Turkiye Petrol Rafinerileri AS

IST:TUPRS.E

Earnings Call Transcript 2019-Q3

[Operator]

Welcome to the Tüpras Third Quarter 2019 Conference Call and Webcast.

I will now hand over to Mr. Levent Bayar, Head of Investor Relations. Sir, please go ahead.

[Levent Bayar, executive]

Hi, everyone. Good evening to all from Tüpras headquarters, and welcome to our teleconference for the third quarter 2019. I am Levent Bayar, Head of Investor Relations. I am here with Dogan Korkmaz, CFO; and team numbers from Tüpras' Investor Relations and reporting departments. Over the next hour, we will first go over our operational and financial results for the third quarter of 2019. Then we will continue with the Q&A session.

I'll draw your attention to our cautionary statement. During today's presentation, we will make forward-looking statements that refer to our estimates, plans and expectations. Actual results and outcomes could differ materially. Please refer to our financial reports and material disclosures for more details. These documents are available on our website. In the next 2 slides, we will provide you with a brief summary of the key highlights regarding the third quarter, and we'll go into detail for each subject on the following slides.

Let's start with Tüpras' highlights for the third quarter of 2019. We have finally started to see IMO 2020 impact on mid-distillates towards the end of the third quarter of 2019. In the first 2 months of the quarter, diesel cracks have drawn a similar picture compared to last year. However, in September, long-expected, IMO-driven, high- and mid-distillate crack environment made its presence felt. However, the effect was slightly overshadowed by global demand concerns.

On the other hand, the tight supply conditions for heavy crudes continued in the third quarter of 2019, and differentials against Brent remained quite narrow. At Tüpras, the key profitability challenge that we faced throughout this year was this, and it continues to impact us in the third quarter as well.

After the successful completion of the RUP maintenance in the second quarter of 2019, we have finalized our preparations in our main assets for IMO 2020. In the third quarter of 2019, all of our refineries and RUP units were running at full capacity, and we have managed to average utilization rate of 105%.

Finally, we would like to sum up what we have achieved in the third quarter of 2019 in numbers. We have produced 7.5 million tons of total crude and other feedstock, sold about 7.8 million tons of refined products and generated around TRY 1 billion of EBITDA.

Now let's take a look at global oil and Turkish market developments in the third quarter of 2019. Here, we will provide you an overview of the market environment during the third quarter of 2019. We cover this section in 2 main components as developments in global oil market and developments in Turkish market.

Let's start with the top-left box. We just wanted to say that IMO 2020 impact has started to be seen in the third quarter of 2019. Widening of diesel HSFO crack margins throughout the quarter is another indication of this development. In addition to IMO, with strong aviation demand globally, jet has an even stronger performance compared to last year, and it's -- and against its historical average. Recovery of gasoline cracks from the very low of the first quarter of this year continued in the high season and almost reached third quarter of 2018 levels.

In numbers, diesel and jet fuel cracks were up by 7% and 19%, respectively, compared to last year's same period. On the other hand, high-sulfur fuel oil cracks and gasoline were down by 22% and 0.5%, respectively.

Since the ending of the third quarter of 2019, we observed that the impact of IMO has strengthened quite significantly on both mid-distillates and HSFO, stronger on the latter one. In addition to that, gasoline has been performing slightly above historical average levels, substantially healthier compared to its performance -- weak performance last year.

In the top-right part, we see Brent price development in the third quarter of 2019. Brent price had a significant decline in early August. The following flattish trend afterwards was disrupted in September mainly because of drone attack to the oil production facilities in Saudi Arabia. The attack initially led to a rapid rise, but later, it was reverted with the expectations of swift recovery to nominal production levels.

The effect in September did not change the overall trend as the quarter average of Brent price posted a 10% decrease compared to the second quarter. This overall downward trend has resulted in an inventory loss for Tüpras in the third quarter of 2019.

Now taking a look at the bottom row, Turkish market. Bottom-left part shows U.S. dollars versus lira in the third quarter, showing you about TRY 0.1 appreciation during the quarter. This effect, being mostly contained within the quarter, had very limited impact on our P&L.

Finally, we do have the Turkish fuel market data for the first 8 months of this year. Even though diesel demand growth in the first 8 months still adds up to about 5.1% contraction compared to last year, the positive figures in the last 2 months led to a partial recovery from 7.5% contraction in the first 6 months of this year. This process can be attributed to relatively improved economic activity. On the jet fuel side, we see that the growth in consumption remained steady, with healthy aviation demand.

