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 Business Performance Overview and Human Resources Strategy Briefing. I want to express my deepest appreciation to our investors for your continued support for and understanding of our business. Let's begin with Section 1, where I'm going to give you an overview of our business performance. And the very first thing I want to talk about is the business outlook and the revisions to our dividend forecast. Here is the business outlook for FY '22, which we announced back on February 1. The Q3 cumulative figure for core operating income have been fair to middling at JPY 142.2 billion, but the tide turned during the summer due to a major slump in market prices of petrochemicals and methionine, coupled with changing business environment surrounding display business and others, we now expect a quarterly loss for Q4. The biggest factor going forward is how much China's economy will rebound after Beijing ditched the Zero COVID Policy, but we currently expect to earn about JPY 120 billion in core operating income for FY '22. Now the biggest element in the room is, of course, these nonrecurring items this fiscal year. But let me assure you that most of these one-off charges of JPY 120 billion are paper losses and not cash outflows. We've already posted JPY 70.7 billion as one-off charges by Q3, most of which came from impairment losses related to the drug named KYNMOBI, and we expect to post another JPY 49.3 billion as impairment losses in Q4, and that includes an impairment loss of JPY 20.5 billion due to the cancellation of a cancer drug, TP-0903, development, which Sumitomo Pharma announced back on March 3. The rest includes also noncash out risk factors such as impairment of intangible assets of Sumitomo Pharma. That is why we expect to break even for this fiscal year. As for the business performance outlook for FY '23 and beyond, we have every reason to expect that our efforts to upgrade our business portfolio will come to fruition in each segment, boosting core operating income by about 50% year-on-year, except for the Pharmaceuticals sector. The full year impact at the end of exclusivity period for Latuda is just massive. And that is why FY '23 is going to be a really difficult year. Having said that, however, the major post-Latuda M&As will begin to pay off, they'll be [ elated ] by 1 to 2 years. For FY '24 and beyond, the sales of Orgovyx, Myfembree and Gemtesa will kick in big time, bringing us back to growth. More details on our guidance for FY '23 and FY '24 will be provided at the earnings briefing scheduled for May 15, and I will explain it to you as we review and revise our current corporate business plan. One of the pillars of our policy on dividend distribution is to be a stable dividend payer. As we remain committed to this policy, coupled with the fact that we are confident that our efforts to upgrade our business portfolio will come to fruition, we have revised the year-end dividend forecast and decided to pay JPY 6 a share for FY '22. And that makes the total dividend payment for FY '22, JPY 18 a share, including the interim dividend of JPY 12 a share. Now let me move on to talk about our business portfolio strategy, the outlook of the businesses which have a big impact on our company's financial performance and their overall direction and performance trends for FY '23 and beyond. What we have done so far to upgrade our business portfolio is, first and foremost, to make ourselves more resistant to market volatility and boost our ability to generate cash, both of which have been the most important management priority for the past decade since the beginning of FY 2013 corporate business plan. And as you can see in the slide, we have allocated more than 90% of our strategic investments to what we refer to as specialty areas and reduce the exposure of our commodity businesses, which are more sensitive to market volatility. We have particularly focused on OLED display materials, semiconductor materials, crop sciences, pharmaceuticals, high-functionality materials and life sciences. And instead, we have either exited or shrunk the so-called unprofitable commodity businesses, which are sensitive to market volatility. And one example of that is shutting down ethylene production at Chiba Works. As a result of our efforts to upgrade our business portfolio, the percentage of specialty areas within our sales revenues increased from 50% in FY 2013 to almost to 70% today. And on top of that, the increase in specialty area sales revenues has been driven by our high value-added product portfolio, reflecting our technological strengths. OLED polarizers, cutting-edge resist, battery materials and biorationals are among our product portfolio haven't made significant strides over the past decade. And we have only just begun and are ready to move even faster. For example, because we made a bold decision to shift our focus from LCD polarizers to OLED polarizers for both TV and mobile displays, the sales revenue from all the polarizers now accounts for 45% of all the polarizer sales revenue. It was 0 back in 2013, and now we want to raise that to 80% in the future. Likewise, the share of sales revenue from cutting-edge resist as a percentage of the total order resist sales revenue rose from 51% to 71%. And now 80% is our future target. Sales revenue of battery materials increased from JPY 4 billion to JPY 75 billion, and we hope to generate more than JPY 100 billion from battery materials in the future. Biorationals, or nonchemical crop sciences products, saw their sales revenue increase from $2 billion to $3.5 billion in 10 years. Our goal is to generate $10 billion from biorationals in the future. We attribute this sharp drop in earnings for FY '22 to a number of unanticipated impactful changes in the business environment, which transpired before our efforts to create a business portfolio came to fruition. We think that those changes were caused by market price factors and structural factors, so I'm going to explain what we are going to do to address them over the