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 today's briefing on our corporate business plan. 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. The current corporate business plan got started at the same time as I became President of Sumitomo Chemical 3 years ago. So first, I'd like to take a look back on the progress we've made over the past 3 years, and then I'm going to talk about where we want to be for the next 3 years based on the new corporate business plan, followed by the explanation of the business strategy for each of the 5 sectors. This new plan is a JPY 3 trillion package of spending and investment, and that's why this is such a chunky presentation deck. I'll just focus on key points and spend as much time as possible on answering whatever questions you may have to make sure you understand our plan. So let's take a look back on what we have accomplished over the past 3 years with the current corporate business plan. In the current plan, we have been working on these 6 areas such as further improving business portfolio or accelerating the development of next-generation businesses. And we can summarize the past 3 years by pointing to the fact that we have been addressing 3 major business challenges. The biggest challenge of all was, of course, the development of post-Latuda products in our Pharmaceutical business. The second challenge was how to make our AgroSolutions business stronger because we knew back in 2019 that we had a profitability issue. And the third was what to do with our Petrochemicals & Plastics business. And for us, it was specifically about putting the ongoing Rabigh II project on track. And for each of these challenges, we did what needed to be done, including making large mergers and acquisitions and have paved the way forward for growth. Furthermore, we introduced a new company-wide initiatives such as creating innovation ecosystem in our group to further encourage the development of next-generation businesses, driving digital innovation or pursuing carbon neutrality, which was not included in the original plan. And you see here that we have successfully laid the foundation for each and every endeavor. Also, as a result of all this, our core operating income has grown steadily and strongly, thanks to solid growth seen in the high-performance materials and life science deals, and I want to give you more detail on each of that in the next few slides. Let me slice and dice it using key financial metrics first. This graph clearly shows that our high-performance materials and life science businesses, outlined with red dotted lines, have improved under profitability and have pushed up the overall core operating income over the past 3 years if you exclude the performance of more volatile Petrochemicals & Plastics business. When it comes to capital efficiency on the next slide, we compare between the first and final year of the current corporate business plan period for the amount of invested capital and ROI. ROI is on the vertical scale and the capital invested is on the horizontal scale. It is clear that the amount of invested capital increased significantly over the past 3 years, thanks a large part to big M&A deals. ROI is also improving and expect to reach 5.7% for fiscal year 2021, but it will likely fall short of its goal of 7%. Although I'm going to explain it later, I'd like to note here that not all the fruits of our investments come through immediately, and we are trying to achieve the 7% target during the period of the next corporate business plan. Our overseas sales revenue has also increased more than JPY 350 billion over the past 3 years, accounting for 67.5% of the total revenue. We have successfully expanded our global footprint. And when you look at the green area of the chart, you see that growth in Central and South America has been particularly robust, driven by our crop protection businesses there. In terms of shareholder returns, we are very sorry that we have to lower our dividend payout for fiscal 2019 and 2020 from the previous year. But for fiscal 2021, we are happy to announce that we are planning to raise dividend to JPY 24 a share, the highest ever payout in the company's history as we expect also a record high figure of JPY 140 billion in net income. Next, I'm going to briefly talk about the progress we've made over the past 3 years and some of the key items of our action plan. The most critical of all is, of course, further improvement of our business portfolio. We identified which businesses to make more competitive and which businesses we should exit from or downsize. And we believe we're now seeing a clear way forward in addressing the 3 management challenges that I mentioned at the beginning, and we have put in place these measures you see in the slide to make these businesses bigger and stronger. At the same time, we downsized and exited from businesses that we judged to be not growing and less profitable in the future. We exited from EPDM and shuttered one line at our Methionine plant. And we will continue to do so as appropriate in response to changes in the business climate and from a long-term perspective while doing everything we can to mitigate the impact on our stakeholders. When it comes to how much we invest in what under the current corporate business plan, the total amount of investment is expected to be about JPY 880 billion on a decision basis. As the table on the left shows, we are investing approximately JPY 600 billion as what we call strategic investments which exclude those needed for maintenance and repair. I'd