S-Oil Corp

KRX:010950

Earnings Call Transcript 2024-Q1

[Unknown Executive]

Good morning. This is S-Oil Treasurer, [ KD Kong ]. Let me first thank all the investors and analysts in and out of Korea for joining the conference call for S-Oil's Q1 2024 earnings release.

I am joined by CFO, J.W. Bang; IR team leader, J.W. Ahn; and the team members.

I will first share Q1 performance highlights.

In Q1 2024, the company recorded KRW 454.1 billion in operating income, which is a turnaround from the previous quarter and a major jump driven by higher refining margin and oil price.

Q1 refining margin was higher than the previous quarter, thanks to healthy demand for fuel products and tight supply from global refining companies. One-off inventory-related impact tied to oil price was around minus KRW 140 billion in Q4 2023, but it recorded roughly KRW 20 billion last quarter, which means its impact on Q1 incoming gain is almost neutral.

As accounting standard requires inventory valuation to be based on the lower of manufacturing cost and market value, we believe positive inventory impact from oil price increase in Q1 will be divided in Q1 and Q2, and subsequently be reflected in the performance of both quarters.

Next is outlook. This year, we are forecasting solid demand growth for oil around the world. Average oil demand growth forecast for this year by major institutions is between 1.5 million to 1.7 million bd, which is above the 3-year average of 1.3 million bd just before the pandemic.

Global transportation fuel inventory, on the other hand, fell to the lower side of the historic range. This suggests that refining margin will further pick up when summer driving season and air travel season come close and positively impact demand for transportation fuel.

We also forecast a seasonal upturn for PX, which is our key petrochemical and lube base oil in Q2 or Q3.

I will now share the updates on the company's renewable fuel and circular chemical business as well as established green initiatives to respond to the future energy transition trend and, accordingly said, greenhouse gas reduction, chemical expansion and eco-friendly energy business as our major strategic directions.

It is to this end that we started coprocessing of bio feedstocks, which has used cooking oil and waste plastic oil in our existing refining facilities to produce renewable fuel and circular chemicals whose demand is forecasted to grow in the longer term.

We also acquired 3 ISCC certificates, which is an international certification for sustainability and low-carbon products. Among the 3 ISCC CORSIA certificate, which is the international certification for sustainable aviation fuel, it is the first of its kind in the Korean refining industry. We plan to gradually expand coprocessing business in the short to midterm. In the longer term, we are reviewing an option to build a dedicated plant for SAF.

Finally, allow me to briefly go over the progress of Shaheen Project. The company is executing Shaheen Project with a goal to prepare for energy transition and raise our corporate value in the longer term. The project is cruising according to the plan with 75.4% progress rate of site preparation work and 22.4% of EPC work as of the end of March. We will push ourselves to successfully deliver the project to boost the company's shareholder value in the longer term.

I will now turn over the mic to team leader, J.W. Ahn, for Q1 performance and the rest.

[J.W. Ahn, executive]

Good morning. This is S-Oil IR team leader, J.W. Ahn. And before earnings release, please be advised that financial results for Q1 2024 are provisional and subject to change according to outside independent auditors' audit. Allow me to first touch on Q1 2024 performance and outlook.

First, Q1 2024 financial results are on Page 5. Q1 sales revenue dropped by 5.3% from the previous quarter to approximately KRW 9.3 trillion. International oil price went up in Q1, but quarterly average was slightly lower than that of Q4, and average sales price was a little lower as a result.

Q1 operating income recorded KRW 454.1 billion. This is a big jump from the previous quarter, which is attributable to the rise in refining margin and oil price. And for your information, inventory impact reflected in operating income is KRW 20.6 billion.

By business segment, refining business, which turned around, was the key performance driver; and petrochemical business also marked modest income growth. By contrast, lube base oil business segment's income fell from the previous quarter due to impact from the time lag between oil price and lube base oil price.

Q1 income before tax posted KRW 227.2 billion.

In finance and other income, we recorded KRW 175.5 billion in net FX loss, owing to $1 FX hike. To make sure that FX impact is neutralized in annual income before tax with a certain time lag, we have been running our unique FX risk management policy with consistency.

Next is the financial status. Cash as of end of Q1 2024 is KRW 1.63 trillion. It slightly dropped from the end of last year as oil price increase at the end of Q1 required more working capital.

