S-Oil Corp

KRX:010950

Earnings Call Transcript 2023-Q4

[Unknown Executive]

[Interpreted] Good morning, everyone. This is [ K D Bang ], the Treasurer of S-OIL. I'd like to extend my gratitude to our investors and analysts in an out of Korea for your attention to S-OIL's conference call for Q4 earnings results. Today, we have our CFO, J.W. Bang; IR Team Leader, J.W. Ahn and team members.

First, I will take you through the highlights of our fourth quarter results. Despite one of inventory-related loss caused by oil price decrease and the bearish refining margin, the company recorded KRW 209.8 billion in Q4 net income, thanks to FX gains through organized FX risk management and investment tax credit from Shaheen Project. On a yearly basis, operating income and net income posted KRW 1.4186 trillion and KRW 998.2 billion, respectively.

Next is the market outlook for 2024. The company expects favorable market fundamentals to continue into 2024 for overall refining business. As for refining business, oil demand is forecast to grow steadily this year. According to major institutions' outlook, transportation fuel, mainly gasoline and the jet fuel, will lead a strong demand growth supported by reduced price pressure on consumers with the decline in international oil price. The company's major petrochemical product, PX, is expected to experience improved market fundamentals as larger scale capacity expansion, mainly led by China, was mostly completed in 2023, adding significantly less new capacity this year. Tight supply condition is projected for lube business as no capacity addition that is able to affect global market is scheduled for 2024. As such, we are expecting consistently high complex margin above the pre-pandemic level in 2024. In particular, there will be far less T&I this year as we completed regular T&I for major units over the past 2 years.

Next is about the decarbonization road map of the company. Aligned with global and nationwide efforts to deal with climate change and reduce carbon emission, we set the target to deliver 35% of carbon reduction against the business as usual by 2030 and net zero by 2050. To this end, we established the decarbonization road map, including concrete initiatives and annual pathway to decarbonization, which we are putting into action. This is regularly updated and is reported to BOD as one of the company's key business agendas.

The road map includes specific carbon abatement initiatives such as energy efficiency improvement for existing facilities, low carbon electricity purchase and steam imports. These are implemented in phase based on economics and the feasibility, allowing the company to make visible progress for decarbonization every year. Going forward, S-OIL will continue to put [ all of the force ] as a clean energy and chemical company to enhance the ESG management system, thereby live up to the expectations of domestic and overseas investors.

Team leader [ J.W. Ahn ] will get into more details for Q4 performance with the following slides. [Interpreted] Good morning. I am J.W. Ahn, the leader of IR team. Before we begin, please be noted that Q4 financial results are provisional and subject to change according to independent external auditor's audit results.

Let me begin with Q4 2023 performance and outlook. Please refer to Page 5 for Q4 2023 financial results. The company achieved KRW 9.8 trillion of revenue in Q4, up by 9.2% from the previous quarter due to the increase in sales volume compared to Q3 as regular T&I of several units was completed only in Q3. Q4 operating income stood at KRW 7.6 billion. We had one-off negative inventory-related impact and lagged margin due to oil price drop. For your reference, inventory-related loss of KRW 144 billion was reflected to the company-wide operating income in Q4.

By business segment, refining business turned to loss due to slight downward adjustment in refining margin in addition to oil price decrease. Petrochemical and lube segments saw their income rise compared to the previous quarter. In particular, the rebound in product spreads pushed up operating income of lube business by 54% from the previous quarter. For finance and other income, we had KRW 162.3 billion of FX gain through effective FX risk management under downward trend in WON-dollar rate. As a result, income before tax in Q4 recorded KRW 137.6 billion. Net income stood at KRW 209.8 billion, which was higher than income before tax, reflecting KRW 96 billion of investment tax credit from investment into Shaheen Project. The company's cumulative operating income, income before tax and net income for 2023 is KRW 1.4186 trillion, KRW 1.1957 trillion and KRW 998.2 billion, respectively. For your reference, the impact of regular T&I that the company conducted last year for major units on the full year operating income is minus KRW 460 billion.

