing our production footprint to be more cost competitive as the consolidation of the display industry has led to a clear shift of customers' focus to China. Our Health & Crop Sciences sector is likely to deliver JPY 38 billion in core operating income for fiscal 2021 falling short on meeting the target of JPY 75 billion set forth in the current corporate business plan. We have made progress in addressing our priority challenges. We successfully established a footprint in the crop protection market in India and South America. INDIFLIN, a new fund aside for use to control disease of soybeans was launched in several markets, and I will share with you details about our biorational business and the methionine business in the later slides. The next page, Page 24, shows the summary of major investment and M&A deals for Health & Crop Sciences sector. Just taking a look at this short list of deals makes us realize that we have invested huge amounts of money in this sector. We have been reorganizing the R&D facilities we have across several countries in order to speed up the development of new products, including those within B2020 project. And as you're well aware, we established a bridgehead in the crop protection market in India and South America, the critical regions of strategic importance to Sumitomo Chemical. In India, our Sumitomo Chemical India lists equity shares in the country's stock exchanges. Its market capitalization exceeds JPY 240 billion, and we have a 75% stake in the company. It's a huge business. Please go to Page 25. Crop protection business will be the key driver of growth for this sector if it aims to achieve and even go beyond the core operating income target of JPY 75 billion, as I mentioned earlier. The figure on the slide shows the breakdown of crop protection sales revenue by region to see where we think growth will come from in years ahead. India is a market with the most growth potential, and Brazil is, of course, the biggest crop protection market in the world, and we are poised to focus our resources to these 2 critical markets. I want to share with you a few more details about our biorational business on Page 26. The figures within the table at the upper left of the slide show that the market size of biorationals is still only 1/10 of what it is for chemical crop protection today. But the tightening of regulations of chemical crop protection and the lower development efficiency will further stunt the growth of the business and instead will push the growth of biorationals with a projected rate of 10% to 15% a year going forward. Our biorational products are the most widely used in the world and we continue to leverage our competitive advantage to make this business even stronger. Also at the bottom of the slide to illustrate our ambitions, we have 8 products into pipeline that are at late stages of the development, and we will step up our efforts to launch them as quickly as possible. Next is methionine. Demand for methionine has been steadily expanding. Its market price has been continuously uptrend since December last year. However, as this is the business affected by market prices, our effort has been to have cost competitiveness. So it will make certain level of profit even under the market downturn. For this, we are working on the rationalization activities in both manufacturing and sales operations together. As described here, it was started back in 2019 at the worst time as [indiscernible] project under my direct order. Next is Pharmaceuticals. Development of large-scale products we acquired as a result of strategic alliance with Roivant have shown great progress, and I will briefly explain about this later. Besides Roivant, we launched KYNMOBI for the treatment of Parkinson's disease in the U.S. At the bottom, Nihon Medi-Physics is working on new type of business, Theranostics, which implements radioactive diagnosis and treatment at the same time. R&D facility for this started its operation in 2020. Slide 29 gives you an idea about performance trends of our Pharmaceuticals business. A reason for the gap from our initial plan was suspended R&D of napabucasin, large-scale oncology product from which we were expecting very much. Including this, we were not able to manage R&D of post-Latuda product. Pipelines acquired with alliance with Roivant has shown better-than-expected progress. And this also means we are spending more upfront marketing costs. So our operating income would downswing to JPY 67 billion in FY 2021. Then Latuda's exclusive marketing rights will expire by FY 2022, which is a negative factor. However, with increasing revenue contribution from the expanded sales of 2 major acquired products, and those we developed by our own, we expect contribution of JPY 120 billion or more to core operating income. Slide 30. From the acquired pipeline from Roivant, relugolix was launched as prostate cancer drug in the U.S. In January this year, have had a smooth progress since the launch. Additional indication of uterine fibrosis was approved just recently on May 27 in the U.S. as planned. R&D for another indication of endometriosis has also been progressing steadily. As for this product, we have started R&D and marketing alliance with Pfizer, who has strong capability and track record in oncology and gynecology areas. Another pipeline, vibegron has also been launched in U.S. in April of this