Turkiye Petrol Rafinerileri AS

IST:TUPRS.E

Earnings Call Transcript 2019-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. I am Gitty, your Chorus Call operator. Welcome and thank you for joining the Tüpras Conference Call to present and discuss the 2019 fourth quarter 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 Tüpras headquarters, and welcome to our teleconference. I am Levent Bayar, Head of Investor Relations for Tüpras. 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 fourth quarter of 2019, then we will continue with the Q&A session.

Now I will 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 fourth quarter of 2019, and we'll go into detail for each subject on the following slides. We will begin with an overview of the market environment during the fourth quarter of 2019. We cover this section in 2 main components: that's developments in global oil market and developments in Turkish market.

Let's start with the top left part. During the final quarter of 2019, right ahead of the IMO 2020 implementation, high-sulfur fuel oil crack margins decreased by almost $22 per barrel with respect to fourth quarter of 2018. The long-expected IMO impact on mid-distillates was largely offset by the global demand weakness and the excess capacity available during second half of -- fourth quarter of 2019. Combined with the relatively high basis from the previous year, this led to a tightening in diesel and jet crack margins by around $2 to $3 per barrel. Finally, gasoline crack was stronger compared to previous year's last quarter. However, one should remember that fourth quarter of 2019 had set a very low base for gasoline.

In numbers, diesel and jet fuel cracks were down by $2.3 and $2.7 per barrel, respectively, compared to last year's same period. High-sulfur fuel oil, as the worst performer among all, decreased by $21.8 per barrel with respect to fourth quarter of 2018. Gasoline was up by $3.8 per barrel.

In the top right part, we see Brent price development per barrel. During fourth quarter of 2019, Brent price gradually increased on the back of: First, OPEC's decision to extend supply cuts; second, expectations on the Phase 1 of the trade deal between United States and China; and third, the escalating political risks in the Middle East. By following this upward trend, Brent price posted a 2% increase compared to the third quarter of 2019 on average.

Now taking a look at the bottom row, Turkish market. Bottom-left part shows us U.S. dollars versus Turkish lira in the fourth quarter of 2019. This shows the somewhat sideways trend during most of the quarters to finally close with a step-up towards the end, thus summing up to a TRY 0.28 depreciation during the whole quarter.

We do have the Turkish fuel market data at the right-hand -- at the bottom right-hand for the first 11 months of 2019. Even though diesel demand in the first 6 months has contracted by 7.5% compared to last year, the positive figures in the second half of 2019 led to a significant recovery, ending the first 11 months with a 1.6% contraction only. This progress can be attributed to relatively improved economic activity, followed by sequential rate cuts and overall normalization. On jet fuel side, we see that growth in consumption remains quite robust with healthy aviation demand in Turkey.

Now let's take a look at the highlights of the quarter for Tüpras. In 2019, we had a significant operational objective of completing the periodic maintenance of RUP unit. Despite missing volumes because of the maintenance period, we have reached 98% capacity utilization for the whole year, and we were able to meet our capacity guidance range of 95% to 100%.

Global freight rates increased as a result of political developments, including sanctions on Chinese shipping companies and IMO 2020 during the fourth quarter. As you can see from the chart in the middle, with this impact, CIF-FOB spread widened. This outcome has supported our competitiveness against importers while also improving our inland premium.

The last chart on the right-hand side, we have pricing data for asphalt and HSFO. These 2 products have been historically in a close relationship in terms of pricing due to both being bottom-of-the-barrel products. With IMO-related pricing pressure on high-sulfur fuel oil, there has been an ongoing discussion about the pricing of asphalt and potential negative impact of this on Tsüpras' financials. Due to strong asphalt demand regionally with new infrastructure projects, particularly in Africa and increasing trend by refineries to reduce their black yield, we have been observing their demand-supply imbalance lately. As a result of this, we have witnessed the decoupling between high-sulfur fuel oil and asphalt cracks throughout the fourth quarter of 2019, and we continue to see this trend in the first quarter of this year as well. This premium of asphalt over high-sulfur fuel oil has provided a cushion for Tüpras given the fact that majority of our black yielded asphalt at around 12%.