Moving on to the company's financial status. Year-end cash balance for 2023 was KRW 1.974 trillion, up from the previous quarter due to reduced working capital caused by the decline in oil price. Net debt to equity ratio as of the end of 2023 slightly fell year-on-year to 42.5%. Despite KRW 2 trillion of capital expenditure for Shaheen Project in 2023, healthy income generation and timely external financing at a competitive interest rate enabled us to maintain cash balance and financial structure at an appropriate and stable level. As for profitability indicators, ROE and ROCE stood at 11.4% and 9.8%, respectively in 2023. Annual EBITDA recorded KRW 1.853 trillion.

Let me move on to the performance and outlook for each business segment. First, refining business. In Q4, refining business recorded KRW 255.7 billion in operating loss. Regional refining margin inched down in Q4 from the previous quarter due to sluggish off-seasonal demand for transportation fuel and warmer-than-usual early winter weather. But low inventory level of global refining product supported the market. Average Dubai crude price dropped sharply from $93.3 per barrel in September to $77.3 per barrel in December, mostly offsetting the hike in the previous quarter due to increased output from non-OPEC countries, led by the U.S.. But extended output cut by OPEC+ and increased chances of SPR replenishment by the U.S. government limited a further decline in the market.

As for 2024 outlook, we expect Asian refining margin to be maintained at a level higher than past average, driven by globally low inventory level and stable demand growth. After a decline in October with the beginning of off-season for transportation fuel, Asian refining margin bottomed out in November and widened consecutively in December and January. For your reference, Singapore refining margin is maintained at a healthy level [ of $6 ] per barrel in January. In Q1, heating demand for the remaining winter, unplanned shutdown of the global refineries caused by bad weather, spring regular T&I in the region and the demand uptick during Chinese Spring Festival are expected to support refining margin.

Moreover, further expansion in the margin is projected during driving season in Northern Hemisphere and summer high season for travel, which will start from Q2 end. New refining facilities in Nigeria and Mexico are starting up this year, but industry analysis points to uncertainties as to when they will settle into normal operation and how fast. Major institutions' outlook up to now shows that such facilities will have limited impact on the market in the second half and onwards. I would like to share further details and outlook in key business updates.

Next is petrochemical business. Petrochemical business recorded KRW 47 billion in Q4 operating income, similar to the previous quarter despite a slight drop in chemical product spread resulting from the basic fact caused by opportunity loss from T&I in Q3. For aromatics, PX and benzene spread in Q4 remained firm recording $356 and $230 per ton, respectively, despite their fall from the previous quarter. Though seasonal slowdown in gasoline blending demand put downward pressure on the market, demand uptick from the startup of a new PTA facility and high operation rate of downstream polyester facilities in China supported the market. In 2024, demand growth is anticipated to continue amid a significant reduction in new PX and [ building ] capacity addition.

PX consuming PTA facilities in China are planning to go through large scale capacity expansion and gasoline blend demand is also expected to maintain. As for olefin downstream, PP and PO market weakened in Q4 with a narrowing spread due to dwindling demand in derivatives and minimized restocking of downstream customers at the end of the year amid slowing Chinese economy. Such weak sentiment is expected to continue into 2024 with capacity expansion led by China. But chances of gradual recovery also exist aligned with the pace of Chinese economy recovery that will affect the demand of a petrochemical product.

Turning into lube business. Operating income of lube business in Q4 recorded KRW 226.2 billion, up by 54% compared to Q3. Full year operating income in 2023 stood at KRW 815.7 billion, continuing its great contribution to the company's overall income. In Q4, LBO spread improved from the previous quarter, thanks to regional demand recovery after off season with the end of promotion in India, while feedstock price adjusted downward in correspondence to fall in oil price. In 2024, LBO market is forecast to remain firm, driven by continuous demand growth for group 2 and 3 premium products with no meaningful capacity expansion. Usual demand upturn during spring lubricant change season is also expected to revive the bullish sentiment in the market.

Now we would like to give updates on our key business. First, strong market fundamentals in 2024. As for refining business, global oil demand growth outlook for this year ranges between 1.1 million and 2 million B/D, which is stable, given its average from 1.5 million to 1.6 million B/D. On demand side, continuous bullish demand for transportation fuel is forecast to drive a stable growth in Asia, including China, India and Southeast Asia as well as the Middle East and North America. As for gasoline, we anticipate international oil price, which sidelined [ the senses to ] fall in Q4 last year, to put less fuel cost burden on consumers, thereby supporting gasoline demand. That fuel demand, which recovered to 90% of pre-pandemic level at the end of 2023, is also projected to continue such a trend into this year.