next few slides. Let me start with one of the market factors, which is the substantial deterioration in the petrochemicals and plastics business environment. This chart is showing the aggregate P&L of our 3 Singapore subsidiaries or equity profits and losses for PCS. Our petrochemical complexes in Singapore are one of the most competitive plants in the world with years of operational excellence and exceptional cost efficiency derived from a high degree of integration. But that doesn't mean they are immune from economic crisis. In fact, our Singapore businesses suffered losses during the global financial crisis in 2008 and today due to the war in Ukraine. We now expect that they will soon emerge from this trough and start to recover gradually in FY '23 and beyond as the Chinese economy finally emerges from strict COVID restrictions. The other market factor is the one that plays out in our Petro Rabigh business. The chart over here is showing Petro Rabigh's quarterly pretax P&L. Petro Rabigh was doing very fine until the second quarter, April to June of FY '22, but then started to suffer a sharp drop in earnings from July due to the significant changes in the business environment, which I just talked about. We understand that it is inevitable that Petro Rabigh's performance is somewhat subject to market volatility, but we consider this business to be the one that generates cash by selling a large volume of the low-cost general-purpose petrochemical products. That is why we've been focused on cost of rationalization and continue to execute the company-wide profitability improvement program so that we can withstand the impact of a market decline. And in fact, we believe that Petro Rabigh has made significant strides in terms of profitability. These difficult to market conditions lingered through the fourth quarter, October to December last year. But as the global economy emerges from the pandemic, we hope that Rabigh will be back on a path to recovery in FY '23. When it comes to methionine, not only its market prices, but also its sales volume have remained depressed, as shown in the graph. This is because of the slowdown in demand caused by the lack of incentives to produce more chicken due to the outbreak of avian influenza and rising feed prices, coupled with a temporary supply clot as our competitors added plant capacity. For FY '23, there is no schedule to plant capacity addition, and the demand for methionine is expected to grow at around 5% a year in the medium term. That means that the supply and demand situation will improve, market prices will start to rise again, and it is likely that the volume also will recover. Now I want to move on to consider the structural factors, one of which is, of course, about display-related materials. There was robust demand for LCD polarizers for big screen TVs. The so-called the stay-at-home demand during the height of the pandemic has already gone, and there is an emergence of new Chinese polarizer makers. Although we had anticipated this scenario and prepare to further expand into automotive business, step up the development of OLED materials and consolidate the production lines to upgrade our product portfolio. The Chinese competitors were taking share at a much faster rate than we had anticipated. Furthermore, we found ourselves struggling to compete with the Chinese, where we thought we had a competitive edge technologically, such as polarizers for big screen TVs and that still puts a dent on our profitability. So we must carry through the ongoing structural reforms of our display-related business in order to rebuild a solid revenue base as quickly as possible. The other structural factor is what we call Latuda cliff. We were, of course, exploring multiple candidates in anticipation of the end of Latuda's exclusivity period, and it took a while before we finally acquired 3 promising post-Latuda candidates through the strategic alliance with Roivant. And we are pleased to have brought the 3 drugs into the market as scheduled. We not only entered into a partnership with Pfizer to ensure to maximize the sales potential of these drugs, but also acquired the 2 local companies, which are actually in charge of selling the drugs and turn them into 100% owned subsidiaries to put in place a structure that allows us to move much faster and more efficiently. Although we needed to wait a little longer than usual to see the sales pick up after the launch because there were restrictions on trials and promotional activities during COVID-19, our actions I just talked about are sure to bring results in FY '23 and beyond, and we look forward to a rapid expansion of these 3 drugs. There are other investments that we already committed in, but I don't talk about today. And of course, a number of these investments are expected to contribute to earnings for FY '23 and beyond. There are 3 growth drivers: first, semiconductor materials such as photoresist and a semiconductor chemicals; second, new crop sciences products such as INDIFLIN or Rapidicil and increase the presence in global markets such as South America and India; and third, CDMO for nucleic acid in the small molecule drugs. Those 3 drivers and others are expected to generate incremental core operating income of several dozen billion yen in FY '24. So far, I've been talking pretty much about the business outlook. And given the fact that the business environment changed more drastically than we had anticipated, we understand that the actions and initiatives that we took under the current corporate business plan to improve our financial standing and become a leaner organization should be given a complete overhaul and may need some course corrections. The general idea of course corrections can be summarized as follows. First and foremost, upgrading our business portfolio is the most important priority, and we will catch up with and adapt to those changes in the business environment to step up our efforts to boost our ability to generate cash flow, exit unprofitable businesses and develop new businesses. The next is cost of