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

As of this time, let us start the briefing. I am Kobayashi from the Corporate Communications Department. I will serve as the moderator. Thank you for joining the special briefing in spite of the short notice regarding the Petro Rabigh Structural Reform announced today at 1 p.m. and 1:45 p.m. Japan Standard Time. President Iwata will give you the key points. After which, we will be open the floor for questions. We plan to conclude by 5:40 p.m. Now Mr. Iwata, you have the floor.

Good afternoon. I am Iwata, President of the company. Thank you very much for joining us for the special briefing in spite of the short notice. I'd like to extend my heartfelt appreciation to our investors and analysts for your understanding of our business. I look forward to today's dialogue. Let me share with you the structural reform plan of Petro Rabigh. As explained at the investors meeting held on April 30 this year, Petro Rabigh is one of the major management challenge along with Sumitomo Pharma. 20 years have passed since the start of the Rabigh project, and strategic directions and business positioning between Sumitomo Chemical and Aramco have diverged. Sumitomo Chemical is shifting away from commodity chemicals towards specialty chemicals and has completed the transfer of technology to Petro Rabigh, which was Sumitomo Chemical's major role in the project. Sumitomo Chemical does not plan to provide Petro Rabigh with additional funding, and therefore, its contribution to the project is limited. In the meantime, Aramco plans to enhance its downstream Petrochemical business. The current status was shared between the two parties, a joint task force began from May this year to pursue intensive discussions, including strengthening the profitability of Rabigh and coming up with the optimum operating structure. The basic thinking underlying this discussion shared both by Aramco and Sumitomo Chemical was what would be the most desirable setup for the future of Rabigh. From such a perspective, for the past three months, we had intensive discussions day in, day out. As a result, we were able to reach an agreement at a much faster pace than we originally expected on a package of debt reduction measures and change in shareholding. Now I would like to share with you the contents in the turnaround strategy. The turnaround strategy consists of two plans, such as financial improvement plan and a profitability enhancement plan for Petro Rabigh. But today, I would like to put more focus on financial improvement plan. Through funding and writing off of launch by both parent companies, the financial improvement plan of approximately $3 billion or JPY 435 billion at ForEx rate of JPY 145 to the dollar is to be carried out. First, for provision of funding. SCC and Aramco hold 37.5% of PRC shares, respectively. SCC will sell 22.5% to Aramco, resulting in capital structure reform. As a result, SCC's stake will be reduced from 37.5%, down to 15%. On the other hand, Aramco's share will be 60%. Though we have been equal partners, the share ratio of stake will change to SCC, 1 to Aramco, 4. And the SCC contributes its proceeds from the sale of shares to PRC while Aramco also contributes the same amount to PRC at the same time. PRC will receive $1.4 billion or about JPY 200 billion in cash, which will be used for debt repayment. Secondly, loans to PRC in total of $750 million each from SCC and Aramco has amounted to $1.5 billion, and both companies will each write off $750 million. And on SCC's consolidated basis, $188 million of loss or JPY 27 billion at the rate of JPY 145 to the dollar shall be booked. It is not an insignificant amount. But with the financial improvement plan, the Rabigh's financial turnaround will be achieved. And this is, in my opinion, is the most important point. With the new shareholding structure, Rabigh's inherent strengths will be further exhibited through the new structure. The other plan to enhance profitability. In addition to short-term measures listed on this slide being carried out currently, medium- to long-term measures such as upgrading oil refinery equipment will be announced by Petro Rabigh shortly. So this is the overview. And on the next page, you will be able to see the overview of the PRC financial improvement plan, which I hope you will have time to refer to. Now we would like to open the floor for Q&A.

Let me call upon Morgan Stanley MUFG Securities, Mr. Watabe.

This is Watabe from Morgan Stanley. I was caught -- taken by surprise that you were making this announcement and such as speed, and I would like to extend my respect for that. Thank you for the hard work. It has not been completed yet, but I appreciate. The sense of speed at which you have executed this after you launched the task force team, I'm sure it's difficult to share with us behind the scenes, stories. But this 15%, what is the point in keeping that 15%? If that will be my first question.

Thank you for your question. With the sense of speed, to be very honest with you, I, myself, had not expected such a quick and early agreement to be reached. But the task force team, both teams on both sides, day in and day out, for three months had very intensive discussions, and they made sure to get into the details. And in terms of what was going on in the -- behind the scenes, both parent companies were hoping for the sustainable growth of Rabigh. What will be the optimal setup for the future of Rabigh, that was the perspective from which both sides we're having discussions. It was not how to share the proceeds or profit or about the losses for that matter. Both sides, we're looking in the same direction. In other words, what would be optimal for the future of Rabigh. I think that has led to the sense of speed in reaching the agreement. And therefore, the agreement, personally speaking, at this point in time, is the best idea that we could reach and the strength assets of Rabigh, competitiveness of ethane and the fact that it is based in an oil-producing country, they are able to exercise, exert their intrinsic values. And the 15% of stake that we continue to hold. From various perspectives, both companies have had intense discussions and have settled with this percentage. Sumitomo Chemical, as I mentioned earlier, the future of Rabigh, we still believe is promising. And although our stake will be reduced, major decision-making -- we will be involved in major and material decision-making going forward to contribute to the growth and transformation of Petro Rabigh.