also like to note that the pie chart on the right indicates that we have allocated so much on Pharmaceuticals and Health & Crop Sciences that not enough investment has been made in the area of high-performance materials, and this will be addressed in the next corporate business plan. Another company-wide initiative under the current corporate business plan was to create innovation ecosystem, and we did 4 things specifically. First, at the top left, we established 3 CVI offices in the United States and Europe. These are our platform for digging into new R&D topics. Next in the right is the adoption of material informatics. We trained at least 1 data engineer in each development group. You see at the bottom left that we introduced a stage-gate management system. The number of projects at the incubation stage increased from 26 in 2019 to 67 in 2021. We are as excited as ever. The last one is that we decided to reorganize our research sites to make them stronger and more competitive. I'm going to share with you more detail on that later. Drug and digital innovation is yet another component of our company-wide initiatives we launched under the current corporate business plan. DX strategy 1.0 as a first step sought improve productivity, and we successfully deployed digital technologies that were validated at our demonstration plant across many of our sites and in material informatics across all of our research labs. Furthermore, we established a joint venture with Accenture to put structure in place to drive our digital transformation efforts forward. And as you can see, we've made steady strides in developing data scientists and data engineers as well. Carbon neutrality has emerged as one of the important management priorities since 2019. We created the grand design for achieving carbon neutrality by 2050 as announced at the end of last year. I'm going to give you more detail on that later as well. So there has been a brief overview of what we achieved with the current corporate business plan, and we will build on the progress as we swing into action for the next corporate business plan, which will start in fiscal year 2022. First, let's take a look at the business environment that surrounds us right now. I think that it is widely recognized that the business world is going through rapid and tremendous upheavals right now. And the biggest difference between now and 3 years ago is the growing awareness of and interest in sustainability. We will also have to get ourselves more prepared to deal with other dramatic changes such as ever faster digitalization or increasing geopolitical risks. And we see those challenges as opportunities to transform ourselves and to make more contribution to society, a precious reminder that the mission of the chemical industry is to bring together the power of chemistry to contribute to solving society's challenges. More broadly and from a longer-term perspective, we are driving green transformation. Now green transformation is often defined as economic and social transformation that will be brought about by achieving carbon neutrality. But the kind of green transformation to Sumitomo Chemical aims to realize is more encompassing as to include the preservation of ecosystem and the promotion of health. And that is why we are focusing on the environment, food, health care and ICT and enhancing our business portfolio so that we will be able to meet the challenges posed by green transformation. This is the slogan for the new corporate business plan. We keep change and innovation and have added with the power of chemistry as sort of a subtitle. But what does the power mean? We've put a lot of thought and passion into this word. We define that the power is the multiplication of our strengths and opportunities for growth. Our biggest strength is the diversity of our businesses, technologies, geographies and people. And the change in business environment such as growing interest in sustainability or digital innovation, will provide us with a lot of opportunities for growth. And thus, the power that stems from the multiplication of our strengths and opportunities for growth will help us find solutions to the society's challenges in the 4 priority areas and allow us to demonstrate the power of chemistry. Next, I'm going to share with you more details about our next corporate business plan in terms of its basic direction and plan of key actions. Let me start with the basic policy and explain what it is all about. First of all, there are 2 big principles. One is putting ROI at the center of running our businesses and the other is carrying out company-wide projects to serve as the foundation of our businesses. And these principles translate into an informed practices such as making our businesses stronger through technologies, transforming the business portfolio based on GX with driving changes and adaptations based on competitiveness, growth potential and our sustainability with the ultimate goal of establishing competitive superiority. And there are 7 elements that inform the basic direction for the next corporate business plan. Improving our business portfolio is not only about improving our earning capacity, but also adapt into green transformation. The development of next-generation businesses must build on the foundations that we put in place over the past 3 years and go ahead at a greater pace. Carbon neutrality is added as a new company-wide initiative and the digital innovation projects should set their sights on not just improving productivity, but also making our businesses more