Regarding market placement, we continue to employ the new capabilities that we have developed in 2019 for exporting bitumen, and we have exported around 800,000 tons in 2019 in total. One can also expect a revival in Turkish domestic asphalt demand with sequential rate cuts that have been applied in 2019.

Now let's summarize what we have achieved in the fourth quarter of 2019 in numbers. We have produced 6.9 million tons of total crude and other feedstock, sold about 7 million tons of refined products and generated around TRY 738 million of EBITDA.

Now let's take a look at the crude oil and refining market development on the following 2 slides. Diesel cracks averaged at $14.5 per barrel in the fourth quarter of 2019. The cracks have been quite strong in October and first half of November. But as a result of the capacity overload after the return of refineries back to operation and the ramp-up of the new additions, there has been a sizable diesel supply addition. Furthermore, diesel demand was restrained by the milder weather conditions compared to seasonal norms in Asia and Europe, combined with the ongoing concerns on global economic activity. As a result, both supply and demand drivers have largely offset the long-awaited IMO 2020 boost expected for diesel. Compared to fourth quarter of 2014, diesel cracks were down by 13% due to not only current supply and demand dynamics but also a result of high basis from the last year.

Jet fuel cracks posted an approximately 17% decline, averaging at $13.1 per barrel in the fourth quarter of 2019. As a sister product to diesel, jet was also affected by a similar set of dynamics. However, weakness in Asian aviation consumption and additional vulnerability of jet demand to warm winter resulted in high exports to Europe and have challenged jet crack margins even further.

Gasoline cracks were up by 82% compared to last year's same period and averaged at $8.5 per barrel in the fourth quarter of 2019. After historical lows in fourth quarter of 2018 and continued weakness in the first half of 2019, gasoline had made its way back to average levels with the beginning of driving season. The unexpected production disruption in Philadelphia and Europe have supported gasoline cracks further in the third quarter of 2019. With the support of several factors, including FCC utilizations to produce very low sulfur fuel oil, passenger car demand driven by milder winter conditions and maintenance activities in some of the refineries, gasoline crack margins resulted in outperformance with respect to a weaker basis of the fourth quarter of 2018.

Finally, high-sulfur fuel oil cracks decreased by around $21.8 per barrel compared to fourth quarter of 2018 and averaged around minus $29 per barrel in the fourth quarter of 2019. High-sulfur fuel oil crack margins have been continuously falling since July, and this trend has become even steeper in the fourth quarter of 2019, as demand for marine consumption shrank because of IMO 2020 regulation preparations.

Now taking a look at what we have seen so far in 2020. High-sulfur fuel oil crack margin seems to be partially recovering to October levels around $22 per barrel. This is mostly on the back of the low supply with lighter crude slate decisions of refineries globally and scrubber-related demand pickup. Slowing down global economy and increasing exports to Europe from both U.S.A. and Asia continues to cap European mid-distillate cracks. Coronavirus has become an increasing concern lately, in particular, for jet. The novel virus has compressed the jet cracks, particularly in Asia, as both domestic and international aviation activities were curtailed, leading to an approximately 1 million barrels per day decline in global jet demand according to some market reports. Gasoline continues to -- continued its relatively healthy performance after the end of fourth quarter driven by warm weather and ongoing very low sulfur fuel oil-related production.

Moving over to the crude price differentials. In the fourth quarter of 2019, on a simple average basis, heavy crude price differentials to Brent were wider around $1 per barrel with respect to the previous quarter of 2019. This improvement, which have been more visible towards the end of the quarter, was mainly on the back of crude supply decisions influenced by IMO 2020. Simple refineries started switching to lighter crude in order to reduce their black product yield and limit damage from weaker high-sulfur fuel oil crack margins. Despite the initial positive contribution of IMO so far, differentials have not recovered to levels of previous years since a significant part of heavy crude supply continues to be unavailable globally.

The expansion of OPEC cut into second half of 2019, overcompliance to this decision by the number of producers, continuation of sanctions on Iran and Venezuela, maintained the shrinkage of heavy crude supply globally. All of these factors have led to about 4 million to 4.5 million barrel per day drop in heavy crude supply which is around 15% of total OPEC 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. Regarding supply, we believe setting a clear outlook is challenging, given the fact that there are uncertainties around impact of coronavirus on crude slate decisions, outlook for global economic activity and ongoing turmoil in geopolitics.