year with an indication of overactive bladder. This concludes my explanation about the progress of our midterm plan by business divisions. In summary, this time in FY 2021, we were not able to harvest from all the large-scale investments we made in last few years. We continue our best efforts to prosper more in few years from today with 2 major pipelines acquired from Roivant and the strategic investments in battery materials and agrochemical. Slide 31 is about historical trend of our net operating profit after tax and the capital invested from the past. Y axis is NOPAT and X is capital invested. With large-sized M&As, our invested capital increased significantly in the last few years. However, the NOPAT reduced in FY 2019 and 2020. So our EVA today is unfortunately negative. From now, we are going to move upward by harvesting more from our past capital investments and acquisitions and earning more on NOPAT. And at the same time, in order to hold down invested capital, we work on improvement of cash conversion cycle, disposition of assets and the vigorous selection of investments. With this, we'd like to achieve EVA positive as soon as possible. In Slide 32, we posted charts by business domains for your reference later. Now I'm going to explain about the efforts to improve our financial structure. Slide 34, historical trend of interest-bearing liabilities and debt-to-equity ratio. Financial condition got worse from 2019 because of the 2 large M&As. Then it has been recovering in 2020 and 2021. However, even today, debt-to-equity ratio is about 0.9x and interest-bearing debt is more than JPY 1.3 trillion. By around 2024, we want to change our debt to equity ratio to 0.7x, the level we have been saying as our mid- to long-term goal. And to make it happen, we have been conducting several measures by reviewing our milestone plans every quarter. What you find in the next page is reduction of investment. Initially, we had a plan to spend JPY 700 billion as decision-making basis capital expenditures and investment in 3 years from 2019. However, as we had 2 major M&As, the forecasted figure has been changed to JPY 950 billion as aggregated counts. From this point, we applied strict selection of investment items and also reviewed the timing of them. As a result, we have compressed the amount by around JPY 100 billion, mainly in maintenance CapEx and we have now come to believe that we will be able to reduce them to JPY 850 billion. Next, asset sales and the cash conversion cycle. For asset sales, our target has been to sell JPY 50 billion by the end of FY 2024. With the sales of strategic shareholdings and other assets, we have already sold more than JPY 40 billion in 2 years in 2019 and 2020. This year, we have plans to sell more of those strategic shareholdings, and we'll be hitting the target even before FY '24. So we'd like to add even more reductions. As for CCC, we are working hard to make improvement by setting inventory reduction as a top priority and also using DX and other efforts. Shortening the CCC by one day benefits JPY 6 billion of savings. Therefore, by reducing 8 days of that in 4 years from 2020 to 2024, we expect to enjoy about JPY 50 billion savings. Slide 37 is our plan for asset breakdown in FY '24. As you see, with enhancement of profitability, net asset itself will also increase. In order to hit the D/E ratio target of 0.7x, we need to reduce the interest-bearing liabilities by JPY 100 billion from 2021, but we believe it as attainable goal. We are not going to slow down our investments to enhance our businesses, but of course, by striking balance with financial disciplines. Next, let me explain about progress about our medium-term key initiatives such as next-generation businesses. Our initiatives to create next-generation businesses have been categorized in 4 areas. Text in red are recent progress in last 6 months. I will not touch up on everything. But in healthcare, we decided to enter CDMO of regenerative medicine and cell therapy. We already won an order for contracted development of corneal endothelial cells and also had specific progress for the second project, but I'm afraid I cannot describe its details due to NDA. In nucleic acid medicine, we started to supply long chain RNA for CRISPR-Cas9. This business has become very attractive, and we are planning to build new capacity to enter full-scale production. As for reduction on the environmental impact, let me explain about PDH in red text. In the area of technical recycling, I have explained the technology under development with Shimane University to produce methanol from CO2 at high level efficiency. And we also have started studies to combine the method with PDH technology, which produce propylene from propane gases. This means we'll be able to produce Olefin from CO2 emitted from chemical complexes. So this should help us to increase our production output, but also to reduce environment load at the same time. Next slide, in food area, we focus on biorational materials. We have added 2 pipeline ingredients in the late-stage development. In ICT, as a new growth area, we have been developing peripheral materials for CMOS image sensors, materials for ultra-compact, ultra-high resolution Si-OLED displays for AR or VR applications are also under development. Initiatives aimed at digital innovation. Under the DX 1.0 strategy, we have been working