Turkiye Petrol Rafinerileri AS

IST:TUPRS.E

Earnings Call Transcript 2018-Q2

[Operator]

Ladies and gentlemen, welcome to Turkish Petroleum Refineries Corporation Tüpras Second Quarter 2018 Financial Results Conference Call and Webcast. I now hand over to Ms. Asli Gülçur, Strategic Planning Director. Madam, please go ahead.

[Asli Gülçur, executive]

Sure. Good evening from Tüpras headquarters. Welcome to our teleconference. I'm Asli Gülçur, Strategic Planning Director at Tüpras, and I'm here today with our CFO, Dogan Korkmaz; our Financial Reporting and Planning Director, Tuncay Onbilgin; our IR Manager, Levent Bayar; and our IR Coordinator, [indiscernible].

Over the next hour, we will first present the results and then take your questions. In the next few slides, we will provide you with a brief summary of the key highlights regarding the second quarter, and we'll go into detail later, as we did last quarter.

Now let's start with the highlights for the quarter. Here you see an overview of the key factors that impacted us regarding the external market environment. First, we continue to witness strong growth in refined products market in Turkey in the first 5 months of this year. As we see on the top left, diesel demand grew by 12.5%, jet demand by 12.6% and gasoline by 5.5%.

Second, in Q2 2018 compared to Q2 2017, middle distillate cracks continued their strength as in the first quarter. On the other hand, gasoline and fuel oil cracks remained weak. As you see on the table there, while jet cracks was higher by 39% and diesel cracks by 29%, gasoline cracks were lower by 11% and high sulfur fuel oil cracks by 79% this quarter compared to Q2 2017.

Now if you look at the right side of the slide, you see that the increase in geopolitics, especially concerning Iran, supply problems of Libya, Canada and Venezuela led to a 16% increase in Brent price during the second quarter. The production increase and seasonal effect on Russia announced on June 22 was significant. The shift in policy was well received after the oil price peaked in May. However, the crude price increase picked up again at the end of the quarter due to supply-related constraints mentioned before.

Now on the right bottom hand of the slide, you also see that the dollar to TL FX rate increased significantly during Q2, by around 15.5%. As you note, this FX increase during quarters can cause an FX loss initially as we regard our stock as natural hedge. Such FX loss can then be recovered as inventory turns and sales are achieved. As you see in the graph, in Q2 2018, we saw that the dollar-TL rate peaked in May. As a result, selling some of the inventory in June partially offset the overall net increase during the quarter.

We will now go over the next slide and talk about our business performance. As you very well know, this year, we were -- we are ordinarily taking an important maintenance schedule in order to prepare our refinery for the high season and position us for the upcoming IMO 2020 regulatory change. In the first quarter of this year, we had already left behind the yearly maintenance program. Although we still had a few maintenance during Q2 2018, this quarter -- the last quarter, we -- in Q2, we achieved 92% capacity utilization rates.

In a rising Brent price and FX environment, our higher stock levels, given the maintenances, being sold led to a net $231.4 million inventory gain in Q2. This figure was $301.8 million in the first 6 months of the year.

We have a robust balance sheet, given our strong position in a short, growing refined products market in Turkey, and our capital structure is supported by ample amount of cash, $1.3 billion to be exact, as of end of June, strict financial policies and high inventory turnover, around 1 to 1.5 months. At the end of June, our net debt to rolling EBITDA ratio was 1.5x, and there's no credit rollover in the near term that can impact our liquidity negatively.

If you look at the right side, right top side, you see that Tüpras' net margin was $12.3 per barrel as a result of production increase over Q1, high inventory gains that I just mentioned and strong middle distillate cracks. This was the highest Q2 net refining margin amongst second quarters over the last decade.

Tüpras continues to address our country's increasing demand for middle distillates. Our domestic diesel and jet sales were 4.4 million tons, 8.5% higher than the sales in Q2 2017. Again, our priority in Q2 was domestic sales as opposed to exports due to maintenances. So if you wrap this up, in summary, we processed 6.5 million tons of total crude and other feedstock, sold 7.4 tons of refined products and generated around TRY 2.2 billion in EBITDA in the second quarter this year.

Now we can go over the recent announcements we just made. As you've seen, we're opening a new trading office in London. And the key idea behind this decision is to have a physical presence in one of the world's most active crude oil petroleum product trading hubs and, of course, to have a direct access to market intelligence there. Trading of petroleum industry products will help us optimize and extend our supply chain and will help us steer our operations better against changing market conditions. In terms of operations, Tüpras' margin trading office will operate as a branch of Tüpras' head office in full harmony with the existing commercial operation and our existing 4 refineries in Turkey. And just, again, in terms of timing, as we have announced, we plan to open the office until the end of 2018.

