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

As it is time, we now would like to start the conference call for fiscal year 2021 earnings results. Thank you very much for joining us. Today, Mr. Sasaki, Managing Executive Officer, will take you through the financial results for fiscal year 2021. He will later be joined by Mr. Yamauchi, Executive Officer and our Manager of Accounting Department for Q&A. Mr. Sasaki, the floor is yours.

This is Sasaki speaking. Thank you very much for joining us today for the conference call. And let me take this opportunity to express our deep appreciation to our investors and analysts for your understanding and support in the management of our business. I will go through the financial results for fiscal year 2021 and outlook for fiscal 2022. Please turn to Slide 4. Consolidated financial results for fiscal year 2021 was JPY 2,765.3 billion in sales revenue, up JPY 478.3 billion year-over-year. Core operating income representing the recurring earning capacity was JPY 234.8 billion, up JPY 87.2 billion year-over-year. Nonrecurring items of JPY 19.8 billion in loss that are not included in core operating income consists of JPY 10.6 billion in restructuring charges and JPY 8.1 billion in impairment losses, which worsened by JPY 9.3 billion from the previous year. As a result, operating income was JPY 215 billion, up JPY 77.9 billion year-over-year. Finance income was JPY 36.1 billion in gain, up JPY 35.4 billion year-on-year, of which gain on foreign currency transactions was JPY 45.6 billion, owing to the depreciation of the yen towards the end of the fiscal year, up JPY 36.3 billion year-over-year. Income tax expenses was JPY 64.7 billion, JPY 5 billion in tax expenses eased year-on-year. As a result, net income attributable to owners of the parent was JPY 162.1 billion, up JPY 116.1 billion year-on-year, reaching record high net income. Exchange rate and feedstock not surprise affecting the business was as follows: average rate during the period was JPY 112.3 to the dollar and JPY 56,900 per kilo for naphtha. Yen depreciated and feedstock prices went up. Our business outlook announced in October gave a guidance of JPY 2,710 billion in sales revenue, JPY 245 billion in core operating income and JPY 225 billion in operating income, JPY 140 billion in net income attributable to owners of the parent. Sales revenue was up compared to forecasts. However, core operating income and operating income fell short of forecast due to a decline in margin from increased feedstock prices. In the meantime, large foreign exchange gain was realized from the weak yen, thereby, net income attributable to owners of the parent exceeded forecast. Let me turn to the next page for earnings breakdown by business segment. Please turn to Page 5, starting with sales revenue. Sales revenue for the company was up JPY 478.3 billion year-on-year. By segment, sales revenue increased across all business segments. Let me note that the Petrochemicals & Plastics segment was renamed to Essential Chemicals & Plastics segment as of April 1, 2022. A factor by factor analysis of the year-on-year change in sales revenue for the company shows sales price variance was up JPY 202 billion. Volume variance contributed by JPY 176.7 billion. Foreign exchange gains from sales revenue of foreign subsidiaries accounted for JPY 99.7 billion. Please turn to Page 6. Core operating income was up JPY 87.2 billion year-over-year for the company. By business segment, core operating income increased across all segments other than Energy & Functional Materials segment and Pharmaceuticals. Factor analysis shows that price had a JPY 6.5 billion negative impact, cost had a JPY 29.5 billion minus impact. In the meantime, volume variance, including equity and earnings from investments in affiliates, had a JPY 123.2 billion in positive impact. The following slide, I will go over earnings summary by segment. Please turn to Page 7. Essential Chemicals & Plastics segment. Sales revenue was JPY 842.5 billion, up JPY 253.2 billion year-over-year. Core operating income was JPY 53.5 billion, up JPY 65.5 billion year-on-year. Periodic plant maintenance at Chiba Works had an impact, but recovery in demand for synthetic resin and raw materials for synthetic fiber and various industrial chemicals and rise in feed prices led to improved market price and better margin. In the previous fiscal year, Petro Rabigh, an equity method affiliate, had a periodic shutdown maintenance, and coupled with COVID impact, faced sluggish shipment of auto-related applications, and therefore, sales revenue and core operating income were up year-on-year. Please turn to the next page. Energy & Functional Materials segment. Sales revenue was JPY 316.4 billion, up JPY 71.1 billion year-over-year. Core operating income was JPY 20.1 billion, almost flat year-on-year. Shipment of lithium-ion secondary battery separators increased steadily. The market prices for aluminum and raw materials for cathode materials went up, driving higher sales price. In the previous year, shipments