Turkiye Petrol Rafinerileri AS

IST:TUPRS.E

Earnings Call Transcript 2020-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. I am Jota, your Chorus Call operator. Welcome, and thank you for joining the Tupras conference call to present and discuss the third quarter 2020 financial results.

At this time, I would like to turn the conference over to Mr. Dogan Korkmaz, CFO; and Mr. Levent Bayar, Head of Investor Relations. Mr. Bayar, you may now proceed.

[Levent Bayar, executive]

Hi, everyone. Good evening to all from Tupras headquarters, and welcome to our teleconference. I am Levent Bayar, Head of Investor Relations. I am here with Dogan Korkmaz, CFO; and team members from Tupras Investor Relations and reporting department.

Before we start, we would like to say we are very sorry for the earthquake in Izmir, which has resulted in more than 100 deceased and around 1,000 injured.

Our Izmir refinery was not affected from this terrible incident and operations continue without any problems. Our refinery search and rescue teams helped the local authorities in searching and rescuing people in need and removal of debris.

Over the next hour, we will first go through our operational and financial results for the third quarter of 2020. 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 will go into detail for each subject on the following slides.

Let's start with a brief summary of the highlights for the quarter. In the third quarter of 2020, mid-distillate cracks were quite weak. Compared to both pre COVID normal and also against second quarter of this year. The key reason for this was lower demand, especially in jet fuel and elevated stock levels. This is one of the main reasons for our weak third quarter operational profitability.

Second, heavy crude differentials were also quite narrow in the third quarter, mostly on the back of the agreement of OPEC+ in May, which resulted in reduced output by members. This development also put pressure on our operational profitability as well.

As a positive note, with the ongoing improvement in Brent prices, we have recorded a substantial inventory gain in the third quarter. This has helped us recover majority of the inventory loss that we have incurred in the first half of this year. Turkish lira depreciation accelerated in the third quarter, resulting in an elevated FX losses below EBITDA. We continue to recover this at EBITDA level with the help of FX-based pricing mechanisms.

Now let's take a look at Tupras highlights in detail for the third quarter of 2020. As we have discussed earlier, mid-distillate Cracks have been particularly weak in the third quarter of this year.

Following the demand through in the second quarter, diesel and jet Crack margins started third quarter with a positive trajectory but the trend has reversed later due to elevated supply and stagnating demand. The start to fourth quarter is again with an uptick. Jet Crack margins have finally shown some positive figures in October, first time since April. This has been supported for diesel cracks as the weakness in diesel was especially driven by jet fuel demand and supply dynamics in the first place.

On the other hand, gasoline remains relatively strong on the back of increased demand for private passenger vehicles. As you may remember, we had incurred a sizable inventory loss in the first half of this year. Following OPEC+ production cut agreement, Brent prices started to recover in May and has averaged around $43 per barrel in the overall third quarter, considerably higher compared to the second quarter.

Consequently, we have recorded the size of the inventory gain in the third quarter sales and therefore, recorded significant portion of the inventory loss that we have incurred in the first half.

On the months chart at the bottom, we have an indicated simple leverage of main regional heavy crude oil price differentials against Brent price per barrel. As you can see, the heavy crude differentials narrowed materially in the third quarter, this had a negative impact on third quarter operational profitability of Tupras. Differentials were extremely narrow in July due to OPEC+ production cut, mostly being from heavy grade producers but have been gradually widening again. It is currently at a narrower level than historical averages.

Looking forward, they will likely remain volatile due to several factors on demand and supply dynamics.

Now let's move on to the market section and take a look at the global and domestic development on the following 3 slides.

We've sectioned in 2 main components as developments in global oil market and developments in Turkish market. Let's start with the top left box. This chart presents the year-over-year change in jet fuel demand and a number of global commercial flights. Both indicate that there has been somewhat a gradual recovery since the second quarter. However, there remains a long path to go before fully normalizing, considering that the number of flights are 35% below from last year. This picture broadly summarized why jet Crack margins are at historically low levels despite some limited improvement in October onwards.