My second question is with regards to the profitability improvement plan. PRC, I think, is going to eventually announce the plan to enhance profitability. And you also refer to the strength of Rabigh. Aramco, 60% subsidiary, it is going to become, so refinery and business and various initiatives will be easier to executed. I think you -- there are various nuances associated to what you mentioned, but I understand. And with regards to the financial improvement plan and the plan to enhance profitability, to what extent do you plan, expect the profitability to improve? It's a public company, so I'm sure it's kind of difficult to elaborate, but the net profit is going to turn around. Is that what you're expecting? That is my question.

Thank you for your question. It is a very difficult question, I must say. But as you suggested and as I mentioned, PRC is going to share the overview of the plan to enhance profitability, and we look forward to that as well. The $3 billion -- close to $3 billion financial improvement plan, how that is going to be spent will be decided by Rabigh and other minor decisions are going to be decided going forward. And the borrowings, if that is going to -- the entire $3 billion is going to be spent for the loan collection, that is going to further improve their -- the financial situation. Petrochemical is an area where they have a competitive advantage, but also oil refinery, sophistication of oil refining business has not been executed yet. But with regards to sophistication of Refinery business, I expect that the effort will be accelerated going forward. To what extent there will be a contribution in that area and how the P&L of Rabigh will change and improve going forward, it's not that clear at this moment.

I see. So Rabigh Q2 earnings were announced. But this improvement plan has not been announced today yet.

Well, Rabigh, in their disclosure, within 60 days, the plan is to be announced within 60 days.

Thank you very much, Mr. Watabe. From Mizuho Securities, I would like to ask Mr. Yamada to speak now.

Yes. This is Yamada speaking. I'm from Mizuho Securities. Can you hear me?

Yes.

I have two questions. First question is related to the financial improvement plan. I thought it was amazing to have this plan in place in such a speedy manner. Congratulations. And I have two question as regards to the plan. First one is the provision of funds. Sumitomo Chemical stake in shares of Rabigh, I think that has been secured as a collateral. So collateral in the amount of JPY 197.1 billion, and through [ round ] the trip will be returned to financial institutions. Therefore, in principle, there may have been, to some extent, agreement with financial institutions, and a little over JPY 211 billion in debt guarantee will be lifted. Is my understanding correct? And the provision of funding, about $700 million returned, what kind of nature would you say as regards to this provision of funding or contribution by SCC?

Thank you for your question. In our discussion with financial institution, I believe that as soon as we are prepared, we will start negotiation with financial institutions. And that's to be repaid, and that is the main point in discussion as regards to which I believe that they will take a positive forward-looking manner in the discussion. As regards to the contributions, how are we going to account for it? That has not been determined yet. In what nature this funding will be contributed to Rabigh, the specified, the stocks, is it going to be considered as loans or stocks? Inclusive of all these, we will need to make adjustments and coordination of this relevant stakeholders. So that will be made going forward.

I have next question. After closure of this transaction and SCC will become a minor partner. However, still holding the influence of the business. So after the conclusion of this transaction, do you think that there will be an additional contribution of funds, but that -- you think that there will be no request for that. See, our partner, Aramco in the future, is going to lead the business operation in order to carry out whatever necessary improvement measures will be taken. Is this correct?

Yes, this is one of the key points. After closure of transaction, we will hold only 15% in stake. There will be a minority shareholding. So 15% or so equivalent rights and obligation of shareholder will remain. Therefore, there is no further obligation to make additional funding. And Sumitomo Chemical had expressed the intention not to carry out any additional funding, but that will be realized through the new structure of the shareholding. I hope you understand this. Thank you very much.

Thank you very much, Mr. Yamada. Let us go to the next question. SMBC Nikko Securities, Mr. Miyamoto.

Mr. Miyamoto of SMBC Nikko Securities. Thank you for your explanation. And congratulations on the agreement. To enhance the corporate value, I think this is a great move. My first question, 15% stake. About the contribution, how to handle that has not been decided yet, I understand. But the proceeds from sales when that is paid to the Petro Rabigh like a third-party allocation kind of maybe the stake of 15% will not change as a result of that? That is my first question. And from a long-term perspective, in order to specialize the business, I think it will be best to maximize your corporate value if the company not become the equity method affiliate. So I would appreciate if you could share with us your thoughts on that.