Now let's take a look at the crude oil and refining market development on the following 2 slides. Compared to third quarter of 2018, diesel cracks improved and averaged at $15.6 per barrel in this quarter. Compared to third quarter of 2018, they were up by 7%, mainly due to initial indications of IMO-related demand shift, high levels of refinery maintenances and less exports from Saudi Arabia after the drone attack. The stronger performance in the later section of the quarter indicated that IMO 2020 impact has started, and it is expected to accelerate. To put things into numbers, October average was $18 per barrel.

Jet fuel cracks posted an approximately 19% growth and averaged at $16 per barrel in the third quarter of 2019. With the beginning of tourism season, jet cracks have already started to improve, and the trend continued throughout the quarter. Engine aviation demand pickup and declined export volumes to Europe also contributed significantly to the increase in the prices.

In addition to these, the impact of IMO, since jet is a sister product to diesel, and the attack to the oil production fields in Saudi Aramco should not be omitted as well. As it has been the case for diesel, jet cracks has also been rather strong in October and averaged at $17.4 per barrel.

Gasoline cracks declined by 0.5% compared to last year's same period and averaged at $12.5 per barrel in the third quarter of 2019. After starting the year at historical lows, gasoline made its way back to average levels. The beginning of the driving season and the unexpected production disruptions in Philadelphia and Europe have supported gasoline cracks since second half of June.

The boost effect was, in a way, counterbalanced by the existing structural challenges of gasoline. Increase in shale oil processing continues to create significant growth in gasoline yields globally. In addition to that, lower naphtha demand due to decreased petrochemical-driven consumption makes gasoline supply abundant as well.

If you take a look at how gasoline cracks margins have been performing since the ending of the quarter, we see that it has been around $11 per barrel during October. This is slightly above historical average levels and considerably stronger with respect to weak performance of last year.

Finally, high-sulfur fuel oil cracks decreased by around 22% compared to third quarter of last year and averaged around minus $12.3 per barrel. The HSFO crack margins have been continuously falling since July, with one exception that is the brief period when Saudi production was disrupted during September. This trend is the earliest and, so far, the strongest indicator of IMO 2020. During October, cracks averaged around minus $22.5 per barrel, indicating that the trend remains intact.

Moving over to the crude price differentials. In the first quarter of 2019, on a simple average basis, heavy crude price differentials to Brent were narrower by $2 to $2.5 per barrel with respect to third quarter of 2018. The main driver, limited availability of the heavy crude oil, remained intact in this quarter as well. The extension of OPEC cut into second half, over-compliance to this by the member producers, continuation of the sanctions of Iran and Venezuela, maintained the shrinkage of the heavy crude supply globally. All of these factors have led to about 4 million barrels per day drop in heavy crude supply, which is more than 10% of the OPEC's total heavy crude supply.

Looking forward, we continue to believe the outlook for heavy differentials will be set in accordance with level of heavy crude supply as well as IMO 2020-related crude slate decisions. Our base case scenario for IMO era is unchanged. We still look forward to see widening differentials, with the switch in crude slates of the refinery.

Before we take into -- take a look into Tüpras' specifics, let's take a look at the developments in the first 9 months of 2019 from a top-down perspective.

Looking at cracks, as you might recall, the first half of 2019 was not very strong, mostly on the back of weak gasoline, crack margin and high supply levels for mid-distillates. While we began to observe IMO-driven support for our mid-distillates in the third quarter, concerns on global economic slowdown shut off the overall performance.

On differentials, there were many developments from different parts of the globe, sectors and value chain. We have observed that with all 8 waivers expiring on May for Iranian crude exports, there have been a substantial drop in heavy supply globally. In addition to that, one of the lead suppliers of the heavy crude, Venezuela, has almost been completely missing from the picture in 2019.

While OPEC numbers began the year slightly below 100% compliance rate for the December 2018 production cut decision, the era between March and August show around 100% compliance rate on average. Since August, compliance rate for OPEC cut decision is roaming around 120% to 150% range, which is severely limiting availability of heavy grade globally.

Unanticipated events, such as the contamination in Druzba Pipeline and the drone attack on Saudi fields, were relevant for a shorter period but were negative developments as well. Our calculations indicate that there has been a cumulative drop of around 4 million barrels per day heavy crude from the market in 2019, which is more than 10% of the total global heavy supply.