were sluggish, especially for automotive-related applications due to COVID. However, core operating income remained mostly flat year-on-year, mainly due to a decline in margin resulting from higher raw material prices in the second half of the year. Please turn to the next slide. IT-related Chemicals. Sales revenue was JPY 473.7 billion, up JPY 41.9 billion year-on-year. Core operating income was JPY 57.8 billion, up JPY 18.1 billion year-on-year. Sales revenue saw a drop in selling price of polarizing film, but shipments of processing materials for semiconductors, such as high-purity chemicals and photoresist, increased in volume due to growing demand. On the back of work-from-home demand from last year, shipments for display applications increased, which explains the year-on-year increase in sales revenue. Core operating income was up, thanks to increase in shipment more than offsetting the drop in selling price. Please go to the next page. Health & Crop Sciences. Sales revenue was JPY 473.8 billion, up JPY 50.8 billion year-on-year. Core operating income was JPY 42.3 billion, up JPY 10.7 billion year-on-year. Sales revenue was up as a result of strong shipments of crop protection product in North America, South America and India as well as higher market price for methionine. Core operating income was up owing to improved profit margin on methionine and increase in shipments of crop protection products. Please turn to the next slide. Pharmaceuticals segment. Sales revenue JPY 591.7 billion, up JPY 45.3 billion year-on-year. Core operating income JPY 61.7 billion, down JPY 10 billion year-on-year. For sales revenue, sales price was impacted by the NHI price revision in Japan. In volume in the second quarter, Sumitomo Pharma, our consolidated subsidiary, posted lump sum revenue for joint development and license agreement with Otsuka Pharmaceutical. Products such as Orgovyx and Gemtesa launched in the first quarter and Myfembree contributed to increase in sales revenue. On the other hand, sales of Latuda and Brovana for which exclusivity has ended, dropped. As a result, the segment ended with a year-on-year increase in sales revenue. Core operating income was down due to significant increase in SG&A expenses in new items on the back of a sales increase. That concludes the overview by segment. The next slide will give you a breakdown of nonrecurring items. But I have already covered this at the outset of my presentation, therefore, I will skip this page. Next slide is on consolidated balance sheet. Please turn to Page 13. Total assets as of March 2022 was JPY 4,308.2 billion, up JPY 317.9 billion from the end of the previous year. This is due to increase in inventories, our working capital, trade and other receivables due to higher feedstock prices. Interest-bearing liabilities was JPY 1,350.5 billion, down JPY 0.6 billion from the end of the previous year. Equity was JPY 1,702 billion, up JPY 219.9 billion from the end of the previous year. As a result, equity attributable to owners of the parent to total assets, or capital adequacy ratio was 28.3%, which is an improvement by 2.8 points from the end of the previous year. Let me cover consolidated cash flow on the next slide. Please turn to Page 14. Cash flow from operating activities was an inflow of JPY 171.7 billion, down JPY 202.7 billion year-on-year. As mentioned earlier, this was mainly due to an increase in working capital. Cash flow from investing activities was an outflow of JPY 115.4 billion, down JPY 62 billion from the previous year. As a result, free cash flow totaled JPY 56.3 billion, down JPY 140.8 billion from JPY 197.1 billion in the previous fiscal year. Cash flow from financing activities was an outflow of JPY 81.4 billion, up JPY 41.4 billion year-on-year. Next, I'd like to talk about full year outlook for fiscal 2022. Please turn to Page 16. In fiscal 2022, assumption used was an exchange rate of JPY 125 to the dollar, and naphtha price of JPY 80,000 per kiloliter. Sales revenue is expected to increase 12.8% from fiscal year 2021 to JPY 3,120 billion. It was the first time -- it will be the first time that we would exceed JPY 3 trillion. Core operating income is expected to decrease 14.8% to JPY 200 billion. Operating income is expected to drop by 16.3% to JPY 180 billion. Net income attributable to owners of the parent is forecast to fall by 22.9% to JPY 125 billion. Sales revenue is expected to post a record high due to a rise in selling prices against the backdrop of rising raw materials prices in Essential Chemicals & Plastics segment. On the other hand, due to the deterioration of profit margin caused by higher raw material prices and absence of special factor of the recognition of lump sum revenue from a collaboration and license agreement in the Pharmaceuticals segment, which is present in fiscal 2021, profits at all stages are expected to fall short of the year before, and ROE is forecasted to be 10%. The forecast for the dividend is JPY 12 per share for the interim period and JPY 12 per share for the year-end, for a total