On supply side, net capacity addition is projected at 800,000 B/D to 1 million B/D in 2024. But this comes with a limited direct impact on the market according to major institutions as there remain uncertainties with the timing for commercial operation and ramp-up. The 650,000 B/D refinery in Nigeria that is known to have started up the CDU in the beginning of this year is the largest one this year. As new operation of refining facility begins gradually and consecutively in the long term, it takes minimum 15 months and up to 2 years to settle into normal operation from initial feed-in as was witnessed in the recent cases. Considering the situation, major institutions presume the new facility will only affect the market from the second half or afterwards.

Next is supply-demand outlook for PX that accounts for the largest portion in the company's petrochemical product portfolio. PX market also experienced a large capacity expansion led by China over the past few years. Despite 9,600 KTA of capacity addition, which was the largest since 2006, spread of PX over naphtha remained firm, averaging at $389 in 2023, driven by strong gasoline blending demand for feedstock aromatics. In 2024, major capacity expansion will come to an end and annual demand growth will naturally outpace capacity addition. Such is projected to address supply [ block ] in the region.

PX market sentiment is anticipated to improve from 2023, driven by steady growth in gasoline blending demand and large-scale capacity expansion of the PTA facilities, which amounts to 9 million tons. LBO market condition is also forecast to remain strong as there is no scheduled capacity addition that may affect the market condition. Moreover, major LBO producers plan to have regular T&I in the first half. Once realized, demand uptick from spring lubricant change season is expected to put upward pressure on spread, resulting in bullish market sentiment.

Next is decarbonization road map of the company. We established a quantitative target of a 35% reduction in carbon emission against the business as usual by 2030 based on our mid- to long-term business operation plan and NDC scenario. In the long term, we set net zero in 2050 as our way forward. This comprehensive road map includes a specific reduction pathway based on estimated future carbon emission, required reduction amount and cost-effective emission initiatives to achieve the target.

This is updated on a regular basis, considering the company's mid-to long-term strategy and the changes to external business environment, including global policy trend and development of a carbon abatement technology. We came up with specific initiatives to achieve the road map, which we are implementing in phase based on priority with consideration into feasibility, including technical maturity and economics.

We have 5 major initiatives to achieve decarbonization which are, operational levers, low carbon utility, clean hydrogen import, CCUS and carbon credit and under these initiatives, the company is going after heater efficiency improvements, waste heat recovery and process heat integration for refinery energy efficiency; second, low carbon utilities such as gas turbine cogeneration to reduce carbon intensity of electricity, steam and water used for engineering process, import of low-carbon steam and solar power generation facility; lastly, external hydrogen imports, sales of CO2 for industrial use and overseas SDM project to reduce global GHG emissions.

According to estimated contribution by each initiative, operational lever and low-carbon utility that come with the feasibility and economics compared to other initiatives will allow us to achieve over 70% of the total planned reduction target by 2030. Such efforts made by the company are resulting in meaningful progress every year as we achieved 249 KTA of carbon abatement from 36 [ inspection ] items in 2023. 34 items in operational levers, including energy efficiency improvements were also completed.

Solar power generation panel is installed at the idle space of Incheon terminal to secure eco-friendly energy. In addition, the company is cooperating with [ Tongon Chemical ], which manufactures carbon products, such as liquid carbon for beverage and dry ice as a result of capturing and utilizing 100 KTA of CO2 from our hydrogen production process since 2016. Last year, we expanded captured volume of CO2 to 200 KTA. To better implement decarbonization road map, we monitor the status of facility investment and emission for carbon abatement regularly under the greenhouse gas reduction target we set as part of core performance indicators to achieve mid- to long-term vision. Results are reflected to performance evaluation of all officers and team leaders. We will continue to share the status and our efforts for decarbonization with the market on a regular basis.

With this, I'd like to wrap up my presentation. Thank you.

The Korea presentation is still ongoing. Allow us to wait for a brief moment. Thank you. Q&A session will start soon. Please wait for a brief moment. Thank you.