In the top right box, we see global diesel stock levels, which was, in a way, also shaped by the dynamics presented in the previous chart. As you can see, the diesel inventories have been piling up from March to August and have been above 5-year maximum as of October. This was not only driven by the demand loss due to the outbreak, but also supported by contango related activities in the first half of this year and excess supply from refineries as they have increased their diesel output in order to reduce jet volumes.

Now taking a look at the bottom row, Turkish market. Bottom left box shows U.S. dollars against Turkish lira in 2020. We observed that Turkish lira depreciation has accelerated in the third quarter. Following a steady trend from May to July, lira depreciation was visible pretty much until the end of the quarter, summing up to almost 1 lira decrease from the start to the end of the third quarter.

Finally, we do have the Turkish fuel market data over the first 8 months on the bottom right side. As you may remember, we had shown the data of credit card payments in fuel stations provided from Central Bank of Turkey's data set as an indicator of fuel consumption going back to pre COVID levels in June, and continue to remain healthy in July onwards.

Now that the regulator has published the data for up to August, we can present the actual picture and confirm that indication was accurate indeed. With only 1% contraction versus last year, we can say that diesel consumption in Turkey is very resilient. Even during the most distressed period of COVID-19, its performance was still better than the others with the help of uninterrupted food and efficient goods transportation and overall logistics demand at time.

Moreover, diesel demand has been posting positive year-over-year growth since June on a monthly basis.

Gasoline demand has also been positive since July. With both seasonal and post lockdown dynamics as well as higher preference for personal vehicles. However, year-to-date growth of domestic gasoline demand was at negative 5.1% due to the contraction during April and May, which were peak of the lockdowns.

Jet fuel has also been growing on a monthly basis after hitting the bottom in April. However, despite the fact that domestic flights were almost back at last year's level, the recovery in jet fuel demand was lower, mainly due to lower number of international flights. Hence, domestic jet fuel demand has contracted by 56% in the first 8 months compared to the same period last year.

As an additional note, asphalt demand was also quite strong with highway and other infrastructure activities.

Let's take a look at Crack in comparison to the last year's third quarter on this page. Third quarter 2020 presented another weak Crack margin environment despite the easing of containment measures and the support of seasonal dynamics. Diesel Cracks were down by $11.1 per barrel compared to last year's third quarter and averaged at $4.5 per barrel in the third quarter of 2020. Diesel Cracks weakened in the third quarter, mostly due to elevated supply levels rather than a weakening in demand. The key factors behind elevated supply levels work, refineries applying swing cuts in their production and switching their jet fuel output to diesel as much as possible. This has resulted in elevated supply and compressed diesel Cracks.

In addition, contangos that were executed in the first half resulted in additional supply of diesel during this quarter as well, resulting in further imbalance between demand and supply.

Following the improvements in demand in Asia, diesel Crack began showing improvement in October and averaged around $4.3 per barrel. Jet fuel Cracks averaged at minus $2.10 per barrel in the third quarter of 2020 and posted an historical $18.1 per barrel decline compared to the same period of last year. The weakness of jet fuel Crack margins seen in the second quarter largely remained the same in the third quarter due to reduced number of flights volume. While showing slight improvement in July, jet fuel continued to worsen in August and September, due to weaker demand against supply in barrels.

With the improving demand in Asia, due to winter season and refineries going under maintenance in Europe, we have observed an improvement in jet cracks. In October, jet cracks has seen first positive level since April and reached $0.5 per barrel. Gasoline Cracks were down by $6.6 per barrel compared to last year's same period and averaged at $5.8 per barrel in the third quarter of 2020. The increased personal mobility with passenger cars and to supply disruption due to hurricanes in the Gulf Coast, were not enough to counterbalance the adverse effect of the outbreak on demand.

With easing of COVID-19 relates mobility constraints and the seasonal demand dynamics coming into play, gasoline cracks continued its gradual monthly incline throughout the third quarter, starting at $4.6 per barrel on average in July to reach $5.1 and $7.7 per barrel on average in August and September, respectively. With the seasonal demand support starting to disappear, gasoline Crack has been weakening lately and has averaged at around $6.6 per barrel in October.