annual dividend of JPY 24 per share, which will be the same as the fiscal 2021. Please take a look at Page 17. I'll talk about our forecast for sales revenue by business segment. We forecast total sales revenue of JPY 3,120 billion in fiscal 2022, up JPY 354.7 billion year-on-year. By business segment, we expect a positive growth in sales revenue in all, but Pharmaceuticals. We -- if we analyze total sales revenue by factor, JPY 180.5 billion is attributed to sales price variance, JPY 56.7 billion to shipping volume variance and JPY 117.5 billion to foreign currency conversion variance in sales revenues of overseas subsidiaries. The core operating income is projected to be JPY 200 billion, down JPY 34.8 billion year-on-year. By business segment, we forecast higher earnings in the IT-related Chemicals and Health & Crop Sciences, but lower earnings in Essential Chemicals & Plastics and Energy & Functional Materials and Pharmaceuticals segments. If we analyze the total core operating income by factor, price and cost variance are expected to contribute to a deterioration of JPY 73.5 billion and JPY 8.5 billion, respectively. While shipping volume variance and other, including changes in equity and earnings from investments in affiliates, are expected to improve by JPY 47.2 billion. The following is a summary of the forecast performance for each segment. Please go to Page 19. In Essential Chemicals & Plastics segment, sales revenue is expected to be JPY 1,120 billion, up JPY 277.5 billion year-on-year. The core operating income is expected to be JPY 41 billion, down JPY 12.5 billion year-on-year. We expect sales revenue to increase due to higher market prices and absence of the impact of periodic shutdown maintenance in Chiba Works and Singapore in fiscal 2021. The core operating income is expected to decrease due to worsening profit margin of synthetic resins and other products, despite an improvement in Petro Rabigh's performance, and recovery from the impact of periodic shutdown maintenance in Chiba Works in Singapore. Please go to the next page. In Energy & Functional Materials segment, sales revenue is forecasted to be JPY 340 billion, up JPY 23.6 billion year-on-year. And the core operating income is expected to be JPY 18 billion, down JPY 2.1 billion year-on-year. We expect sales revenue to increase due to higher sales prices and expanded sales of super engineering plastics, among others. The core operating income is expected to decrease due to worsening profit margin caused by raw materials price hikes despite an expected increase in export earnings from higher shipment volumes and the weaker yen. In IT-related Chemicals segment, sales revenue is expected to be JPY 480 billion, up JPY 6.3 billion year-on-year. The core operating income is projected to be JPY 61 billion, up JPY 3.2 billion year-on-year. Although the impact of falling selling prices is expected to continue, we forecast expanded sales of processing materials for semiconductors such as photoresist and high-purity chemicals. The core operating income is expected to increase as the negative impact of lower selling prices will be offset by the positive effects of higher shipment volumes, cost reductions through rationalization and other measures and higher export earnings due to the weaker yen. Please go to the next page. In Health & Crop Sciences segment, we forecast sales revenue of JPY 540 billion, up JPY 66.2 billion year-on-year. And core operating income of JPY 47.5 billion, up JPY 5.2 billion year-on-year. We expect sales to increase due to higher market prices of methionine as well as expanded sales of crop protection products overseas, mainly in North and South America. The core operating income is also expected to increase due to improved performance in overseas crop protection products and methionine as well as an increase in export earnings due to the weaker yen. Please go to the next page. In the Pharmaceuticals segment, sales revenue is expected to be JPY 580 billion, down JPY 11.7 billion year-on-year. The core operating income is projected to be JPY 33 billion, down JPY 28.7 billion year-on-year. Both sales revenue and core operating income are expected to be -- to decline due to the NHI price revision in Japan, an absence of lump-sum revenue from a collaboration and license agreement posted in fiscal 2021 despite expected increase in shipment of newly released products in North America. That's about it for core operating income. Next, I'd like to explain about cash flow outlook. The cash flow from operating activities is expected to increase by JPY 63.3 billion year-on-year to JPY 235 billion. Cash flow from investing activities is projected to increase by JPY 124.6 billion in outflow from fiscal 2021 to JPY 240 billion. As a result, free cash flow is projected to be a net outflow of JPY 5 billion. The balance of interest-bearing debt at the end of fiscal 2022 is expected to be JPY 1,400 billion. That's the end of my presentation. I would like to take your questions. Thank you very much once again for your participation today.