Net debt to equity, at the end of the quarter, was 48.8%, which is a little higher than that of 2023. Although we have been facing high volatility in the external environment, we have full liquidity and stable financial structure needed to ensure uninterrupted execution of Shaheen Project.

And as for profitability indicators, annualized Q1 return on equity was 7.4%, and ROCE, 7.6%, respectively; and Q1 EBITDA was KRW 410 billion.

And next, I will go over to Q1 2024 market environment and Q2 outlook by business segment.

First is the refining business segment. In Q1, refining business marked KRW 250.4 billion in operating income, which jumped by KRW 561.7 billion from the previous quarter and turned around. Asian refining margin in Q1 recovered to a slight extent from the previous quarter. Bullish demand, coupled with supply disrupted by global refiners' T&I, facility troubles and geopolitical unrest were the key factors. T&I in the Middle East in the first 2 months of the year was bigger in scale than the previous years. From March, spring T&I started in refineries in China and Asia. And on top of this, a cold snap in the United States, drone attack against a Russian refining facility, and refining facility troubles in Japan, Malaysia, Thailand and Vietnam kept supply tight.

Q1 Singapore margin was $5 per barrel, which is $1 higher than the previous quarter. And also OSP of Saudi crude oil, which was treated in Q1, was lower than the previous quarter, giving a wider margin to the company as a result.

Dubai crude oil price jumped from $77.3 per barrel in December average to $84.2 per barrel in March average and substantially made up for the loss in the previous quarter.

OPEC+ is continuing output cut, and escalating geopolitical tension in the Middle East pushed up oil price.

And turning to Q2 outlook. While we go through the slow demand season in early to mid Q2, Asia refining margin is projected to stay calm and stable supported by regional T&Is and subsequent adjustment in supply. As we approach summer high season, we forecast demand to grow and refining margin to turn upward again.

This is spring T&I season in Asia, and many state-run Chinese refiners and big-sized independent ones will have their T&Is in April and May, both of which are forecasted to support refining margin. We expect the gasoline market to benefit from seasonal strength during the summer driving season, while global inventory level is low.

Jet fuel market is also forecasted to improve. This is based on the projection that air traffic will recover to the pre-pandemic level until 2025, and stockpiling demand for jet fuel will grow ahead of the summer high season.

More details on the outlook will be explained in key business updates with more concrete data.

Next is the petrochemical business segment. Q1 operating income in the petrochemical business segment went up from the previous quarter and posted KRW 48 billion. Spread of all chemicals like benzene, polypropylene, propylene oxide, other than PX, went up from the previous quarter. Inventory-related gain tied to oil price was a key contributor.

Starting with aromatics, PX spread in Q1 was sound at $341 per ton. The downstream polyester run rate stayed at a high level, except during the Lunar New Year holidays, but T&I of PX plants in Korea and Japan. And production troubles in major PX facilities in India adjusted supply and supported market conditions. Growth momentum of the spread, however, was limited by gasoline blending demand for aromatics, which was in a slightly low season.

Benzene spread in Q1 recorded $313 per ton and jumped significantly from $230 in the previous quarter. Shutdown of many benzene production facilities in the U.S. due to cold snap at the beginning of the year and higher demand for benzene import as refining and petrochemical facilities in the U.S. went into T&I were the key contributors.

In Q2, we are forecasting widened spread for PX and benzene for a number of reasons. Start-up of new PTA plants will create new demand, and aromatics for gasoline blending in summer is projected to be higher in demand. Supply side will also tighten up when PX plants in Northeast Asia enter into their planned T&I in April and May.

As for olefin downstream, PP and PO market rebounded in Q1. While downstream demand was slow, several factors limited supply. PP plants in the Middle East had T&I and PO plants in the Middle East and U.S. faced production troubles.

Downward pressure could persist by excess facilities in China in Q2 when market conditions could start to slowly rebound buoyed by China's economic stimulus policies.

The company's PP and PO use propylene in RFCC plant as feedstock, which is an operating unit that treats low-value HSFO to produce gasoline and propylene. This gives us outstanding cost competitiveness, which allows us to enjoy economics regardless of the generally slow petrochemical market and thus, keep our run rate relatively high.

Next is lube. Q1 operating income of lube base oil business marked KRW 155.7 billion, which was smaller than the previous quarter. Q1 spread slightly dipped from the previous quarter, largely because of a spike in oil price, which pushed up feedstock cost and time lag until it is translated into product price.