[Operator]

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

[Jin-Myung Lee, analyst]

[Interpreted] I am J.M. Lee from Shinhan Investment Securities. I have 3 questions. First is, what is S-OIL's estimated export quota from China? And how do you think this will affect the overall regional supply and demand in 2024? And the second question is, you have and shared with us the inventory valuation for this -- for last year. Could you break that down into the business segments? And third is, recently the South Korean government's Financial Services Commission introduced the corporate value program. Given the fact that your company's PBR is not very high, do you have any policies to promote the return to the shareholders other than the dividend policy?

[Unknown Executive]

[Interpreted] So to answer your first question on China's light oil export quota. At the end of last year, China announced [ its first on ] export quota for 2024 for the light oil, which amounted to 19 million tons, which is almost the same as 18.99 million tons that was issued as the first export quota in year 2023. Many institutions interpret this as the efforts by the Chinese government to strike a balance between keeping the refining industry efficient by controlling the export volume and driving up the Chinese economy through the exports. So under the situation, the Chinese government is expected to have a total of 40 million tons in export volume for this year, which will not be very different from the previous years.

However, in the short term, we are not expecting a big spike in the export volume by China because of a few reasons. First of all, there is a demand to stockpile inventory in advance of the upcoming China Lunar New Year holiday, and there's also scheduled 2 million B/D regular T&I in sometime around April and May. However, [ that ] is subject to some changes depending on the export economics and the degree of demand in the China -- in domestic China market.

So as for the inventory impact, in Q4, the total inventory valuation was a total of minus KRW 144 billion across all 3 business segments. But if I may break it down into by each business segment, it was minus KRW 132 billion for the refining business, minus KRW 3 billion for the petrochemical business and plus KRW 11 billion for the lube base oil business. If you look at the whole year of 2023, the inventory valuation stood at minus KRW 98 billion, of which minus KRW 86 billion was in the refining business, plus KRW 9 billion in petrochemicals and minus KRW 21 billion in lube base oil.

And to answer your third question on the corporate value program introduced by Financial Services Commission, we always put improving the corporate -- the shareholder value as one of our top priorities and this is always reflected as a priority in running the business. We always reflect it when we set the mid- to long-term business strategies and also in our shareholder return policy. And therefore, we are in full -- we fully share the government's policy intention and we fully support it.

We have a higher return on equity compared to our competitors, which is also an indicator of our competitive edge. And in order to boost the company's corporate value in the mid to long term, we are in the middle of the Shaheen Project with a target completion at first half of 2026.

So even though we are in the middle of a very big project, the Shaheen Project, we have made it a guideline to maintain our dividend payout ratio at 20% or higher of the net income for fiscal year 2024 and 2025 in order to protect the shareholder value. Once the project is over or even during the project execution period, when we have secured enough -- a certain level of capital needed to invest in the project, we can raise the company's dividend payout ratio.

So after Shaheen Project, the company's capability and income creation will be much, much bigger, and therefore, we'll be more aggressive in the company's shareholder return policy. And once the government comes up with all the details around the corporate value program, we will look at them and we will make proper responses to those new policies.

I hope I answered your questions.

[Operator]

[Interpreted] The following question is by Cho Hyunryul from Samsung Securities.

[Hyunryul Cho, analyst]

[Interpreted] I am from Samsung Securities. I have 3 questions. First of all, I would like to know your estimation for the heating fuel demand in the winter season 2024 and what is your outlook on the diesel and kerosene margin for this year? Second question is, as you know, there are some supply logistics disruptions in Panama Canal and the Red Sea. How is this affecting S-OIL's performance? And third question is, I understand that S-OIL recently started the initial feed in of the bio feedstock and the waste plastic pyrolysis oil into your refining process. Could you please share with us any concrete business plan around this initiative or whether you have any plans to build a dedicated plant?

[Unknown Executive]

[Interpreted] So to answer your first question about the heating fuel demand in 2024 we are receiving, as you know, in December last year the temperature in the Northern Hemisphere was higher than we thought. And as a result of that, we believe -- as a result of that, in December last year, the heating fuel demand was rather disappointing. There is an indicator that can be a good barometer for heating fuel demand, which is called the heating degree days. And this went down by 20% in Europe compared to the previous year. And it was also the same in the United States, where it also went down by the same level, which means the demand for heating fuel also moved down at pretty much the similar level.