Now we can just proceed to the market conditions of the second quarter. In general, what we witnessed in Q1 2018, which was higher middle distillates versus weaker gasoline and fuel cracks compared to 2017, continued in Q2 as well. So if you look at the markets closely, diesel cracks continue to be supported by strong economic activities and infrastructure projects. Strong PMI numbers and infrastructure spending of U.S., Europe, China and India contributed to the strength of diesel cracks. Jet cracks outperformed all products in terms of growth rate, given strong air traffic growth and aviation growth. In April and May, refinery maintenances continued globally and tightened products [ acquired ], affecting all product cracks positively. In addition, complex refinery maintenances decreased demand for heavy crude and led to widening of select to heavy crude differentials.

Although with the beginning of high season the gasoline cracks performed very well in Q1 2018, they were still weaker compared to Q2 2017. And this was mainly due to high stock levels in Europe and the U.S. With the completion of maintenances by June, refineries started operating at almost full capacity utilization. This situation created a supply increase and negatively affected crack margins in June. Furthermore, supply increase, especially from Russia and Middle East, led to increase in trade flows to the Med regions. Lastly, power generation shifts from crude oil to natural gas as well as seasonality led to a decrease in fuel oil demand in Asia.

Now let's take a look at the cracks. In the second quarter of 2018, diesel cracks increased by 29% over Q2 2017, from $10.7 per barrel to $13.9 per barrel. And this was again -- we mentioned the reason for it earlier, due to strong demand activities and light infrastructure spending. As you see on the right side, jet cracks significantly increased by 39% to $13.8 per barrel, driven by the strong aviation growth. So now if you look at the bottom 2 graphs, the left, the gasoline, you see gasoline and high sulfur fuel oil cracks decreased by around 11% to -- and 79%, respectively, over Q2 2017. Fuel oil cracks declined the most in Q2, a trend we also observed in the fourth quarter of 2017 and first quarter of 2018.

Now we can move on to the Turkish markets. Diesel consumption once again grew significantly, driven by infrastructure projects and due to vehicle consumption. And as you see on the graph, the left top side, in the first 5 months of 2018, the diesel market grew by 12.5% over the same period last year, reaching to 10 million tons. On the right side, you see that jet consumption increased by 12.6%, reaching to 1.8 million tons. And on the left bottom, you see that the gasoline demand was also strong, with a 5.5% growth rate. And as I mentioned earlier, fuel consumption of fuel oils continue to decline, as we see, 21.6% in the first month of this year.

So now let's look at differentials. So if you look at the right graph and compare Q2 2018 versus Q2 2017, you see that the price differential between Brent and select Middle Eastern heavy crudes widened slightly by around $0.4 per barrel, on average, driven by -- mainly driven by complex refinery maintenances. As you know, differentials narrowed during 2017 due to the OPEC cuts, and you see that in -- on the graph clearly. And in early 2018, differentials widened due to worldwide refinery maintenances, but they were expected to narrow after the end of maintenance period in May, as OPEC cuts were in place until the end of the year. However, after the sanctions announcement regarding Iran, OPEC changes policy and announced production increase plans instead. This was to compensate for the expected loss of supply from Iran. Following the increase in production, we see a reversal of this narrowing trend, and we see that the differentials are widening in July. And when you look at this differential picture and think about the [ future ], there are 2 moving parts at the moment, and we'll be all monitoring how differential will change as the OPEC post the shifts and Iran sanctions take place.

So if you then focus on Tüpras and look at our operations, and let's start with the production and capacity utilization figures in the second quarter. In Q2, our total crudes and other feedstock capacity utilization was 92%. While this was an improvement over Q1 of this year, this level was still below last year same quarter as a result of periodic maintenances conducted in the Izmit, Izmir and Kirikkale refineries.

On the left graph, you can see the impact of these maintenances on our production. Our production in the second quarter was 6.2 million tons. As you know and as we said repeatedly before, we have planned our maintenance schedule at the end of 2017. And since we're on track, we're not revising our full year production or capacity utilization targets.

So now let's move on to the next one and talk about the production of our products. And if you look at the product breakdown, compared to Q2 2017, we increased our middle distillate yields in order to benefit from the strong cracks in jet and diesel. Our jet yield was 20.1%, around 3% of our jet yield a year ago. Diesel yield was also high at 32.1% in Q2. On the right side, you see that the -- our product yield was 20.9%. Strong outflow demand allowed us to increase bitumen yield to 14.5%, which positively impacted the profitability of the by-product category in general.