on initiatives in 4 areas in the slide with main focus on productivity improvement. In parallel with the DX 1.0, we also started the DX 2.0 strategy a year earlier than we originally planned to enhance competitiveness of each business. Next slide, 2 important changes for strengthening IT organization to promote DX. First, we have absorbed and merged with our subsidiary, Sumitomo Chemical Systems Service for 3 years, and we're able to enhance our IT talent to promote DX. Another move was an establishment of a joint venture with Accenture announced in April. This made us possible to use Accenture's innovative digital technologies and talent development programs. Lastly, let me explain about carbon neutral, our initiatives against climate change. Page 44. On the left, we have history of our past initiatives. On the right, our path to carbon neutral by 2050. Our carbon neutral strategy consists of 2 parts of perspectives, duties and contributions as a chemical company. Duties mean we are going to minimize emission of greenhouse gases from our own manufacturing activities. Contributions mean we contribute to the reduction of GHGs through our products and technologies. We have 3 categories here: A, B and C. A is about indirect contribution to our society through the reduction of GHC's by our commercialized products in the market. B is about contribution by participating into technological development of CCS or CCU, collection and the usage of greenhouse gases and help their implementation into societies. C is about efforts in longer term. In order to reduce the absolute amount of greenhouse gases already emitted on the covering behalf today, we are developing carbon-negative technologies. Next page is to explain about the technologies within our scope. These 4 boxes are examples of technologies we are aiming at to implement into the society. We have duties at the bottom left. The key to our duties were to minimize our own emission should be the use of carbon recycling system and especially chemical recycling. Then as for examples of indirect contributions with our products: a, in the area of highly efficient energy infrastructure, we are contributing through our own product, such as materials for all solid-state batteries or powered semiconductors; b, is CCU or CCS related contributions. Economic hydrogen production and use means we generate hydrogen pyrolytically from methane, then mixing them with CO2 from CCUS to produce petrochemical material. So this is relevant to CCUS. As for long-term theme, c, carbon-negative, we are thinking about the use of Mycorrhizal fungi, one of the biorational products. Our goal is to commercialize technologies to enhance plants photosynthesis process that locks carbon dioxide. Next, Slide 46. To realize carbon-neutral by 2050, the innovative measures to reduce the mission I have explained should be the main. On the other hand, we would need to use different approach for the target to reduce greenhouse gases by 46% by 2030, agreed in the Leaders' Summit on Climate in April. As we have very limited time left, use of the best available technology or BAT should be the main of our activities. This slide gives you an idea. First of all, our target to reduce the emission by 30% by 2030 relative to the level for 2013 has been already certified by the science-based target initiative. With measures, including shutdown of our ethylene plant in Chiba Works, we have already reduced our emission by 24% to 7.22 million tons in 2019. In addition to that, by adapting fuel conversions to LNG at Ehime and Chiba Works where we have made investment decision and started construction, we reduced 900,000 tons. This means we are reaching to 34% reductions in terms of the SBT initiative target by 2030. So I think we are ready to clear the 30% target, but further reduction to 46% should be very challenging hurdle as the level is linked to SBTs well below 2.0. But we are working really hard to find a way to make it happen by setting new targets of our own. Slide 47 is about the information we released to the press this morning. As activities toward carbon neutral has been fully accelerating, we decided to build new research facilities in Chiba to transform our existing R&D functions there to be integrated hub of innovation for the development of the relevant technologies. Chiba area has been the center for technologies of catalyst process of polymer designs through petrochemical businesses in many years. And more than that, it has validation equipment and the facilities for a variety of scales from the lab to commercial levels. Furthermore, our idea is to use this new facility to accelerate our R&D to develop highly sophisticated polymer materials for next-generation mobility, 5G or other applications. Lastly, Sumitomo Chemical aims at creation of economic value and social value in an integrated way by realizing the Sumitomo's business of [Foreign Language], meaning benefit for self and others, private and public interest are one and the same. We are determined to contribute more to tackle the social challenges in these 4 areas through our businesses. As I keep saying, by sharing such aspirations of us with our stakeholders, we'd like to become a company which our stakeholders can feel proud of and feel joy. We continue to work hard with this vision. This concludes my presentation. Thank you very much for your attention.