We forecast bullish lube base oil fundamentals in Q2 driven by high seasonal demand growth and T&Is of key global suppliers in Europe and Korea. Furthermore, India, which is the company's biggest lube base oil sales outlet volume-wise, is enjoying strong manufacturing activities, and we anticipate this will serve demand well.

Next is the key business updates. I will now briefly touch on transportation fuel demand, which remains strong. This year, global oil demand growth outlook moves in the range of 0.9 million bd to 2.2 million bd, and average outlook is around 1.5 million bd to 1.7 million bd. In particular, non-OECD countries like China, India and those in Southeast Asia, are forecasted to drive demand growth this year around transportation fuels like gasoline and jet fuel.

Gasoline is estimated to have seen 280,000 bd demand growth in Q1 compared to the previous quarter, thanks to firm demand in Asia and Europe. Even on an annual basis, we are expecting roughly 300,000 bd growth in demand. Gasoline inventory in the biggest consuming country, U.S., is down to the lowest end of historic range.

In 2023, gasoline market turned up when it entered into a high-demand season amid low inventory level. As driving season demand approaches from the mid-Q2 this year, we are anticipating high chances of bullish gasoline market.

As for kerosene and jet fuel, demand for heating fuel fell short of what we had expected due to warm weather in February. The demand for jet fuel steered the growth momentum driven by surge in travel demand during the Lunar Year holidays in China. We forecast jet fuel market to steadily drive recovery to pre-pandemic level until next year and provide additional engine to boost refining margin during the summer travel season.

Next is renewable fuel and circular chemical business. As demand for renewable fuel and circular chemicals is growing, the company is actively exploring opportunities to enter into and expand markets to supply low-carbon fuel products.

To accelerate market entry, we initiated co-processing to produce renewable fuel and circular chemicals like SAF and renewable diesel from bio feedstock and waste plastic oil in the existing refining facilities.

To elaborate further on our progress, we signed partnership with Samsung C&T in 2021 and DS Dansuk in 2023 to establish feedstock supply chain like ECO and palm oil. Last year, we earned government approval on regulatory sandbox to treat these feedstocks in the existing facilities.

In January this year, we treated the initial bio feedstock and waste plastic oil in our facilities and acquired 3 ISCC certificates, which are international certifications for eco-friendly products. This was in April. And in particular, ISCC CORSIA certified that we have satisfied SAF criteria as per IATA's carbon offsetting and reduction scheme, which is the first of its kind in the Korean refining industry. This means that ISCC EU certified the company that the company complied with EU's Renewable Energy Directive to sell renewable fuel in Europe. Also, ISCC PLUS is a voluntary certification that guarantees sustainability of products made with bio-based and waste-based feedstock.

During the remaining months of the year, the company will expand logistics facilities to treat feedstock and raise co-processing volume as well. Our goal is 150,000 tons of bio feedstock until 2023. In the longer term, we are also studying an option to build a dedicated plant for SAF. We will keep updating progress of the company's new low-carbon energy businesses and how they will perform.

This is the end of the presentation. Thank you.

[Operator]

[Foreign Language] [Operator Instructions] The first question will be given by Lee Jin-Myung from Shinhan Investment Securities.

[Jin-Myung Lee, analyst]

[Foreign Language] I am Lee Jin-Myung from Shinhan Investment Securities. I have two questions. Recently, the refining margin is being just corrected downward. Can you share the reason for the falling refining margin and the future outlook?

And my second question is about the increased export from China. Would you share your outlook for the future export volume related to its export quota and Chinese export volume?

[Unknown Executive]

[Foreign Language] Let me answer your first question on recently correcting downward refining margin and the future outlook. The main reason behind the recent adjusted downward refining margin is diesel spread, which adjusted downward from late March.

As for diesel, the product is passing through a raw season. And due to warm winter weather, inventory level in the EU went up slightly. And because of logistical risk in the Red Sea, less volume has moved toward EU from Asia. And this served as a downside factor for the falling diesel spread.

As for the future outlook, from May to June, the major demand outlets, which are China and India, will experience active agricultural and construction sector, which is expected to expand regional demand. On supply side, China is scheduled to have major T&I in April, and this will adjust the supply.