We now will open the floor for questions. The first question is from Mizuho Securities, Mr. Yamada.

So my question is, in terms of the forecast for this new fiscal year, if you could give some color, especially for the Energy & Functional Materials segment. Lithium-ion battery related, there were some companies who incurred impairments. In your business, lithium-ion battery business, what is your outlook for the new fiscal year? And in IT-related Chemicals segment, display drop in selling price, raw materials, feedstock prices are up, but why would selling prices go down? And lastly, methionine, I think you said business is improving, but on Page 22, methionine margin is expected to drop. So is it a volume improvement? Or maybe I misunderstood your explanation, I would like to ask for a clarification. So those are my questions.

Thank you very much for your questions. Let me start with our outlook for next fiscal year. With the situation in Ukraine, developing, it's quite turbulent. It's very unclear. It's very difficult to foresee the future. And for various reasons, as you correctly pointed out, raw material prices are soaring. How would that impact our business? That is an area which is very difficult to foresee. And the first part of your question was on lithium-ion batteries, separators, raw material prices are on the rise. Yes. That is right, raw material prices are rising. And in the meantime, separator business, as you know very well, it's not the filmmaking where we have strength. It's the application part on the film where we have strength, and therefore, impact of price increase is not that strong on our business. EV is -- how should I say it? In terms of volume, it is expected to increase. And against this backdrop, rather than the rise in raw material prices, players in China, among others, are putting a lot of focus in this area, and therefore, there will be a pricing pressure we are expecting. And in terms of volume, we are expecting an increase. So how should I say it? It's not a situation where we can relax and say that we're expecting a very strong increase. Rather, I would say, in terms of profit, we are expecting something that will be quite similar to this fiscal year so flat growth year-over-year. That is our view on separators. But it is not a bad market, as you correctly pointed out, as you see in other companies posting impairments, we do not have that in our case. So that is how I would explain about that. And the second part of your question was on IT-related Chemicals. Price variance, yes. In IT-related Chemicals, I think there are factors that would lead to a drop in prices. One factor will be for TVs. In the past year or 2, people have been staying home, which have led to some strong demand and people are working from home so monitors were also quite strong in demand. But whether this situation will continue into fiscal '22 compared to '21? Well, actually, we are expecting a slowdown in '22 vis-a-vis '21.. So if volume is not going to grow strongly, pricing pressure -- price cut pressure, I think, will emerge. This is something that I can say. When it comes to films, there is a rise in Chinese players, Chinese manufacturers, and therefore, we are expecting a more challenging competitive environment. In the past, we would have tried to compensate with that with the rise in smartphone demand, for example. But actually, now, when you look at smartphone demand, I guess the overall demand for smartphones is flat. And in the meantime, we're shifting to OLED so that we can get back in the playing field, and that will be sort of a negative aspect. As raw material prices are on the rise on many fronts. And so taking into account the rise of raw material prices, and in the meantime, accommodating price cuts vis-a-vis our customers, it's -- this is very challenging and very difficult for us. So we would need to communicate and negotiate with our customers so that we can pass on the cost increase to the prices, to be very honest with you. And so -- and this does not only apply to IT-related Chemicals segment, but I guess this will be a challenge for us in this new fiscal year.

And how about the methionine margin situation?