Regarding pricing mechanics, since majority of the supply drop occurred in May and accelerated during summer with over-compliance increasing in OPEC cut decision, price adjustments mostly happened during August as they're reflected to the third quarter. Looking forward, we expect a better outlook for refining as IMO cracks are now in place for mid-distillates and differentials are widening.

Now let's move on to our operations. Starting with the capacity utilization, in the third quarter of 2019, our total crude utilization was 96% and other feedstock capacity utilization was at 9%, reaching to 105% for the whole system. With all major maintenances completed, we were able to perform at a peak level, improving our capacity utilization amount throughout this year. In 9 months, our capacity utilization has materialized at 98.3%, almost 3 percentage points above last year's same period.

On the left-hand side graph, you can see our production numbers. Our total production in the third quarter was 7.5 million tons. As you know, we had announced our maintenance schedule at the beginning of this year. And since we are on track, we are not revising our full year production and capacity utilization targets.

Moving over to the sales, let's start with the chart on the left side. We generated total sales of 7.8 million tons in the third quarter of 2019. Our exports are almost 40% above last year's same period, driven mainly by fuel oil and bitumen exports.

Our domestic sales show a decline compared to last year at around 1.3 million tons. This is mostly on the back of the contraction in Turkey's demand. And as a result, we opted to focus on sales out of our own production and limited our imports. Another sizable impact in our sales mix is our growing bitumen exports, which continue to compensate for the weakening of domestic demand.

In the first 9 months of this year, we have exported around 600,000 tons of bitumen. Since we are in line with our initial projections, we do not revise our full year sales target of around 30 million tons.

Now let's move to the financials. Let's start with the refining margin developments on this slide. During the third quarter of 2019, Mediterranean refining margin decreased by $1.8 per barrel to $3.3 per barrel compared to third quarter of 2018. This was mainly due to lower fuel oil cracks and narrower oil Brent differentials.

Tüpras' net refining margin was materialized at $4 per barrel in the third quarter of 2019. The sizable drop compared to last year's same period has 4 main reasons. Differential were on average $2 to $2.5 per barrel narrower. We have recorded about $1.4 per barrel of inventory loss this year against the $3.1 per barrel gain in the last year's same period, accumulating to about $4.50 per barrel gap between the 2 periods.

Elevated energy prices that costed more than $1 per barrel on our net refining margin, including natural gas, hence, many other OpEx, which was elevated with higher inflation and currency adjustments throughout 2019. Despite all the unfavorable conditions, we were still $0.7 per barrel higher than net margin, thanks to our higher white product yield and more advantageous crude slate.

Now let's take a look at the P&L items for the third quarter of 2019 compared to third quarter of 2018. Our revenues decreased by 23% to around TRY 23 billion. This was mostly on the back of 18% decrease in Brent price. Similarly, our COGS also dropped by 16% with the Brent price decrease. Due to narrower differentials, elevated natural gas prices and very limited increase in cracks and inventory losses stemming from the Brent price drop during the third quarter, our gross profit generation was adversely affected. It has declined by 70% and realized at around TRY 1.2 billion.

When comparing against last year's same period, it's important to note that the significant inventory gain of the third quarter of 2018 is the main reason of the significant gap between the 2 periods. Our operational expenses increased by 39%, mainly due to lira depreciation compared to third quarter of 2018 and inflation adjustments to the lira-based cost. With the help of Turkish lira appreciation, the loss from other operations shrunk sharply from TRY 2.8 billion to TRY 100 million.

Regarding our financial expenses, our net interest expenses are lower as we have increased the share of lira-based deposits to enjoy higher rates in the third quarter. Since our FX deposits were lowest, we had to use more forwards to cover our FX balance, which have resulted in elevated derivative expenses.

With lower FX deposits, our FX expenses have increased as well. However, as we have mentioned above, Tüpras' FX position needs to be evaluated in a holistic way. While financial expenses increased by around TRY 650 million, we have recorded nearly TRY 2.8 billion recovery at the operating level. Therefore, the net drop in FX-related items are around TRY 2 billion positive. With the weak operational profitability and shorter level of financial expenses, our bottom line was materialized at TRY 155 million negative.

Now for the EBITDA. Our reported EBITDA materialized as TRY 956 million in the third quarter of 2019. Despite the hedging gains, we have recorded TRY 692 million of inventory loss, stemming mainly from the Brent price drop the third -- during the third quarter. When we deduct this inventory loss from reported EBITDA, we reached about TRY 1.65 billion of clean EBITDA, or EBITDA CCS, in the third quarter of 2019, which is 22% below last year's same period.