And overall, until the summer season, the strong demand for jet fuel is expected. So in terms of overall middle distillate, it will serve as a supporting factor.

In particular, after the mid-second quarter, gasoline is expected to be the rebound of refining margin. According to institutions' outlook, between January and April in 2024, market fundamental was tight compared to the last year.

As demand for gasoline is witnessed all over the regions evenly, and U.S. inventory of gasoline is low, we are expecting a strong summer high season-driven trends as we experienced in last years.

[Unknown Executive]

[Foreign Language] To answer your question on the export quota of light oil in China, Chinese government announced the first export quota for 2024, which amounted to 19 million tons. And that is similar with the first quota issued in 2023, which amounted to 18.99 million. As the first export quota is being exhausted, the second export quota is expected to be issued between late April and early May based on usual practice. And according to a major institutions outlook, the total export quota from China for entire year 2024 will be similar with that of 2023.

As for the volume outlook for China, as domestic demand is growing in China and heavy T&I is scheduled between April and May, actual export availability for major products such as gasoline, jet fuel and diesel will be limited. That! Concludes my answer.

[Operator]

[Foreign Language] The following question is by Lee Jin Ho from Mirae Asset Securities.

[Jin Ho Lee, analyst]

[Foreign Language] I am Lee Jin Ho from Mirae Asset Securities. I have three questions. My first question is on the emerging cooling technology. Recently, cooling technology is gaining attention because of AI and the data center. So the development of lube base oil for emerging cooling is an issue. So I want to know whether you have the related project ongoing.

And my second question is about aromatics spread, which is favorable these days. So do you expect any time that it will recover? And recently, PP and PO unit utilization rate was around 72% and 89%. Would you share your future outlook for utilization rates?

And my third question is about biojet fuel. During your presentation, you mentioned about the certified sustainable aviation fuel for the first time in Korea. Does that biojet fuel comes with better economics compared to traditional jet fuel?

[Unknown Executive]

[Foreign Language] About your first question of entering into the emerging cooling market, recently, a global emerging cooling market is gaining attention that utilizes LBO and additive for that technology. Because of the growth in the data center and ESS is projected, we are also considering emerging cooling markets based on our size of LBO facilities, and we are actively exploring business opportunity on that area.

We already came up with the test products that meets the requirements of each data center. And we are planning to verify the stable operation of the server and efficiencies of the server and energy saving throughout demonstration. And we are working on joint development with multiple partners for related technologies. When the adequate timing comes, we will share more details on this.

[Unknown Executive]

[Foreign Language] And let me answer your next question on the outlook of a petrochemical product. First, as for aromatic products, in the second quarter, PX market is expected to be supported by tight supply based on T&I schedule and the demand recovery driven by high season for gasoline and the operation of new PTA facilities in China.

Generally, in summer season, demand grows because of the consumption on the drinks and the clothings. And this will be supported by the demand of PET and PU. So the demand growth in downstream is expected. And an upset price, which was corrected downward, and the favorable demand for the middle distillate were serving as supportive factors for the market.

Let me add the outlook for benzene market. In the second quarter, mid- to large-sized NCCs are scheduled to have a heavy T&I in Northeast Asia region. And as summer season comes, aromatics to gasoline demand will go up. So the import demand of benzene in the U.S. will go up, and thereby, we are expecting a healthy market with benzene.

As for the PP and PO market outlook for the second quarter, because of the supply pressure caused by new capacity addition of downstream facilities and economic boost package, expectation for economic growth in China are forecast to improve the market sentiment.

Let me add some more explanation. The Chinese government announced a trade-in program for the vehicles and the consumer [ burst ] to boost domestic economy. And in detail, the central government of China will cooperate with a local government to help consumers replace their older vehicles and old home appliances with new ones with incentives.

As for the internal viewpoint from China, this type of policy will boost new demand, and that is amounted to almost KRW 40 trillion to KRW 100 trillion. So as a result, this will significantly improve GDP according to their outlook. Given the fact that most of the vehicles and home appliances are made of a compartment based on PP and PO, the demand for PP and PO is to improve a lot.

[Unknown Executive]

[Foreign Language] Let me add explanation on the utilization of PP and PO units. And we are running a PO process at maximum capacity based on our economics.