Finally, high sulfur fuel oil Cracks averaged around minus $6.7 per barrel in the third quarter of 2020 and increased by nearly $5.8 per barrel compared to the last year same period. After reaching historic highs in the second quarter, HSFO Cracks continued to outperform strong in the third quarter, even outperformed against the peak of the last 5 years despite the IMO 2020 driven demand loss.

There were a number of factors behind the strength of HSFO Cracks, including decreased availability of heavier crude grades due to affect a production cut, which reduced overall HSFO output. Lower high-sulfur fuel oil supply with run cuts into refinery due to COVID-19 and additional demand to be used as conversion feedstock and as replacement fuel for power generation. This strong HSFO footprint has also been going into fourth quarter so far, and HSFO cracks averaged at minus $3.8 per barrel in October.

Moving over to the crude price financials. The second quarter was surprisingly favorable in terms of heavy crude differentials. This was mainly on the back of the unsuccessful meeting of OPEC+ on March 5, followed by the increased heavy crude availability triggering big discounts. Eventually, OPEC+ members have reached to an agreement on reducing their productions by a significant amount, starting as of May. This decision resulted in a reversing of the wide differentials offered in April and May. Hence, June and July, the financials became dramatically narrower. Then the initial cut was extended and that the amount of heavy grade was kept out of market for an additional month as well.

With the reduction of the total production cut amount starting as of August, the heavy crude supply availability started to increase again in later third quarter.

As a follow-up to this change in supply, OSP announcements for September were wider around $2 per barrel compared to August, and differentials have been gradually improving since then.

In summary, third quarter had faced a challenging differential environment after a quite supportive period in the second quarter. The trend seems to be reversing once again, considering the gradual widening pattern that has been observed in July. However, the differentials are still quite narrow with respect to long-term levels in general.

Looking forward, we continue to believe the outlook for healthy financial will remain volatile and will be set in accordance with level of global demand recovery as well as supply cut decisions by the major suppliers.

Now let's take a look at Tupras operations in the production volume. On the left-hand side, you can see our production numbers. Our total production in the third quarter was around 6.4 million tons. And with that, our total production in the first 9 months sums up to 17.3 million tons. The quarter-over-quarter increase in production was mainly driven by reopening following the heavy lockdown period and supportive seasonal dynamics, leading to a recovery in domestic demand. Consequently, the operations in Izmir refinery was reinstated at the beginning of July, in line with the disclosed time line.

Due to ongoing production optimization plan, our production amount remains below last year's same period. In the third quarter of 2020, our total crude destination capacity utilization was 80%. And other feedstock capacity utilization was at 9%, reaching to 89% for the whole system. All in all, our capacity utilization in the first 9 months was realized at 71%, which is slightly above our current full year guidance range of 75% to 80%.

Moving over to the sales. Let's start with the chart on the left-hand side. We generated total sales of 6.7 million tons in the third quarter of 2020. Adverse effect of the COVID-19 outbreak was higher on export volume compared to domestic sales.

In the first 9 months, our domestic sales and exports reached to 14.7 million and 3.5 million tons, respectively. Summing up to 8.2 million tons in total. As you can see from the chart on the right, which presents the domestic sales of the selected products, jet fuel was the most severely affected product in line with expectations. However, the decline in domestic jet fuel sales was mostly offset by higher diesel, gasoline and bitumen sales. Pulling domestic sales on the back of robust recovery in mobility and infrastructural activity.

Now let's move over to the financials. Let's start with the refining margin developments on this slide. During the third quarter of 2020, Mediterranean refining margin decreased by $5.2 per barrel compared to third quarter of 2019 and settled at negative minus $9 per barrel. This is the lowest quarterly average for the Mediterranean refining margin for more than a decade.

Weakness in steel -- weakness in mid-distillate and gasoline crack margins were the main factors behind the decline in net margin despite stronger high-sulfur fuel oil margins.