Thank you for your questions. The first question with regards to 15% and equity method affiliate, that is the sort of the framework that we are contemplating. And therefore, the setup will be made in such a way that the proceeds will be made in such a way. In other words, our stake will not increase above 15%. And the next question was about the equity method affiliate and whether 15% is going to stay as is. And our view at this moment is to stick with 15%. We don't have plans to change that because the top priority is to improve the profitability of Petro Rabigh. So 60% Aramco ownership, that's the capital structure under which we will operate, and Sumitomo Chemical will be making contributions on par with the 15% stake. That will be the first step.

Thank you very much for that. And my second question is kind of overlapping with the earlier question. The sense of speed was wonderful, but the fact that you are selling of Petro Rabigh shares was deemed to be quite difficult over the past years. But I would appreciate if you could elaborate a little bit on why this has become possible this time around. Looking at Petro Rabigh accumulated losses, 53% of equities, and this cumulative loss has piled up over the years, has that led to this agreement? If you could give us some more color on the background.

Thank you for your question. The intentions of Petro Rabigh is not something that I can comment on. But from Sumitomo Chemicals' perspective, we have made a decision not to make additional funding. And under that policy, how to turn the business around Petro Rabigh from a financial perspective and also for the refinery sophistication that requires investment, and so for SCC, what is it that we can do to contribute. And we've already made a decision to not increase exposure. So the proceeds from sales will be left for Petro Rabigh to manage. We found that very slim lining and Petro Rabigh and Aramco is going to contribute the same amount to Petro Rabigh. We reached that conclusion. We were on an equal footing in investing in Petro Rabigh and the new setup is different from that. But when we think of the future of Petro Rabigh, the operation -- running of the Petro Rabigh business should be under a capital structure where Aramco holds the majority in stake. Although this is going to be somewhat digressing from an equal power footing, but we made a decision that, that will be best interest for Petro Rabigh.

Understood. Thank you very much for sharing us -- with me in detail.

Thank you, Miyamoto-san. Next, I would like to ask Mr. Umebayashi of Daiwa Securities to have the floor.

This is Umebayashi speaking from Daiwa Securities. Congratulations on the decision you made. And let me ask you questions. The first one is related to time line. As a sequence, first, sale will be done and contribution will be made from the proceeds on sales and the debt forgiveness will be achieved. There will be such three steps. And in what sequence, if I may, I would like to ask you. And to what event -- which event will be carried out by the end of this fiscal year and which will be postponed to next fiscal year?

Let me explain the time line. First, debt forgiveness or writing off of loans will be done in two steps. So that is the steps we have in our mind. More specifically, in 2024 in August and in January 2025. So at two points in time, we are going to write off loans. As regards to the sale, in April 2025 is the time line we have in mind currently. The reason why is in relation to the sale, there needs to be potential approval by the competition authorities in relevant countries. And with financial institutions, we needed to seek agreement and also relevant procedures need to be made. Therefore, we assume that it will take several months. So in April 2025, which we envision as for timing for sale. In the meantime, after sale, how we are going to contribute cash will be considered in parallel. And after that, after the sale, the contribution will be implemented. So that is the time line we currently envision.

Yes. My another question is after sale of equity in the amount of about JPY 100 billion. Accordingly, sales proceeds and loss on sales may be accounted for to some extent or do you envision no such losses or profits related to the sales?

As I explained earlier, in April next year, the actual sale will be conducted. And we will consider the cost of shares to be sold is not known to us yet, and there will be some kind of loss of expenses on the contribution as well. So in line with the sale for Sumitomo Chemical, what will be the impact on the P&L of Sumito Chemical is not really known in specific numbers yet. However, we set some range, and we believe that there will be no significant impact on our P&L. That's based upon our own internal calculation.

I understood.

Nomura Securities, Mr. Okazaki. Please ask your question.

This is Okazaki from Nomura Securities. Congratulations on your wonderful agreement and execution of the plan. My question is kind of a follow-up on earlier question. Looking from the outside, the conditions of the agreement seems to be in favor of Sumitomo Chemical. For example, additional funding from Aramco, for example. Maybe Aramco has a strong feeling, intentions towards Petro Rabigh, was that reflected in this agreement?

Well, with regards to this framework, which does it favor maybe you could see it differently, depending on how you see it. But we are not thinking of benefiting from this, either party has that view. We were thinking what will be best for the future of Petro Rabigh. Both parent companies have that view, and it was shared between the two parties.

My second question, again, is related to an earlier question. Your exposure to Rabigh at this point in time, with the debt write-off of JPY 75 billion, JPY 750 billion or JPY 110 billion, whether it will be further reduced from there, it would depend on the money from Rabigh. Proceeds, if you have any further discussions on that, and I have poor understanding on that point. So I would appreciate if you could elaborate.

What you just mentioned is correct. It's not that there is anything other than what you mentioned was involved in the deal.

Thank you. That was very clear. Appreciate .

Thank you, Mr. Okazaki. Now the time to close this session is approaching. So we would like to conclude and close this special briefing session. So this concludes today's meeting. Thank you very much for participation in today's briefing.

Thank you very much. [Statements in English on this transcript were spoken by an interpreter present on the live call.]