As for PP units, we set the utilization rate in a flexible manner considering economics. However, because of T&I, the utilization of the PP units was adjusted downwards slightly in November and December. In the first quarter, PP utilization rate was slightly improved compared to the second half of last year on average, and we may raise the throughput gradually considering the economics and the market situation later.

Lastly, let me add explanation on biojet fuel and economics of co-processing. The product price based on fossil fuel, I mean, the renewable fuel and the circular chemical products, price for them are higher than fossil fuel-based products. However, since we are at the very early stage of the market which will grow, we will consider demand and sales of premium and proceed this in a way to maximize economics.

As for the SAF plant construction, we are at the early stage of reviewing investment in that. And please understand that it's hard for us to share details such as a schedule, economics and the size of the investment at this stage. We will continuously consider the related law amendment and the sales of premium, and we will consider also market development and proceed with the business after securing economics. This concludes my answer.

[Operator]

[Foreign Language] The following question will be from Parsley Ong from JPMorgan.

[Rui Hua Ong, analyst]

I have three questions. The first one is, could you share with us the impact from Middle East tensions on your refining lubricants and chemicals divisions, respectively? So some positives and negatives, could you just give us some color?

The second question is, you mentioned earlier that your lubricant spread fell in first quarter and you are expecting it to improve in second quarter because the first quarter fall was due to lag oil price impact, could you share with us the extent of the recovery? Do you see potential for a recovery in the first half 2023 levels? And when do you expect that to be realized?

Third question is, if you look at your nonoperating expense, it was pretty high in the first quarter, so I guess this is a combination of your FX losses and interest expense. For interest expense, given global interest rates have been rising, could you share with us your effective interest rate now and your future outlook and expectation on the interest expense? And then for your FX losses in second quarter, do you expect it to narrow?

[Unknown Executive]

[Foreign Language] On your first question about the impact of the geopolitical tension in Middle East and the company, there are uncertainties around the political situation in the Middle East and that affects international crude market. However, most of the company's export is taking place within the region. So despite this geopolitical conflict, impact of this on our sales is expected to be limited.

And if we refer to the current situation shortly, tension in the Middle East is not growing further given the current status of Iran and Israel. And the further worsening of the war, the chances for that is evaluated to be low. So we believe that no impact from the Middle East tension will be on our crude supply and demand.

[Unknown Executive]

[Foreign Language] As for LBO market outlook, in the second quarter, stable market sentiment is expected because of the arrival of a high season and demand growth, which will be driven by the industrial demand and manufacturing activities of India, which is our biggest sales outlet. On the supply side, stable to firm sentiment is our forecast for a certain period of time because inventory build of demand is witnessed over all regions, and supply tightness will be ongoing because of a T&I in the EU region.

As for Group 3, suppliers are maximizing their throughput to attach the favorable production margin compared to Group 2 products. In the second quarter, supply is expected to remain, although the supply will ease and supply will improve slightly because of T&I of major regional suppliers.

[Unknown Executive]

[Foreign Language] As was mentioned in our presentation deck, in the first quarter, on nonoperating side, we had a loss of KRW 175.5 billion from FX loss. And for the interest expense, it was minus KRW 58.4 billion.

Let me explain about the FX loss first. We are running FX risk management policy, under which the FX impact on nonoperating side is offset with FX impact on operating side to ensure that the impact of FX movements on income before tax becomes neutral on a yearly basis. So we have to look into our gains on the operating side that offset the FX loss of minus KRW 175.5 billion, and our gain on operating side amounted to KRW 87.3 billion. As a result, net FX impact was KRW 88 billion. However, the aforementioned FX risk management policy will offset this minus KRW 88 billion of FX loss on a yearly basis at the year-end.

And as for the effective interest rate, it is a 4.0% range, which is the lowest among our industry peers. And as for the interest rate outlook, the growth in the domestic bond market is slower than that with U.S. treasury market. And we are expecting the healthy outcome. And as for the market outlook, the interest rate is expected to gradually reduce. However, the timing that to be realized will be delayed.

This concludes my answer.

[Unknown Executive]

[Foreign Language] And now we've reached the time to conclude this earnings release. And once again, I'd like to thank investors and analysts who called into our earnings release with your attention to S-Oil. We will continue to do our best to communicate with the market transparently.

If you have any further questions, feel free to contact with IR team. Thank you.

[Operator]

[Foreign Language] This concludes the fiscal year 2024 first quarter earning results by S-Oil. Thank you for your participation.

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