Now let's take a look at the profit before tax bridge. As you can see, the decline in profit before tax over the third quarter of 2018 was mainly driven by the narrow differentials and increase in natural gas prices. Except for fuel oil, all of the main product cracks posted a flat performance compared to third quarter of 2018, which led to $0.1 per barrel increase in the total weighted average crack margin of Tüpras. That had a positive impact at around TRY 31 million.

Due to $2 to $2.5 per barrel narrowed heavy crude differentials, we recorded TRY 549 million of negative impact from the differential part. We have reduced our total production by 200,000 tons to produce lower amounts of black products, which resulted in a TRY 50 million negative impact.

Higher natural gas prices covers the majority of the elevated operational expenses in the third quarter, while higher inflation and FX adjustments to some other costs contributed to the TRY 385 million negative impact compared to last year.

The trend of the Brent price was at the opposite direction of last year's same period, and our inventory loss delta, i.e. the sizable inventory gain last year against the loss in this year, had resulted in a TRY 2.4 billion of negative inventory effect on this bridge. With lira appreciation, again, an opposite trend to last year's same period, we have recorded TRY 2.5 billion of FX gains on the bridge. Since these 2 factors mostly canceled each other out, we have recorded TRY 90 million net positive impact. All in all, the third quarter profit before tax was materialized as negative TRY 146 million.

Now for the financial highlights of this quarter. Our EBITDA was realized as TRY 956 million. This brings reported EBITDA to TRY 3.3 billion in the 9 months of 2019. We have a net income of TRY 340 million in the 9 months, with a negative TRY 165 million net income in the third quarter.

Regarding gearing, our net debt-to-EBITDA ratio is at 1.7x, and our current ratio is at 1.1x. Our rolling return on equity materialized at 21%.

Let's continue with the details of our balance sheet. Our cash and cash equivalents and financial liabilities at the end of the quarter was TRY 10.1 billion and TRY 18.8 billion, respectively. This has reduced our net debt to TRY 8.7 billion as of the end of the third quarter.

The short-term portion of financial borrowings was TRY 3.9 billion as you can see from the top-right box. Around TRY 3.5 billion of -- out of that TRY 3.9 million was a short-term portion of our long-term borrowings. As you can see from the redemption schedule that the majority of our late long-term financial debt consists of our USD 700 million euro bond, which has a fixed 4.5% interest rate. Working capital stood at a negative TRY 2.3 billion, mainly because of our ongoing efforts on optimizing cash and receivables management.

Let's move to FX exposure management slide. Regarding our FX exposure management policy, we have opted to increase the share of Turkish lira deposits during third quarter to enjoy higher rates against lower U.S. dollar deposit rates. To ensure a closed FX position, we increased the amount of forwards in the third quarter of 2019. Forward rates were cheaper compared to the spread between Turkish lira loan rates and the USD deposit rates.

In addition to that, we used the additional Turkish lira cash better at the Turkish lira deposit rate with longer maturities. Following rate cuts, current TL deposit rates are around 30%, which imply around 600 basis points gains for Tüpras. Our FX position will still cost actual amount by USD 11 million with the help of our financial hedge mechanism.

Now taking a look at the maintenance calendar. We are on track with our initial maintenance calendar that was disclosed in the beginning of this year. We have added 2 minor maintenance tasks to our 2019 maintenance schedule. These are quite brief maintenance activities to resolve some minor efficiency issues. We want to ensure the high performance of these units before we move further into IMO 2020. We do not expect a change to our production targets from this revision. Therefore, we maintained our production target for this year.

The final slide of this presentation is on revisions to our 2019 full year expectations. As we have discussed earlier, in terms of crude pricing, majority of the supply drop became more effective after August. In addition to that, IMO-driven mid-distillate cracks were being overshadowed by concerns over global demand levels.

Based on these developments, we revised down our med refining margin expectation from $3.75 to $4.25 per barrel to $2.75 to $3.25 per barrel. We have also revised Tüpras' net refining margin estimation to $4 to $4.5 per barrel from $6 to $7 per barrel.

Our guidance for 2019 regarding our production sales and capacity utilization targets remain unchanged. For CapEx, we would like to see the full impact of IMO 2020 to rerun the feasibility and basic engineering aspects for some of our projects. Thus, our refining CapEx expectation was revised down to USD 150 million from USD 200 million.

Thank you for listening to me.