Tupras net refinery margin realized a $2.1 per barrel in the third quarter of 2020. The decline compared to last year's same period was driven by the historically weak Crack margin environment and very narrow differentials in spite of nearly $4.4 per barrel positive contribution from the inventory effect compared to the third quarter of 2019.

Now let's take a look at the P&L items for the third quarter of 2020. Our revenues decreased by 27% to around TRY 17 billion. This was mostly due to a 31% decline in average Brent price and 15% decline in sales volume as well as weak Crack environment.

Our COGS also dropped by 28% with the decrease in Brent price and at around 1 million tons of lower production. Negatives from weaker cracks and narrower differentials were largely offset by the substantial inventory gain. As a result, our gross profit increased slightly by 3% and materialized at TRY 1.19 billion in the third quarter of 2020.

Our operational expenses increased by 11%, mainly due to Turkish lira depreciation and inflation effect. Due to Turkish lira depreciation around TRY 0.97 million in the quarter, the most from other operations materialized at minus TRY 492 million versus minus TRY 92 million in the third quarter of 2019. We have recorded TRY 78 million positive contribution from equity investments, which is dominantly OPEC. This was mainly on the back of the inventory gain and normalization trend in domestic demand.

Our net financial expenses were down by 2% compared to third quarter 2019. In details, although we had FX losses due to depreciation in Turkish lira in the third quarter of 2020 compared to the appreciation in the last year's same period. We have counterbalanced this growth in FX losses with the gains in derivatives. As you can observe from the table, we have recorded negative TRY 556 million of profit before tax in the third quarter of 2020. Below profit before tax, we have recorded some gains stemming from the taxes carry forward, which could be driven to TRY 136 million to reach to the bottom line of negative TRY 420 million in the third quarter of 2020.

Now for EBITDA. Our EBITDA CCS materialized at negative TRY 463 million due to weak operating environment in third quarter. We have recorded around TRY 1.439 million of positive inventory effect due to the recovery trend in Brent price. With the help of this inventory gain, our reported EBITDA materialized at TRY 977 million, which is 2% above last year's same period.

Now let's take a look at the profit before tax bridge. As you can see from the waterfall chart, we had a sizable positive contribution from the inventory effect in the third quarter of 2020 compared to the same period of last year when we had a negative inventory effect. However, this upbeat support was more than offset by a number of negating factors. First, due to the ongoing COVID-19 related drivers, discussed earlier, Crack margins were extremely weak. The average Crack margin has declined by around $4 per barrel in the third quarter of 2020 compared to the same period last year. In addition, differentials were also narrowed, damaging to operational profitability further. Considerable amount of Turkish lira depreciation against last year's appreciation led to a negative delta in FX impact. Lower production with respect to last year was also another unsupportive factor.

All in all, third quarter profit before taxes materialized as a negative TRY 556 million.

Now let's take a look at the financial highlights. In third quarter, our EBITDA was realized at TRY 977 million but summing up to TRY 163 million in the first 9 months of 2020. We have a net loss of minus TRY 420 million in the third quarter of 2020. This brings our net loss for the first 9 months to TRY 2.9 billion. Due to weak EBITDA, net debt-to-EBITDA ratio inclined quarter-over-quarter to 19.7x from 12.5x. We would like to remind you that 2020 has shown quite unprecedented developments in our sector, and there are several outcomes that happened As a result of these developments that we have discussed in the earlier part of the presentation, our EBITDA is weakened in this extraordinary environment. This development creates a skewed book into our gearing ratio as well. Our current ratio is at 1.1x, in line with the last 5 years. And on the bottom right panel, we have the ROE due to negative bottom line, our rolling ROE materialized at minus 24%.

Let's continue with the details of our balance sheet. Let's take a look at the top row first. Our cash and cash equivalents and financial liabilities at the end of the third quarter 2020 was TRY 11 billion and TRY 29 billion, respectively. Net debt is TRY 17.8 billion as of the third quarter of 2020. The key reason behind the elevated net debt is the additional funding requirement for working capital. As you may see from the redemption schedule on the right-hand side, the majority of our short-term debt is in TL terms.