Yes. Thank you very much. That was also your question. In terms of price of methionine, it's broadly on a rise. In the second half of the past fiscal year it was on the rise. But more than that, raw material prices are rising more strongly, and therefore, from a price perspective, it's quite challenging. But in the meantime, as you know very well, a plant in Ehime has been suspended in the past fiscal year. Now the plant has resumed operations. So that was a onetime. It was a temporary factor and the resumption of operation could be a positive factor, and therefore, we are expecting somewhat of an upside in terms of our performance. With weak yen, that is also taking into account -- weakening of the yen is also taken into account in terms of the hypothesis. I hope that answers your question.

Well, yes, I think you broadly answered my question, but I would like to confirm just 2 points. One is about the margin for methionine. You are a vertical integrator, very rare, so much better than your peers, but are you expecting a drop in margin, decline in margin. And it might be difficult for you to comment on this because it's publicly listed as a subsidiary, but the cathode, are you able to pass on cost increase through prices?

Well, thank you for your questions. I think it will be very difficult to answer those points. We're trying to do our best in order to mitigate the impact as much as possible. And as for the cathode materials, of course, metal, which is used as raw materials is also rising in price. And we want to pass on the cost increase as much as possible. And we're also doing what we can in order to mitigate the impact. But having said that, a certain level of impact will remain. And of course, we will make effort in order to mitigate the impact as much as possible.

Well, yes. Thank you very much for taking my questions. The cathodes, I think, is like a formula and so I will be looking forward to that.

We'd like to move to the next one, Morgan Stanley MUFG Securities, Mr. Watabe from Morgan Securities [foreign language].

Can you hear me?

Yes.

First of all, for the overall performance, the core operating income is JPY 200 billion for this fiscal year. And compared to the midterm business plan, well, there is some great part, but it was almost on par at JPY 200 billion. But foreign exchange rate has been changed from JPY 110 JPY 125, and naphtha prices are going up. And Rabigh has enjoyed a good refinery margin, but you have come up with JPY 200 billion, which is flat in the forecast. Are you looking at the situation in Ukraine because things have been changing for the past few months? So can you explain why you have come up with the same number?

Thank you for the question. Well, it just happened or it just turned out that our forecast is almost the same. But as you said rightly, the assumptions have changed significantly and completely. And under such circumstances, first of all, if you look at the raw materials, crude oil prices are going up. And obviously, that would be positive for Rabigh. Ethane benefits would increase, obviously, but if the naphtha prices go up, on the other hand, the naphtha-based plants would suffer. And also, fuel prices and energy costs would increase as well. And based on that, on balance, they are offsetting each other. The gain on the foreign exchange rate is also taken into account, and they are canceling out each other, and it just happened that we have become neutral. Well, if you can just take this as a coincidence, that would be appreciated.

So you're not just matching your forecast?

No. that's not what we did. So foreign exchange rate, with 1 yen difference, you would have JPY 2 billion positive. Well, the sensitivity was JPY 3 billion. So JPY 45 billion in positive number compared to the past, but there was a cost increase, that would be equivalent to that. Yes.

As for the Health & Crop protection Sciences, in this fiscal year, the profit in methionine is expected to increase. That's your assumption. And crop protection has enjoyed a weaker yen. And this is the profit that you are getting. As for methionine, because of rationalization, you suspended operation and you just resumed the operation. And also, can you explain about your current valuation?

As for the methionine plant, Well, we have announced this, but in December, if I remember correctly, there was an accident during the periodic shutdown maintenance and starting up was delayed after that. But it was started up in March. And in terms of market prices, if you look at the annual average, from '20 to '21, more than 10% increase was seen. And in the second half, around September, the prices were starting to go up gradually, and that's the situation. And -- but the raw materials costs are also increasing. And there was an invasion in Ukraine. And since then, the crude oil prices in the market have been going up, and this has had quite an impact. So for that, we are working and talking to our business partners. So as much as possible, the increase in crude oil prices could be passed on through the prices to them, and that is something that we need to work on going forward. The volume has increased and the profit margin deterioration has been offset by that, and you're looking at the slight increase in profit in methionine, yes.

So there is not much increase in profit in the crop protection, even though there's a weaker yen?