However, things turned around in January this year where the U.S. East Coast, Japan and Europe were hit with a cold snap in January and also starting in February. And as a result of that, we are estimating the heating degree days in these regions to have increased by 10% to about 20%. And if this remains the same during the remaining period, this will be the factor supporting the refining margin.

And as for the market outlook for diesel, jet fuel and kerosene this year, in 2024 because of the low inventory in Europe and the cold snap which affected the heating fuel demand in the winter season this year and the spring regular T&I in Asia and the Middle East, which is estimated to be similar to last year or even more than that are expected to support the diesel spread this year. However, there may be some slight adjustments as we move on due to seasonality.

As for the market outlook for jet and [ kero ], this will -- the spread will be supported by the high heating fuel demand early this year because of the low temperature and because of the recovery of jet fuel demand in China. This will be another factor that will be supporting the spread throughout the year. The jet kero demand recovered to almost 90% of the pre-pandemic level last year, and it is expected to go higher at the end of this year and at the end of next year.

And as for the geopolitical tensions around the Red Sea, about 90% of our crude import passes through the Formosa Strait and -- I believe the eastern part of Saudi Arabia and then passes through the Formosa Strait. So we have 0 risk around the Red Sea issue. And there is some spot volume that is passing through the Red Sea, but we're responding to this by -- through a detour around the Cape of Good Hope. The increase in the freight rate due to this is very minimal and negligible compared to the amount of crude that we import. And as for our product export, most of the export takes place within the region, which means there is no impact on our business and our export because of the Red Sea risk.

And as for the disruptions in Panama Canal, we have no impact as a result of this. As you know, this is impacting the exports to Brazil and parts of South America and also the U.S. West Coast. When there are product exports outside of Asia and down for Brazil and the U.S. West Coast, they have to pay a high grade rate premium. And as a result of this, the price has to go down. And we believe this could be an opportunity for the Asian refineries in terms of exporting to South America and the U.S. West Coast.

The third question was about the renewable fuel. As part of S-OIL's green initiatives in order to respond to the energy transition, we have a plan to utilize the bio feedstock and the waste plastic pyrolysis oil to produce eco-friendly fuel oil and eco-friendly petrochemical products.

So in order to enter into the market with feed, we started the co-processing, which is about producing the renewable fuel and eco-friendly chemical products from the bio feedstock and waste plastic pyrolysis oil, which is treated into the existing refining process. We earned the government or regulatory sandbox approval for co-processing and on January 29, which is only a few years ago, we did the initial feed in of the bio feedstock and the waste plastic pyrolysis oil into our process.

So our plan for this year is to acquire the international sustainability and carbon certification and sell the eco-friendly products in earnest. And after that, we have plans to further increase the co-processing volume. Of course, this will be with consideration into the impact on our processes and the market situation.

And in the mid to long term, we are considering a separate facilities investment to produce the renewable fuel, and the details will be confirmed after doing the feasibility study. That answers your third question.

[Operator]

[Interpreted] The following question is by [ Chonu Je ] from KB Securities.

[Unknown Analyst]

[Interpreted] I am from KB Securities. I have 2 questions. First is about Shaheen Project. Could you share with us the CapEx for 2024 through 2026? And one interesting thing that captured my attention this time was the tax -- investment tax credit. Will this be communicated going forward on a quarterly or on an annual basis? And could you also tell us the rough amount of the investment tax credit? My second question has to do with the one-off cost that you said there was about KRW 144 billion in inventory loss in Q4. Is there any other one-off factors like the crude lagging impact or the T&I?

[Unknown Executive]

[Interpreted] So your first question has to do with the CapEx for Shaheen Project and also the investment tax credit and its impact. In order for the company to mobilize all our resources and capabilities into this mega project, we have plans to minimize other investments to minimum. As of the end of last year, our total CapEx into Shaheen was KRW 1.65 trillion. For this year, we have plans. We're planning KRW 2.7 trillion, and the rest will be executed in 2025 and 2026.