So now let's look at the domestic sales and move from production to sales. We generated total sales of 7.4 million tons in the second quarter. And as we see on the left graph, once again, given the scheduled maintenances and strong domestic demand, we gave priority to domestic sales over exports. As you can see on the right graph, internal strong domestic sales performance of diesel, jet fuel and gasoline sales increased by 6.5%, 13.4% and 4.6%, respectively, compared to Q2 2017. And overall, domestic mid distillate sales were 8.5% above last quarter's second quarter -- last year's second quarter.

So now let's look at our Opet. Opet continues to be the second largest fuel distribution company in Turkey, so there's no change there. As of May 2018, Opet had 17.3% market share in white products and 29.9% in black products. And the number of stations were 15 -- 1,589 as of June 2018.

So I think we can now move on to the next category, which is about our financials. As I mentioned at the very beginning of our presentation, we recorded $231.4 million inventory gain in Q2 on the back of 2 factors. The first one is, as I explained before, Brent price increased by 16% and dollar-to-TL rate increased by 15.5% during the quarter. Given our higher starting inventory level at the beginning of Q2 due to the maintenances in Q1, we had a crude and other feedstock cost advantage, boosting our profitability.

In addition, as we start the year with 0 inventory hedge and increase our coverage towards full protection by the year-end, the inventory hedging was limited in Q2, allowing us to recognize some portion of the upward shift in prices and [ expected ] appreciation. One can assume that as the hedging amount will increase, the gains/losses will be limited in the coming quarters. You can see from the table, as the Brent price and FX peaked in May, the inventory gains were the highest in that month.

So let's move on to the next slide, and this was our second highlights or one of the highlights at the beginning. We said in the Q1 2018 teleconference that our net refining margin will increase as our production increase with the completion of maintenances. We achieved record Q2 net refining margin of $12.3 per barrel in Q2. This was driven by our production increase compared to Q1, strong middle distillate cracks and high inventory gain. Our net refining margin was $4.5 per barrel higher than net margin of Q2 2017. And in the same period, Med margin decreased by $1.4 per barrel to $4.4 per barrel compared to Q2 2017, mainly due to lower fuel oil cracks and tighter oil and Brent differentials.

So net-net, as a result, Tüpras' $12.3 per barrel net refining margin in Q2 was significantly higher than the Med complex margins. And excluding the $3.3 per barrel inventory effect in Q2, Tüpras clean net margin was $9 per barrel, still significantly higher than the Med margin. So if you sum this up in terms of the difference, higher middle distillate yields and advantages crude slate of Tüpras compared to the net margin composition created the difference between Tüpras and Med margins.

So let's move on to the income statement. Compared to Q2 2017, in second quarter of this year, our revenue increased significantly by 59% to TRY 20 billion. On average, 50% increase in Brent price and 22% increase in dollar to TL led to higher product prices. This impact was partially offset by 9% decrease in sales volume due to maintenances. Our gross profit increase was capped at 39% with the impact of negative total crack impact, given our total yield mix.

And if you go down to operating profit expenses, you see that thanks to our new company, Körfez Ulastirma, we were able to utilize more railway transportation. And together with the help of this change, our operating expenses increased only by 7.4%, well below the inflation rates.

Loss from other operations increased mainly due to FX loss trade payables, given the 16% increase in the Brent price and 22% increase in dollar to TL on average. And this FX loss in trade payables, resulting primarily from crude purchases, was mostly offset by the inventory gain effect in the gross profit level that I mentioned earlier.

So if you go -- if you keep going down the table, in a rising interest rate environment, despite our total debt of TRY 14.8 billion, our interest expenses only increased by TRY 163 million as a result of our proactive financing activities. Furthermore, our interest collar was at a comfortable level of 11x in Q2. Despite a total hard currency debt of $2.7 billion, we have also managed to reduce net FX expenses with favorable income.

Similar to Q2 2017, we had a positive tax impact due to the revaluation of the remaining tax incentives. As you know, the declaration of the revaluation rate by the government impacting the remaining tax incentive amount on the balance sheet started in 2016, and we applied, as declared in the revaluation rate by the government, twice in Q2 and Q4 during the year -- twice during the year, actually, in Q2 and Q4. Although the production decreased and weaker-than-optimal total crack and differentials impact restrained operational profitability, substantial inventory gains on stock led to 43% growth in EBITDA in Q2.

So let's look at the bridge. And as you can see, the decline in profit before tax over Q2 2017 was mainly driven by the FX loss and decrease in production, and this was partially offset by the inventory gain. As we explained previously, gross advantage of our higher stocks, due to maintenances and a rising crude oil, and a dollar-to-TL FX environment during the quarter generated around TRY 1.2 billion inventory gain. On the other hand, we had TRY 1.1 billion FX loss compared to Q2 2017. As I mentioned before, net FX increase during the quarter can cause an FX loss initially, as we regard our stock as a natural hedge. Such FX loss can be recovered as inventory turns and sales are achieved. And in fact, the FX loss in Q1 2018 was recovered in the inventory gains seen in Q2 2018.