rationalization and that does not simply mean cost cutting. DX and the creation of next-generation businesses are among many projects and initiatives we have been undertaking and now is the time to have a complete review on them in terms of priority and efficiency. We will also give a complete overhaul to our operations as the way we work is also changing rather dramatically. When it comes to investment, the total amount may end up being higher by about JPY 50 billion than anticipated due to inflation and currencies. But we are going to stick to our selective investment policy and try to cap it under JPY 750 billion as planned initially. We will also continue to improve asset efficiency by reducing the amount of cross shareholdings and leveraging DX for better inventory management to make significant improvement in cash conversion cycle. These are all strategic continuous efforts and not single year tactical initiatives. I will share with you more detail, including the time line when we announce FY '23 guideline on May 15. Last but not least, although we are suffering a temporary lull because of the decline in petrochemical market prices, Latuda cliff and other factors, I just want to repeat that we've already put in place the necessary initiatives to get us back on track. So FY '23 should be marked as the beginning of the post-Latuda era. We are confident that we are going to bounce back to growth in FY '24 and in FY '25, we will go above the level seen in FY '21, which was the final year of the previous corporate business plan. And I'm committed to doing everything I can to make sure we reach those milestones. That's all for me. Thank you for listening.

Hello. My name is Niinuma, I'm going to talk about our human resources strategy. First, I'll be speaking about our unchanging philosophies very briefly and give you an overview of our human resources. Then my main topic today is what we are doing to secure and leverage talent on Japan's declining population. And lastly, I want to present to you where we are headed and how we want to evolve and talk about some of the challenges that we're going to respond along the way. I'm going to spend the next 15 minutes or so to cover all these topics, so let's get right into it. What are our unchanging philosophies? These are very simple. As you can see in the slide, we want to secure good talent. We are committed to fair treatment of our people, and we provide everyone with opportunities of development and grow as one team. Those are the 3 unchanging philosophies, and we continue to uphold them. And it is based on these philosophies that we are going to bring our human resources, strategies and tactics to the next level to meet our goal of the current corporate business plan, as you can see at the bottom of the slide. As for the overview of our human resources, I'll just touch upon a few points. This chart shows changes to the number of our employees over the past 2 decades. The bars represent the number of employees, and the line represents sales revenue. It is quite obvious that our sales revenue almost tripled from JPY 1 trillion in 2002 to around JPY 2.7 trillion last year. 20 years ago, we hired about 18,000 people. But today, we hired around 35,000 people. It's almost doubled. But what I want you to take a close look at is the bars in the darkest color at the bottom, which indicates the number of employees at Sumitomo Chemical as a stand-alone entity. It actually increased very slightly from a little over 5,000 to just under 6,500 over the past 2 decades. But it is safe to say that the number remains almost unchanged over that long period of time. You might want to say that we remain a group of the select few. In contrast, the biggest increase in the number of employees comes from these light blue bars, which are people hired by our group companies outside Japan. 20 years ago, the percentage of our people hired by our group companies outside Japan was less than 10%. Today, it is 45%. And this number doesn't include those companies on equity method, such as Petro Rabigh. This slide shows the global distribution. Obviously, 28,000 out of 35,000 employees in total are in Asia, including Japan. Also, the number of employees has been increasing in Latin America recently. And as these numbers are as of the end of December last year, its current number is likely to be even a little more than this. In order to protect our corporate value, it is essential to have a clear vision for our core human resources of Sumitomo Chemical. This slide shows the age group distribution of 6,500 employees belong to Sumitomo Chemical, which we disclose for the first time. They are evenly distributed in different age groups in general. But since the company slightly increased the number of employees during the bubble economy around 1989, as others did, as a result, the age groups from 46 to 55 now represent the major part of the total employees. As described in the red box on the right, in fact, the experienced professionals hired for positions of managers or above account for 1/4 or 26% of the total. Analysts sometimes pointing out before that Sumitomo Chemical was a closed company, but we actually hire much more experienced professionals than people might expect. Another issue is about employees of over 60 indicated by the bar for 61 to 64, and it currently represents only 3% of the total. However, as I said, as there are many people in the age groups from 46 to 55, and if things remain unchanged within the next 10 years, approximately 17% of our employees will be 60 or older at a maximum. Therefore, in order to properly maintain our core human resources, we need to figure out urgently how to utilize employees over 60 years old. This is a human resource management system. I'm not familiar with the definition of job-based employment, so I will leave it to you to consider if job-based employment is applicable to our system or not. We classify managerial employees by job grade and nonmanagerial employees by roles related to corporate value specialists are mentioned in the upper right box. As