So for the investment tax credit, according to the regulations in the tax law and assuming that our CapEx will remain the same, our estimated tax credit for this year will be KRW 60 billion and KRW 80 billion for 2025 and 2026, respectively. However, the government has plans to extend the temporary investment tax credit, which was supposed to expire at the end of last year, and they have plans to have this put on for passage at the national assembly this year. And if this goes through the National Assembly, the investment tax credit will go up from KRW 60 billion to KRW 170 billion for this year, which means there will be savings in the corporate tax, and this will be reflected in the company's income.

And as for the lagging impact, which was a one-off impact resulting from the decline in the oil price, if you take out the minus KRW 144 billion in inventory valuation loss and the lagging impact, even if you take that out, we still maintained a positive operating income in Q4. So please take that into consideration. But please bear with us that we're not able to share the lagging impact resulting from the bearish crude oil price.

And there was no one-off impact from the regular T&I in Q4. This is the end of my answer.

[Operator]

[Interpreted] The following question is by Parsley Ong from JPMorgan.

[Rui Hua Ong, analyst]

I have 2 questions. Earlier, you mentioned that you have pretty heavy CapEx and therefore it's a bit difficult to do immediate share buyback or like hike dividend in view of the Korea corporate value add program. So can you share with us your thoughts on what kind of financial metrics, for example, what 2024 OP level or net debt to equity or asset liability ratio would make S-OIL comfortable to hack the dividend payout ratio to, let's say, 30% or 40% or maybe even 50% in 2025 onwards. Second question is for your lubricants, you had a pretty strong spread in the fourth quarter. So I think part of that was probably due to the cheaper feedstock costs, which is related a little to the oil price decline, I believe. And you mentioned a robust 2024 outlook. But could you share with us your outlook on first quarter given oil prices are significantly higher? And also, what is your outlook on the [indiscernible] in 2025 and beyond? [Foreign Language]

[Unknown Executive]

[Interpreted] So to answer your first question, I think the best way to maximize the shareholder value is to make the most efficient use of our equity in order to maximize the company's income, and this is one of the ways to maximize return to the shareholders.

So in order to maximize the company's income, we are executing Shaheen Project and during the execution period, we are going to maintain the company's financial stability.

So we are trying to enhance the company's operational efficiency in order to maximize the cash flow and the income during the investment period. As for the operating income, of course, we're trying our best to maximize it, but it is affected by some market volatilities. And even so under such market -- under such volatile market conditions, we're trying our best to maximize the operating income as well.

Our optimum target debt-to-equity ratio is set at 80% to 100%, which we intentionally said because we believe this is the range that will allow us to maximize the corporate value. So once we meet this optimum target DE ratio, we can raise the dividend payout ratio after the project is over or even during the project execution period when we believe we have secured enough capital for investment into the project.

So as for the lube based oil market outlook, if we look at the full year of 2024, we believe that demand will grow during -- particularly during the high season when there will be the lubricant change in the summer -- in the spring season and the summer driving season. And at the same time, this will be coupled with the limited capacity expansion in 2024, which will keep this market strong and healthy.

We believe Q1 will be better than Q4 last year because supply will go down as some of the suppliers in Asia will go into the regular T&I and this will be at a time when we enter into the high spring season. And as for the lagging impact, the direction -- overall direction still remains quite uncertain because, as you said, the feedstock is linked to the oil price.

With the tightening environmental regulations and [ prevention for a ] high-quality lube base oil, we are expecting higher demand for group 2 and group 3 going forward. There will be some capacity additions from 2025. However, we are expecting this market to remain quite bullish for the time being because even though there will be new capacities coming up in a few years, we're still limited in knowing when they will settle down and when they will go into full operation. And there is also some time needed to develop the formulation for lube based oil.

That was my answer. [Interpreted] Our scheduled time is up now. So we have -- I think we have to close. But once again, I would like to thank all the investors and the analysts for showing your interest and attention to S-OIL. We are always so committed to communicating with the market based on transparency and fairness. So if you have any further inquiries about the company and our business performance, please feel free to contact S-OIL's IR team. This closes the conference call for Q4 last year and thank you very much.

[Operator]

[Interpreted] This concludes the fiscal year 2023 fourth quarter earnings [ resulted ] by S-OIL. Thanks for the participation.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]