competitive. For each of these 7 elements, I will share with you exactly what we're doing in practice. The first element of the basic direction is improvement of the business portfolio. The focus of the current corporate business plan has been on improving our earning capacity. But as I said earlier, not all the fruits of the investments we've made are not being realized today. So here is the list of our key investments that we've made so far and expect to reap the benefits of them during the term of the next corporate business plan. As you can see, we have invested heavily in the areas of high-performance materials and life sciences so far, but the return on these investments is mostly expected to realize during or after 2022 and before the end of the term of the next corporate business plan. And we expect to get a return on investment from each and every item on this list by fiscal year 2024, the final year of the next corporate business plan. So we are doing everything we can as quickly as possible to maximize the return on the investments. We will continue to improve our earning capacity for each sector in the next corporate business plan and to do so with a new perspective of green transformation, which I talked about earlier. This new approach is being reflected in our planning of CapEx, investments and loans. As shown in these 2 pie charts of the total amount of our CapEx, investments and loans by sector, we spent about JPY 880 billion during the term of the current corporate business plan. But this amount is a little bit excessive for us, so we are going to bring it down to a more normal level of about JPY 750 billion for the next corporate business plan. This JPY 750 billion new investment plan is significantly different from the previous plan in 2 ways. Firstly, we are going to invest more in essentials, the blue area, and primarily focusing on projects that seek to reduce environmental impacts, such as chemical recycling rather than the usual Petrochemicals & Plastics area. Secondly, we will take a longer-term view and a perspective of green transformation to invest more in high-performance materials, including semiconductor and battery materials, which we didn't invest in enough in the past 3 years. This is the breakdown of the JPY 750 billion investment plan, but the figure for each area should be considered as sort of a general guidance and none of them is a commitment. We set aside a JPY 450 billion as strategic investment and are planning to invest JPY 30 billion in the Petrochemicals & Plastics area with a particular focus on chemical recycling and other projects to seek to reduce environmental impact. Moreover, we are planning to invest JPY 70 billion in battery materials and super engineering plastics, which will help reduce environmental impact. And JPY 90 billion will go to 5G, semiconductor and next-generation displays. And another JPY 90 billion will be invested in the crop protection business to help realize sustainable agriculture. When it comes to capital allocation, our total spending will be about JPY 1.470 trillion, and we will spend JPY 1.290 trillion on business investment. Most of the money will come from our operating cash flow before deducting R&D expenditures, and we're going to raise the remainder or JPY 80 billion by selling assets and lowering the cash position. We will also do our best to maintain the dividend payout ratio of about 30%, our mid- to long-term goal. And at the same time, we're going to improve our financial structure by reducing the interest bearing liabilities by JPY 50 billion and lowering the debt to equity ratio to 0.7. Our priority is to strike a very careful balance between improving the financial structure and investing for growth. We announced at the end of February that our Petrochemicals & Plastics sector was renamed as Essential Chemicals sector, and I want to explain why we did that. First of all, despite the growing call for carbon neutrality, we as a society and individuals will continue to need plastic products. That is why Sumitomo Chemical will continue to produce and deliver essential carbon derived products to meet the needs of the times from our innovative plants, which use nonfossil resources, whether for the generation of thermal energy as a fuel or as a feedstock for production. The new name reflects our determination. We also believe that the expertise and technologies that this sector has accumulated over the long years such as catalysts and production processes are necessary for the CO2 emitting chemical industry to transform itself into an industry that contributes to achieving carbon neutrality. So the name also reflects our conviction that this sector is essential not only for society but also for our group. Exactly what is going to happen to Essential Chemicals sector after being renamed? We will make significant changes to its business portfolio with a particular focus on green transformation. That means that we will expand our subscription-based businesses and integrate our operations in Japan and Singapore to step up research and development of carbon-neutral technologies and deliver them to the world as quickly as possible. We will also continue to ensure stable operations of our Saudi business so that it remains a cash cow, so to speak. We want to nurture this sector so that it proudly stands up to its new name. The next topic I want to talk about is what we're doing with respect to improving our financial structure. We expect to sell JPY 60 billion worth of assets in the 3 years after fiscal year 2021, and that