Now let's take a look at Tüpras' operations, starting with production volumes. On the left-hand side graph, you can see our production numbers. Our total production in the fourth quarter was 6.9 million tons, summing up to 28.1 million tons for the whole year of 2019. This is in line with our total annual production guidance of around 28 million tons. In the fourth quarter of 2019, our total crude utilization was 87%. And other feedstock capacity utilization was at 9%, reaching to 96% for the whole system. With all major maintenances completed, we were able to perform at a higher level. For the full year, our capacity utilization in 2019 is materialized at 97.8%, at about 2 percentage points above last year's same period and closer to the upper end of our guidance range for 2019, which was 95% to 100%.

Moving over to the sales. Let's start with the chart on the left-hand side. We generated total sales of 7 million tons in the fourth quarter of 2019. Our exports are almost 13% above last year's same period, driven mainly by bitumen and distillates. With the excessive demand in Turkey disappearing gradually in 2019, we have reduced our imports and focused on sales from our own production. As a result, our domestic sales show a decline compared to last year at around 800,000 tons. Total annual sales amount for 2019 was realized at 29.2 million tons, largely in line with our sales guidance 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 fourth quarter of 2019, Mediterranean complex refining margin decreased by $6.6 per barrel compared to fourth quarter of 2018 and settled at minus $1.9 per barrel. This was mainly due to sharply falling high-sulfur fuel oil cracks and narrower oil/Brent differentials. Tüpras' net refining margin was materialized at $3.6 per barrel in the fourth quarter of 2019. The decline compared to last year's same period was mainly due to around $1.5 per barrel narrower differentials, around $3.50 per barrel lower average crack margins and other OpEx, which was elevated with gas price hikes and other OpEx adjustments throughout 2019. Despite all the unfavorable conditions, Tüpras' net refining margin was $5.5 per barrel above Med margin, with the help of higher white product yield and more advantageous crude slate.

Now let's take a look at the P&L items for the fourth quarter of 2019. Our revenue decreased by 13% to around TRY 22 billion. This was mostly on the back of 7% drop in Brent price and 8% decrease in sales volumes. Similarly, our cost of goods sold also dropped by 10% with the decrease in Brent price. Due to weaker crack margins, narrower differentials and escalated energy expenses, our gross profit generation was adversely affected. It has declined by around 47% and realized at around TRY 1.1 billion.

Our operational expenses increased by 23%, mainly due to Turkish lira depreciation compared to fourth quarter of 2018 and the inflation adjustments to Turkish lira-based costs. Due to Turkish lira depreciation around TRY 0.28, the loss from other operations materialized at minus TRY 464 million compared to a positive TRY 1.6 billion last year's same period, while lira was appreciating.

Regarding financial expenses, our net financial expenses improved by around TRY 1 billion in the fourth quarter of 2019 compared to the same period of last year. The key factors driving this improvement were lower net interest expenses due to our switch to Turkish lira-based deposits with better rates and lower FX losses due to ongoing stringent FX management and lower lira depreciation. As you can observe from the table, we have recorded negative TRY 439 million of profit before tax in the fourth quarter of 2019. Below profit before tax, we have recorded about TRY 400 million positive impact from tax revaluation gain based on the revaluation gains related to the deferred tax assets in our balance sheet.

As you know, we have recorded around TRY 1.1 billion loss in our statutory books. This was due to shorter depreciation period of the statutory accounting regime and tax revaluation gain excluded from these accounts. This TRY 1.1 billion of loss allowed us to classify an amount of TRY 248 million as tax loss carryforward, i.e., tax to be excluded from future earnings. With this positive impact to our bottom line, our bottom line materialized at TRY 186 million for the fourth quarter of 2019.