Due to maintenance, our production was lower compared to last year's second quarter. We have over 100 -- actually, 117%, to be exact, total capacity utilization in Q2 last year. Due to this high base, we recorded a TRY 365.9 million negative impact on our financials in Q2. Except for the middle distillates, the negative performance of product cracks led to a negative $0.7 per barrel change in total crack margins. With 46.3 million barrels pluses in Q2, the impact on Tüpras' financials was negative TRY 148.7 million. And lastly, the average crude oil differentials slightly widened by $0.4 per barrel, creating a negative TRY 143.1 million impact.

So the -- in the next slide, you see that on the top left, we nearly doubled in -- our EBITDA in Q2 compared to Q1. In addition, our Q2 EBITDA was 21% higher than the EBITDA in Q2 last year on dollar terms. And if you look down to the net debt-to-EBITDA, our net debt graph, you see that our net debt decreased by 16% compared to Q1. And our net debt-to-rolling EBITDA ratio was 1.5x, and our return on equity was realized at 31% in Q2.

So let's look at our balance sheet. As you see on the top left, our cash and cash equivalents and -- was $1.3 billion, and our financial loans, on the bottom left, was $3.2 billion at the end of the quarter. As you can see from the both cash and financial loan graph, we paid down $700 million of matured eurobond in Q2. Thanks to our real proactive look at the management, we had rolled the eurobond 6 months before its maturity date. As a result of this payment, total debt returned back to its historical average compared to the high debt levels at the end of 2017 and Q1 of this year. In addition to eurobonds, we paid out $400 million of the remaining dividends, which were also fully funded with our strong operations. And net-net, our working capital in Q2 improved.

Inventory value remained constant. The effect of the Brent price increase on inventories was mostly offset with the inventory volume decrease as the maintenances ended. Thus, our inventory remains roughly the same in terms -- in dollar terms, and our trade payables increased due to the expansions in trade financing and change in supply mix composed by increase in Brent price and FX.

And our -- in terms of our FX exposure management, we see that our foreign exchange exposure was $54 million long as of June 30, 2018. Active management of FX exposure kept those risks -- this risk level within our limits once again.

So before the outlook, before the wrap-up, we just wanted to highlight the investment case for Tüpras once again. As these things -- you know about these factors really well, but sometimes, they get omitted. And we're proud of our results this quarter, and we wanted to go over some of the highlights of Tüpras.

At Tüpras, we are a strong player in a growing market with significant mid distillate shortage. This gives us a healthy cushion in case spending decreases. Secondly, Tüpras' petroleum market is liberal and well-established with local and international players. Thirdly, our massive investment cycle is completed, and we're now well positioned to capture the benefits, including IMO 2020. And fourth, our balance sheet is robust with prudent financial management practices, including proactive FX management and hedging policies. And we can easily see that we're less prone to [indiscernible] volatility. As a result, with the earnings visibility that we have, we pay out 90% of our earnings annually.

As you see, to sum it up, Tüpras continues to be a compelling investment case with growth potential, strong asset base, profitable operations and robust financial structure, and somewhat immune to pretty much any downturn.

So now we can move on to the next section, and we'll wrap it up soon. This is the refinery maintenance table you've seen in our last teleconferences. So we would like to, once again, remind you that we're providing the tables with details in order to increase awareness and just provide further transparency for you. And in real life operations, there could be shifts and the details in this table can be adjusted. But we urge you again not to get lost in the details here, but instead, track the year-end capacity utilization guidelines we provide. If there are any changes that can affect these guidelines, we'll update the market accordingly. And as of the end of Q2, our year-end total capacity utilization target has not changed, and we expect full total capacity utilization for 2018.

And so in terms of expectations versus results, let's look at what we've achieved so far in the first half of this year against our guidance. With higher production compared to Q1 and higher cracks, our net refining margin increased to $12.3 per barrel in Q2 and was $8.9 per barrel for the first half of 2018, which is clearly above our guidance for the full year. With the completion of maintenances in Q1, our capacity utilization improved to 92%, and it was 85% in the first half. We spent $92.6 million in CapEx in the first half, and our budget target for CapEx is, as you know, $250 million.

So on the next slide, you will see that -- you will see a summary of what we've already discussed during this call. We only updated our average Brent price. Everything else remains the same.

And at this point, we can conclude the presentation and open this for your questions.