During the last 2 quarters, we have renegotiated some of our short-term loans to reset interest rates to NIM lower levels and extend maturities. These actions will help us incur lower interest expenses in due course.

On the bottom left, working capital requirements stood at TRY 2.6 billion, with an increase with respect to the second quarter of 2020. As we have guided before, what we're seeing in working capital is normal under the current environment that we operate in. There are no fundamental changes in our payables, receivables or inventory turnover structures, but due to increased inventory amount following the reopening of Izmit in July, improvements in Brent prices and depreciation in Turkish lira, our inventory amount increased.

We have foreseen this development in the second quarter and bring necessary funding from the market to fund working capital at an early stage before the rates have gone up.

Regarding our FX exposure management policy, due to the recovery in Brent prices, our inventory amount increased to USD 933 million from USD 752 million in the second quarter. Our hard currency cash position is at USD 1.08 billion in the third quarter. Together with our TL cash reserves, it sums up to USD 1.4 billion of total cash position. If you take a look at from a liquidity standpoint, we continue to employ strict FX exposure management policies, which targets to close, which targets a close position at period end.

Before we head into 2020 expectations, let's compare current status versus targets as of the first 9 months end. We have a net refining margin target at around $1 per barrel for 2020 full year. 9 months performance is above that at $1.5 per barrel. Net defining margin was at negative $0.2 per barrel in the first 9 months of 2020 also above our full year guidance at around negative $0.50 per barrel. Our capacity utilization was at 80.9% for the first 9 months. It was slightly above the full year guidance range of 75% to 80%. We have produced 18.2 million tons and sold 17.3 million tons in the first 9 months of 2020 against our existing full year guidance of 22 million tons of production and about 23 million tons of sales. Our refining only CapEx target is about USD 115 million for 2020. Whereas we spent USD 69 million for refining investments in the first 9 months. We have also spent around $30 million in the same period for the investments in our shipping and railway subsidiaries, summing up to around USD 100 million of total CapEx in the first 9 months of 2020.

Now looking at the maintenance calendar for 2020, you might notice a few changes. Due to extraordinary environment that we currently operate in, our maintenance schedule is frequently reviewed. And if needed, updated based on the requirements of the operational plan. COVID '19 related safety measures play a certain role in our planning as well. The maintenance activity of U-4000 FCC, which has been postponed to 2021 was advanced to fourth quarter of 2020.

Additional maintenance activity was planned for Batman's PLT 100/1100 Crude Oil and Vaccum distillates. Brief maintenance activity is planned for Izmit's plant 5 Crude Oil and Vacuum distillate and plant 47 hydrocracker units. Some additional maintenance activities planned for planned 100 and plant 1100 Crude Oil and Vaccum distillate units in Batman. It will begin towards the end of the quarter and is expected to continue in the early days of 2020 as well.

Finally, plant 147 hydro cracker has gone through a brief upkeep in October as well. All in all, we are trying to optimize maintenance Cracks and overall demand in the market to reach the most optimal solution. Due to uncertainties placed by COVID-19, we might revise the schedule more frequently during this term.

We would like to remind that we are providing the table with details in order to increase awareness and provide further information, given the ongoing uncertainties related to COVID-19, there could be changes in our maintenance schedules.

Now on this slide, we have our 2020 expectations. As you may recall, we have disclosed the revision about a month ago. Our expectations were revised down due to the ongoing negative impact of the outbreak, particularly due to the deterioration in crack margins as the global oil product stocks piled up dramatically.

Let's take a look at the details of our current estimates for 2020. We expect met complex refining margin to average around negative $0.5 per barrel in 2020. The we expect Ural-Brent to be slightly better compared to 2019, but jet fuel and diesel crack margins to remain weak. We expect Tupras net refining margin to materialize at around $1 per barrel in 2020. We call for mid-distillates in Crack margins and relatively resilient business, strong HSFO Cracks are the main assumptions. We expect at around 22 million tons of production and 23 million tons of sales, with a 75% to 80% capacity utilization accordingly. We target about USD 115 million of refining only CapEx for 2020.

Thank you for listening to me