obviously exceeds our initial target of JPY 50 billion by fiscal year 2024. That is why we have raised the target by fiscal 2024 to more than JPY 100 billion. We remain very selective in our investment choices and are planning to spend JPY 750 billion for the next corporate business plan, as I explained earlier. When it comes to improving cash conversion cycle, we know that for every day we reduce the cycle, we will save approximately JPY 6 billion in assets, and our target is to reduce it to 110 days by fiscal 2024. This target remains unchanged, and we continue to do whatever we can to achieve it. Let me say a few things about our cash flow plan as well. For the period of the current corporate business plan, we became a company with negative cash flow due in large part to big M&A deals. In fact, in the beginning of fiscal year 2020, our debt-to-equity ratio temporarily spiked to 1.1, causing anxiety over the apparent lack of financial discipline. But since then, there has been steady improvement and it is at 0.8 or so as of the end of fiscal 2021. Today, we are happy to tell you that we are on track to bring it back to 0.7 by the end of fiscal year 2024. This is our mid- to long-term target as planned. This graph is showing the historic changes of interest bearing liabilities and debt-to-equity ratio. I've already explained all this, so let's skip this slide. Let me explain a little more about accelerating the development of next-generation businesses and the new corporate business plan. We will make the most of the innovation ecosystem we have built over the past 3 years, explained earlier, and multiple projects will enter the commercialization stage for environment will produce polyolefin with reduced environmental impact from the waste-derived ethanol provided by Sekisui Chemical as a leading project. Its pilot facility is expected to launch in a new corporate business plan to move to the commercialization stage for food. We will aim for early commercialization and product launch for high-performance feed and new biorational products, which have been promoted in the current corporate business plan. For health care and ICT, multiple projects are in progress in different stages as examples are shown on this slide. Next is development highlights. As announced in the press release, in the end of last year, research facilities are reorganized for enhancement. In Chiba and Osaka, we will build new research labs. In Chiba, we will focus more on developing technologies that reduce environmental impact. And at the same time, we will transfer and consolidate development for highly challenging polymer materials to strengthen R&D organization. In Osaka, we will establish an end-to-end development structure from initial phases of research to commercialization for ICT and life sciences to accelerate new business development further. We already explained about carbon neutrality in detail at ESG briefing in December, so I will cover only important points briefly. To achieve carbon neutrality in 2050, we are working on both obligations to bring our own GHG emissions close to zero and contribution to reduce global GHG emissions through the products and the technologies of our group. This slide is about obligations. Between 2013 and 2020, we reduced GHG emissions by 2.12 million tons, mainly through planned restructuring such as the shutdown of an ethylene plant and the end of liquid-phase caprolactam process. Towards 2030, we are working toward a goal of a 50% reduction from 2013 level through fuel conversion to LNG as well as our energy conservation and rationalization of manufacturing processes. This is regarded as an ambitious goal for a diversified chemicals company. Next is about our initiatives on the contribution side. As a chemical company dealing with carbon on a daily basis, we own a variety of technologies and are promoting a multifaceted approach. For instance, we are promoting technology development in various fields, including circular system for plastics such as material or chemical recycling, turquoise hydrogen production technology to produce hydrogen from methane without CO2 generation and development of mycorrhizal fungi, a useful microorganism and soil as a carbon-negative technology. We will continue to work with partners regardless of industries for early social implementation of products and technologies that contribute to global GHG reduction. Regarding chemical recycling, the full project on the slide was selected for NEDO's Green Innovation Fund. The technology selected at this time is a chemical recycling technology that produces chemicals such as alcohol and olefins from waste plastics and CO2. We are proud that our proposal was highly evaluated and will accelerate the development, leveraging the 10-year support with GI Fund to meet their expectations. Now I will explain about Sumika Sustainable Solutions, which is to contribute to carbon neutrality. This is an initiative to designate products and technologies of our group that contribute to a reduction of environmental impact over the entire product life cycle and promote their development and widespread use. It is expected to achieve the revenue of approximately JPY 560 billion for target products in FY 2021. We set a new target to achieve JPY 1.2 trillion in FY 2030, which is more than double the current figure. This is equivalent to 40% of total revenue in FY 2024. We will strive for this challenging target in the entire group. For digital innovation in the next corporate business plan, we have DX strategy 2.0, which we define as a