a company that provide solutions utilizing the technological foundation, it is essential to secure specialists as we do for line managers and section chiefs. I'll explain about it later. This slide is about the global HR. As described here, it is based on the philosophy to allocate the right person in the right position. We started the first stage in 2004 and almost 20 years have passed. I think we started this initiative relatively early. Now the integrated HR IT system enables us to make use of HR information of employees in the position of manager or above globally at one place. And as shown on the center left part of the table, the first stage HR management system launched in 2007, but its user experience has become less user friendly. So in 2021 or the second stage, a new HR system was introduced. The foundation of the global HR system has almost been completed and proceeded to the second stage. However, unfortunately, the second stage coincided with the outbreak of COVID. But as the world is departing from the pandemic, now we need to make up the lost opportunities to improve the global HR system through increased physical meeting opportunities. This slide shows the results of these efforts over the past 20 years. As described in the middle, for positions of MT1 or higher, which is for managers or above grades, are defined with a common measure globally, and the work performance evaluation system has already been harmonized globally as well. As a result, as you can see in the red triangle, there are 100 important positions, which we call global position holders. It was about 40 in 2006 and has grown to 100 now. In addition, there are currently 400 positions for the next-generation leadership candidates for these top positions. And I believe this layer has become much thicker over the past 20 years. The left triangle is our education system. As you can see, we offer a variety of training programs for each level of employees. In the past, our traditional value was education should be provided equally. But now in the process of globalization, we place more focus on selection in education. The main topic for today is measures to cope with the declining population in Japan. So next, I will cover these 3 items. As I mentioned earlier, the biggest issue for the company is greater utilization of talent of employees over 60. We introduced the rehiring system in 2006. And currently, the rehiring ratio is as high as 97%. This means we have already achieved continuous employment. Having said that, we are aware of the possibility that the number of employees over 60 could reach 17% within 10 years, and the tendency of low expectations from others to those people as well as declining motivation of their own. So we are currently in the final discussions with the labor union about changing the retirement age to 65. The union has generally agreed on this direction, and we intend to shift to this new system with the retirement age of 65 in stages starting in April next year. The main point is the second bullet point, which is compensating employees over 60 consistently based on the principle explained earlier according to jobs for managerial positions and roles for nonmanagerial positions. Recently, many companies set the retirement age of 65. And in many cases, the wage system or wage levels substantially changed at the age of 60. But in our case, as the source of corporate value is our core employees, we intend to extend the retirement age based on a consistent compensation system. The second point is to secure excellent talent. Some say that companies should hire people with experience for this, but we do not agree to this idea. Rather, we believe we should focus on the source where we can hire the most talented people. Currently, we are able to secure excellent personnel and regular hiring of new graduates. So we use this regular recruitment as our main source and supplementing it with hiring experienced personnel. This is another data we disclosed for the first time that is the number of applicants for our so-called creative staff positions, which are equivalent to managerial track positions. Many people apply for these positions, and it is 25 to 30x for technical positions and it is about 100x for administrative positions. As shown in the lower right, we are very grateful that we are popular not only in the chemicals industry. In the job hunting ranking by carrier task, we ramped between 10 and 15 for graduate students in all industries and many graduate students in technical fields are interested in working in our company. As shown by the bar chart on the right, the percentage of PhDs has been high among our employees for a long time. But recently, we have been making a conscious effort to hire them. And now 30% of the technical hires is expected to be PhDs. I will not cover this today. But while we have been able to secure excellent personnel for creative staff positions, we are struggling the higher shift workers at plant, same as other companies. We'll take some measures to cope with this situation. In that sense, as a measure to secure talent in the future, we will appeal our strategy of GX as leverage for growth, particularly to engineering students. We have also begun so-called professional recruitment. This is a recruitment program that specifies duties and rules to a certain extent, and we hire about 30 people per year. Also, with other measures on this slide, we will continue efforts to secure talent with diverse capabilities. Regarding diversity side, we are currently in the third phase. So far, we have enhanced our system and promoted engagement to female workers, and we are currently working to change the mindset of the managers and workplace culture. As indicated in the time line below, it was [ epic ] making to have Ms. Atsuko Muraki as an Outside Director in 2018. And since then, we have accelerated the progress in this area. With these efforts, we set the KPI to have women in at least 10% of positions of managers or above since 2015 and has taken some time. But as I said, it started to