Well, JPY 47.5 billion is the total. So about JPY 5 billion in profit increase is going to be seen for the segment. But there are some positive factors. But as you said, international, or overseas crop protection products are going to see some sort of a profit increase, especially for South America market, we are taking into account the profit increase. So overall, the gain from foreign exchange is incorporated, we are looking at the increase in profits

The next question is from Nomura Securities.

I wish to ask 2 questions. Page 27 of the handout, you talk about the quarterly profit, Essential Chemicals in the third quarter to the fourth quarter, profit has dropped. What is the reason? And earlier, a poor spread in resin is expected in the second -- in this new fiscal year, you mentioned earlier, but what is the current situation? And what is the assumptions for the new fiscal year? These are my questions.

From the third quarter to the fourth quarter, quarter-on-quarter, our view for the Essential Chemicals & Plastics, it's the situation is deteriorating. JPY 10 billion in the third quarter has dropped to JPY 1.5 billion in the third quarter. And the biggest factor, biggest reason is Chiba Works in the fourth quarter, from February to March, had gone through a periodic shutdown maintenance. That is the biggest reason. And this is not only applied for Essential Chemicals & Plastics segment, but the impact of periodic shutdown maintenance at Chiba Works accounts for JPY 8 billion. This is how we explain it. And most of it is from the Essential Chemicals & Plastics segment. So that was a big part of it. And in addition, especially in the fourth quarter or maybe starting from March, margin situation has worsened and prices have increased, including Singapore, we have had impact of that. So from the third quarter to the fourth quarter, JPY 8.5 billion decrease in operating income that has come from those factors.

Thank you for that. So if you exclude the periodic shutdown maintenance in the fourth quarter, there will be about JPY 10 billion in income. And this level will continue into the new fiscal year. Will that be a fair way to put it?

Well, for the new fiscal year, it's very difficult. I would say, difficult because of the Ukraine situation. As I said, it's very difficult to foresee how things will develop so the world economy, compared to the growth rate in fiscal year 2021, will be halved from 5-point-something to 3-point something. I think this is the outlook from IMF. And taking all that into account, the essential chemicals and plastics tend to be exposed and more heavily affected by such impact. And for example, world's auto production manufacturing forecast or outlook shows some deterioration from fiscal '21 to '22. And taking that into consideration as well as a rise in raw material prices, will have an impact. We have a pricing formula for Essential Chemicals & Plastics so that we can pass on the cost increase. We do have that formula, but things that are not included in the formula such as a rise in energy cost, that will be -- that will remain as a negative impact. And we have come up with our fiscal year 2022 forecast by taking those factors into account. And so JPY 41 billion, so it's -- we are taking various factors into account and Saudi Arabia will be a positive. And so all in all, JPY 41 billion. This is our outlook.

My next question is on crop protection products for the fourth quarter. If you look at the breakdown by segment, North America and Central America are not growing much, sluggish growth year-on-year. I thought that they were growing in the third quarter, so maybe we don't need to be that much concerned about that, but that is my question. In the new fiscal year, are you expecting strong and robust growth?

Thank you for that question. As Okazaki-san -- as you mentioned, in the international Crop Protection Products business, the situation is quite favorable, I would say, especially South America, market is doing quite well, but also North America and India. We are focusing on those areas. And I think -- but all of them are doing quite well. So that is reflected in our 2022 forecast. So the fourth quarter was sluggish growth compared to the previous year, but it has been quite good until the third quarter. Is that a good way to see it? Yes. If you compare quarter-over-quarter from the previous year, if that was your question. In the previous year, third quarter saw a big dip. And the trend that we're seeing recently is the shipment tends to be brought forward. And so third quarter and fourth quarter, the business level is a bit different from the previous year, but it does not represent any significant slowdown of our business.

We are getting closer to the ending time, so I would like to conclude the Q&A session. I'd like to ask Mr. Sasaki to give us closing remarks.

Well, thank you very much for joining us for our conference call today. So we responded to questions -- to the questions. And it is very difficult to foresee what is going to happen in this fiscal year. That is the environment that we are in. But in this context, what we've announced as an outlook for this fiscal year is something that we will work hard to achieve. And so we'd like to ask for continued support. Thank you very much for today. [Statements in English on this transcript were spoken by an interpreter present on the live call.]