second step. Its focus is how to leverage digital technology to strengthen competitiveness in addition to productivity improvement in DX 1.0. Our target is data-driven management with a focus on strengthening customer contact points and improving customer satisfaction. Another major initiative is DX talent development. For R&D and production, we have been working on this theme in the current corporate business plan. And as DX strategy 2.0 will mainly focus on business and sales, our efforts will center on developing business translators and business data analysts. Let me touch upon the sixth basic direction, recruiting and developing human resources. There are 3 major action plans. First, it is essential to leverage senior employees with the declining population. We will raise the retirement age to 65 and also consider measures to leverage human resources over 65 years of age. For this purpose, we will implement a job-based HR system consistently from onboarding to retirement at 65 and make sure the valuation is done based on the size of the job to be engaged and the achievement of the required outcome. Second, we will promote recruitment with awareness of matching the business and human resources such as recruitment with clearly defined job descriptions, which is already adopted partially in hiring new graduates. The third point is diversity. It is expected to achieve our long-standing goal to achieve 10% for women in positions of section manager or higher in FY 2022, and we have already achieved over 70% goal for male employees to take childcare leave. These KPIs will be reviewed in April 2023 to set higher standards for our new goals. Let me skip human resource development and engagement on Page 42 as well as safe and stable operations on Page 43 and move on to numerical targets. Please turn to Page 45. These are the numerical targets for FY 2024, the final year of the next corporate business plan. Sales revenue is JPY 3.05 trillion. Core operating income is JPY 300 billion. Net income attributable to owners of the parent is JPY 150 billion. I will explain more about core operating income on the next page. As I mentioned earlier, Petrochemicals & Plastics has been renamed as Essential Chemicals. Reasons for changes by sector are as described here. But in total, we plan core operating income of JPY 300 billion, up JPY 55 billion from the FY 2021 forecast, driven by stronger profitability of overseas crop protection products. Let me explain a little more about the path toward FY 2024, the final year of the corporate business plan. We plan to increase profitability steadily other than the pharmaceutical sector, which is considered to be a major variable, in addition to the special factor of lump sum revenue from a collaboration and license agreement in FY 2021 and the loss of exclusivity for Latuda is scheduled in February 2023. Therefore, we expect this sector will strain earnings of the entire group. On the right is our medium- to long-term targets for financial metrics. Although some items have not reached the target and the final year of the corporate business plan, we want to achieve the target for all items. This slide shows the trend of NOPAT and capital invested so far. The vertical axis is for NOPAT and the horizontal accesses for the value of capital invested. In FY '19 and FY '20, NOPAT declined due to the deteriorating business environment, while invested capital increased significantly. While NOPAT is expected to improve in FY '21, it still has a way to go. In the next corporate business plan, we'll take initiatives to improve profitability and financial standing, as explained earlier. And in the final year, we want to make a recovery to a level above the cost of capital guideline. This slide shows a comparison of capital invested and ROI by sector for FY '21 and FY '24. In Essential Chemicals, ROI is expected to decline for FY 2024, partly affected by the strong market in FY 2021, but we estimate improvement mainly in the life science sector. The company total is estimated at 7.2%, exceeding the mid- to long-term target. Next, I will explain the business strategy by sector. First, Essential Chemicals. Direction for this business is provided on the left and carbon neutrality and unified operations with Singapore were explained earlier. So I will briefly explain the strategy for licensing and catalyst business on the next slide. The key point for licensing and catalyst business is refining our technologies on the right. Technological development, such as longer lifetime of catalyst is ongoing to enhance our competitiveness. In addition to these business advantages, GX is also an important perspective. Propylene oxide and hydrochloric acid oxidation technologies can directly reduce GHG emissions at technology licensees. We consider licensing is an executive tool to allow for both economic growth and carbon neutrality, particularly for developing countries. Next is Energy & Functional Materials sector. The key point of the 3 items on the left is concentrate investments and expand business in growth areas. Battery components is one of the growth areas. And for battery separators, we'll leverage our strength in safety and long life and consider additional production capacity increase. For cathode materials, we aim to commercialize a highly productive calcination process. Based on the result and the demonstration facility, we will make a judgment about full-scale market [ entry ]. As for super engineering plastics below, we have decided to increase production capacity for LCP by 30%. As recently