Now if we take a quick look at 2019 as a whole year. Our revenues were flat as 17% depreciation in Turkish lira was counterbalanced with 9% drop in Brent prices and around $1 per barrel drop in cracks. Due to much narrower differentials, weaker cracks and elevated gas costs, our gross profit nearly halved and amounted to TRY 4.8 billion. 2019 limited Turkish lira depreciation resulted in lower losses at our other operational income level. Our net financial expenses were mostly flat, excluding elevation in our interest expenses in the first half of 2019. As a result, our net income decreased substantially to TRY 526 million versus TRY 3.7 billion last year.

Now as you have seen from our accompanying disclosure, our Board of Directors announced their decision to propose no cash dividend payment out of 2019 earnings. The underlying reason for that is, first, regulation-wise, as a listed Turkish company, we need to base our dividend payment on the lower of the 2 set of accounts, which is TRY 1.1 billion net loss, in our case, in 2019 under our statutory accounts. Second, we would like to have a prudent approach and decided not to pay dividends this year.

Now for EBITDA. Our reported EBITDA materialized at TRY 738 million in the fourth quarter of 2019. We have recorded TRY 89 million negative inventory effect due to offsetting impact of our inventory hedging policy, which kept the potential gains that we would have recorded from the increase in Brent towards the end of the quarter. We would like to remind you that this mechanism worked in our benefit to last year's fourth quarter when Brent dropped from $65 to $54 per barrel. When we deduct this inventory loss from reported EBITDA, we reached TRY 827 million of clean EBITDA or EBITDA CCS in the fourth quarter of 2019.

Now let's take a look at the profit before tax bridge for the fourth quarter. As you can see, the decline in profit before tax over the fourth quarter of 2018 was mainly driven by weaker cracks in the fourth quarter, narrower differentials and FX, with the second and third sharing most of the significant impacts. Compared to fourth quarter of last year, except for gasoline, all main product cracks were weaker, with high-sulfur fuel oil posting the most significant effect. With a weighted average margin drop of around $3.5 per barrel, we recorded negative TRY 1.1 billion impact. Due to $1 to $1.5 per barrel narrower heavy crude differential, we recorded TRY 528 million negative impact from differentials.

Higher natural gas prices covered the majority of the elevated operational expenses in the fourth quarter of 2019 compared to the same period of last year, totaling at around TRY 207 million negative impact. The trend of the Brent price was at the opposite direction of last year's same period, and our inventory impact delta, i.e., the sizable inventory loss last year against limited loss in this year, has resulted in a positive TRY 208 million of positive inventory effect on our bridge.

With Turkish lira depreciation-related FX losses happening in this year's fourth quarter against the appreciation that we have observed in the fourth quarter of 2018 and the following related FX gains, we recorded minus TRY 921 million negative impact difference from FX gains. Combination of these 2 effects resulted in a negative impact of TRY 713 million. All in all, fourth quarter of 2019 profit before tax was materialized at negative TRY 439 million.

Now let's take a quick look at 2019 full year profit before tax bridge. As you expect, biggest negative impact arise from narrower differentials in 2019. That's around $1.5 per barrel worse compared to 2018 due to the supply-related issues that we have discussed earlier. The cumulative impact of this change is around minus TRY 1.7 billion. Cracks were also weaker on a weighted average basis at around $1 per barrel compared to 2018. This was mostly driven by high-sulfur fuel oil-related weakening in the second half of the year. Higher natural gas prices covered the majority of the elevated energy costs that we have incurred in 2019 with an amount of minus TRY 912 million.

As you know, we have disclosed around USD 100 million EBITDA loss from RUP periodic maintenance in first half, which was completed in 75 days. This maintenance period has resulted around TRY 587 million of negative impact for the whole year. With much limited TL depreciation in 2019 against 2018, we have recorded about TRY 2.3 billion less FX loss in 2019. But accordingly, our inventory gain was much more limited as well, resulting in a TRY 2.5 billion less inventory gain in 2019. Combination of these 2 effects resulted in a negative impact of minus TRY 198 million. Needless to remind, the offsetting nature of these 2 items remind the efficiently running FX-based pricing mechanism of Tüpras and successful implementation of our natural hedge mechanism. All factors combined, 2019 profit before tax was materialized at negative TRY 311 million.