accelerate around 2018, and the percentage has risen to 5%, 6% and 7% and is expected to reach 9.5% by the end of March this year. I'm always told not to mention things by comparing to other Japanese companies in the same industry. But if I dare to do it, I think we have a relatively high percentage. We have recently announced the structure of executive officers effective on April 1. And in 2015, the percentage of women in non-Japanese executive officers was 7% with 3 people, but it is expected to increase to 13% with 6 people on April 1st this year. Although this is still insufficient, we will continue to promote this harder. This slide shows the KPIs for the new fiscal year starting in April and we'll step up our efforts and continue these initiatives. One challenge here is related to the first point. We intend to hire female employees to account for about 25% in the total recruitment. However, the number of women who major in science is relatively small in universities where we recruit students in Japan. That is only just over 10% or so. With that situation, it is quite difficult to achieve 25%. This is a national issue as well, so we would like to make efforts such as cooperation in system education and provision of science experiment classes in the community. As shown on this slide, while we exceed a legally mandated rate for the employment of persons with disabilities, we are in the process of enhancing the function of a special-purpose subsidiary. Next is about our current focus, and one is visualization, and the other is more rewarding and motivating work. As for visualization, I may have already mentioned this before. But under leadership of President Iwata, we have been implementing that Sumitomo -- let's do this declaration since 2019, in which labor and management make declarations in 5 areas and work on them. As shown on the next page, we have set KPIs for most of them. As a result, for example, in number three, about education, we achieved JPY 340,000 and 137 hours as annual investment in education per person. This was recently reported in the newspaper, but this is not done for disclosure. Rather, it just means we set KPIs and took data in implementation. We'll continue efforts as we stick to these KPIs. Next slide shows the result of the awareness survey. Again, this is the first time to disclose the result in this detail. The chart on the left shows the results of last year's survey, in which 341 companies participated. The redline shows the average of other companies, and the results are shown in blue. Overall, we achieved high scores in terms of satisfaction, especially for the item at upper right, would recommend working at this company to my friends and family. The surveillance company told us we were among the best, and we are proud of that. However, we are not satisfied with the current status, as described on the right. The second question, in particular, it says there is no feeling that you need to fear failure at the company. And we scored a little lower than other companies. We might be destined for this result as a chemical manufacturer operating at high temperatures and high pressures. Or in other words, it may be because we have established a culture that safety comes first than anything else, and this may lead to an attitude of not exhibiting failure. Some analyst once said that many people in this company were too gentle and they might lack ambition. Now we need to seriously examine what is the root cause of this result and take measures for improvement. Aside from that, last year, we conducted an engagement survey for employees of all domestic and overseas group companies, and the results were relatively positive, as shown on this slide. There are 2 challenges for the future. The first one is to strengthen ties to the management strategy. We'll integrate various HR functions into the next-generation carbon neutrality and digital innovation. For technical infrastructure, we have environment, food, health care and ICT, as shown below. In these fields, specialists are evenly developed, such as senior specialists, who will not easily replace resources and fellow, who are researchers recognized by the public. And their successors are also being developed properly. As for DX talent, while we continue efforts in equipment as shown at upper right, it is more important to have knowledge of a particular business domain, together with DX. So we are also focusing on developing such specialists internally. We currently target to develop about 600 DX specialists shown on the slide. As the company has 6,000 employees in total, this is about 1 for every 10 people. DX repository is held every year. And in the previous time, 1,200 employees participated, including employees from overseas sites. To be honest, such an initiative is more advanced overseas than in Japan so we expect to be inspired by those overseas participants to work on this. Another initiative is a trial of internal secondary work, which is currently prepared to start in April. We do not allow employees to take a secondary job outside of the company. However, with this trial, we expect them to stimulate each other as we have various jobs and human resources as a general chemical company. Another one is considering the introduction of retirement age of 65. This initiative can be used as on the job trainings for their reskilling. This is my last slide. So far, we have been sharing our human resource philosophy to a certain extent with domestic and overseas group companies. Going forward, we will work on well-aligned implementation of our HR strategy. The arrow on this diagram is one way. But in reality, we will stimulate each other in both directions. That is all for our human resource strategy. As we are fully aware that we must grow further through hiring excellent human resources more, we will respond to the expectations of our investors by combining our human resources and management capabilities. That is all from me. Thank you. [Statements in English on this transcript were spoken by an interpreter present on the live call.]