announced in the press release, we are considering to add more production capacity as we are seeing the demand expansion is moving into a new stage for applications such as automotive and 5G high-speed communication connectors. Next is business strategy of IT-related Chemicals sector. For display business, we'll focus on new products for next-generation displays and components of in-house production, such as liquid crystal-coated retardation film. In semiconductor materials business, timely investment is a key in market expansion. Tectonic shifts are occurring in the semiconductor supply chain in response to economic security policies of each country and the geopolitical risks. And we are considering a large variety of measures to ensure capturing the increasing demand. For instance, we are considering a production base in the U.S. following Japan, South Korea and China. Here are highlights for IT-related Chemicals. For photoresist, while the market for EUV photoresist, the most advanced process is expected to grow, we can still expect considerable growth for ArF resist as well. Construction has already started for a new lab for EUV photoresist valuation and capacity increase is ongoing for ArF photoresist, which will continue to drive the market. And these initiatives can lead to sales increase. Next, for compound semiconductors, the market for high-efficiency power devices is expected to grow rapidly and significant growth is expected for gallium nitride and gallium nitride power devices in the future due to their characteristics. This is our target in development. We aim to start mass production of large-wafer gallium nitride substrates by FY 2024 to be the first in the world. This is the business strategy of Health & Crop Sciences sector. 4 main directions are shown here, and I will explain the first point, which is most important. It is business portfolio reforms with conscious of GX. We will differentiate from competitors leveraging our strengths in product groups with low environmental impact, such as biorationals and botanicals. Please turn to next page for more specifics. Revenue of biorationals in FY 2021 is about JPY 30 billion. We plan to increase it to approximately JPY 50 billion in FY 2024 and considering further expansion through M&A. A new topic in this sector is no-till farming or farming without tilling the soil. It is gaining attention recently as an environmentally friendly method of agriculture. Its benefits include soil protection and GHG emission reduction. No-till farming requires clearing weeds before seeding. And S-3100, a major herbicide, we plan to launch in the next corporate business plan, called flumioxazin, which is an existing leading agent suitable for this method, and this is expected to create new demand. In addition to these initiatives, we aim to reach revenue of about JPY 430 billion for crop protection business in FY 2024 through the expansion of South American business, as explained so far. Next is about Pharmaceutical sector. The top priority is to establish an earnings base after the patent expiry of Latuda. We will maximize revenues from highly expected trucks acquired through major alliances as well as promote management efficiency and other streamlining measures. Looking ahead to the next stage, we will take on a challenge for new products in the psychoneurotic field, and regenerative and cellular medicines for medium- to long-term growth. These are the highlights for Pharmaceuticals. ORGOVYX, a prostate cancer drug; and MYFEMBREE, a gynecological drug, are both known as relugolix, and were acquired from Roivant. And GEMTESA, an overactive bladder drug, which is also known as vibegron. We launched these 3 drugs in 2021, and their revenue will be maximized in a new corporate business plan. We have formed an alliance with Pfizer for ORGOVYX and MYFEMBREE to maximize the potential of the drugs. With these 3 drugs, including GEMTESA, we aim to achieve sales exceeding Latuda. On the right, SEP-363856, a new agent in the psychoneurotic area is described. We have also formed an alliance with Otsuka Pharmaceutical to jointly develop the drug. Currently, we aim to launch the new drug in the U.S. in FY 2024. In the last part, I would like to talk briefly about the philosophy of the Sumitomo Chemical Group. As you know, Sumitomo's business philosophy, Jiri-Rita Koushi-Ichinyo, means a business must be beneficial to ourselves as well as to society, and this concept is depicted by the diagram on the slide. And this is shown as a logo on the top page. The horizontal axis measures economic value and is named as the self-interest axis, and the vertical axis measure social value and named as the altruistic axis. The idea is that by unifying self-interest and altruism together, we will improve the total value toward the upper right direction. Furthermore, as I said, in the basic directions, we intend to manage our business by adding the perspective of GX to both axis and the new corporate business plan. This is the last slide. As explained, we'll add green transformation perspectives going forward and continue to innovate our business portfolio to contribute to solving social issues with the technical capabilities in the 4 areas like environment and health care. That is the management direction. As we share these ideas with our stakeholders, we will continue to work toward an ideal of becoming a company that can make people feel proud and happy to be our stakeholders. Thank you. [Statements in English on this transcript were spoken by an interpreter present on the live call.]