Now let's take a look at the financial highlights. Our EBITDA was realized at TRY 738 million in the fourth quarter of 2019. This brings reported EBITDA to TRY 4.039 billion for the whole 2019. We have a net income of TRY 186 million in the fourth quarter of 2019 and a total of TRY 526 million net income for the whole year. Despite ongoing deleveraging, our net debt-to-EBITDA ratio climbed to 2.1x from 1.3x in 2018 as a result of weaker EBITDA. Finally, due to weaker bottom line, our rolling return on equity materialized at 5%.

Let's continue with the details of our balance sheet. Our cash and cash equivalents and financial liabilities at the end of 2019 was TRY 10.7 billion and TRY 19.1 billion, respectively. This has reduced our net debt to TRY 8.4 billion as of the end of 2019. This indicates an ongoing deleveraging despite the challenges we have faced throughout 2019 on operational profitability. The short-term portion of our financial borrowings was TRY 5.2 billion, as you can see from the top right box. Around TRY 3.4 billion out of that TRY 5.2 billion was short-term portion of our long-term borrowings. As you can see from the redemption schedule, majority of our late long-term financial debt consists of our USD 700 million eurobond, which has a fixed 4.5% interest rate.

Working capital requirements stood at a negative TRY 3.6 billion, mainly because of reduced receivables, normalized payables and optimal inventory management throughout 2019.

Let's move to our FX exposure management slide. Regarding our FX exposure management policy, we have opted to increase the share of Turkish lira deposits during the fourth quarter of 2019, similar to what we have did in the third quarter. This was done in order 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 fourth quarter of 2019. The forward rates that we employed were cheaper compared to the spread between Turkish lira loans and U.S. dollar deposit rates in the fourth quarter of 2019. In addition to that, we used the additional Turkish lira cash at better Turkish lira deposit market rates with longer maturities. Following latest rate cuts, current Turkish lira market deposit rates are around 9.9%, which impy around 250 basis point gain for Tüpras.

Before we head into 2020 expectations, we would like to sum up the developments of 2019. At Tüpras, we had a net refining margin of $3.7 per barrel in 2019, landing slightly below of our full year guidance range of $4 to $4.5 per barrel. Net refining margin was at $1.7 per barrel, below our guidance range due to very weak HSFO cracks and narrowing differentials.

Our capacity utilization was at 97.8% for the whole year, closer to the higher end of our guidance range of 95% to 100%. With this capacity utilization, we have produced 28.1 million tons of products and sold about 29.2 million tons of products against our guidance of 28 million tons -- at around 28 million tons of production and at around 30 million tons of sales. Our refining-only CapEx guidance was USD 150 million, whereas we spent USD 157 million for refining investments in 2019. Our consolidated CapEx was materialized at USD 236 million, which includes our investments in our railway and shipping subsidiaries as well.

Looking at the maintenance calendar for 2020. Since majority of the big periodic maintenances are completed in 2018 and 2019, our calendar is pretty light for 2020. Maintenance in our crude unit is located in our smallest refinery, Batman. And majority of the maintenances in Izmir are related to our gasoline production capable units. As a result of this, we do not expect a material change in our processing and conversion capabilities during these maintenances.

Now finally, on this slide, we have our 2020 expectations. As you may recall, Med refining margin was materialized at $1.7 per barrel in 2019. Although HSFO is considerably weaker compared to 2019 average, with the widening oil/Brent differential, we expect $1.5 to $2.5 per barrel Med refining margin in 2020. Regarding product margins, we expect an upward trend in mid-distillates in 2020, flattish gasoline. We expect high-sulfur fuel oil to remain weak versus 2019 on an average basis. We do expect heavy crude differentials to widen compared to 2019.

When we sum up the effects of these developments, we reach a net refining margin target range of $4.5 to $5.5 per barrel in 2020 for Tüpras. Since 2020 will be a maintenance-light year, we do not expect any sizable change to our production plan. And as a result, we target around 28 million tons of production.

As a result of this, our capacity utilization target is 95% to 100% for 2020. Our sales target is around 29 million tons.

For CapEx, we target USD 200 million refining-only CapEx for 2020. This is composed of some improvement projects such as sulfur treatment units and tanks.

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