Lotte Chemical Corp

KRX:011170

Earnings Call Transcript 2023-Q2

[Kim Hoon, executive]

[Interpreted] Good afternoon. This is Kim Sang Hoon, Head of the IR team at Lotte Chemical. I thank everyone for your interest in Lotte Chemical and your participation today. We will now begin the Q2 2023 Earnings [ Results ] Conference Call for Lotte Chemical. We will start with an introduction of the executives present here today, followed by a presentation of the company's Q2 business performance and Q3 outlook, then a Q&A session.

Please be informed that the presentation will be contested in simultaneous interpretation and the Q&A in consecutive interpretation. I will now introduce the executives in attendance today. First, Vice President and CSO, Kim Min-Woo; Vice President, [indiscernible]; Vice President, [ Kang Jong-Won ], the CFO; From Basic Chemical, Vice President, Kim Yoon-Seok, Head of the Strategy Management Division; Vice President, [ Jun Lee Young ], Head of the Business Development Division; Executive Vice President, Kim Yong-Seok, Head of the Monomer Division, EVP, [indiscernible], Head of the Polymer Division; and VP, Lee Sang-hyun, Head of the Aromatics Division.

From Advanced Materials, we have General Managers, Sung Nak-Sun from the Corporate Planning Division; and from LC Titan, Executive Vice President, Philip Kong; from the Corporate Planning Division and from Battery Material, Vice President, [ Sang Kim Won ]; from the Battery Materials Charge Division and from Hydrogen Energy, we have Vice President, Kim Yong-Hak.

Let me now turn to business results of Q2 '23. Let me first explain that financial results of Lotte Energy Materials whose acquisition was completed in March 2023 are reflecting in the company's consolidated financial statements. LC Sanjiang, which was an EO production JV in China, sold off in June, has been excluded from the gain or losses using equity method.

Revenue in Q2 was [ KRW 5.0024 trillion ], up 1.4% Q-o-Q. There was operating loss of KRW 77 billion, and operating profit margin was minus 1.5%. Operating loss increased Q-o-Q as a result of falling ASP from sluggish petrochemical demand, rising inventory valuation loss and reverse lagging effect in feedstock despite some improvement factors such as decline in naphtha and ethane prices, positive currency effects and improved profitability in Advanced Materials and Fine Chemicals.

Pretax income fell by KRW 483.5 billion Q-on-Q turning to a loss. There was a loss on fair valuation of financial assets held by consolidated subsidiaries and the base effect of insurance payment income from the [ Daesan ] plant fire recognized in Q1.

Next is the company's financial position. Assets at the end of Q2 2023 was KRW 31.5469 trillion, down by around KRW 280 billion Q-o-Q. Cash and cash equivalents was KRW 4.5239 trillion, down by KRW 480 billion Q-o-Q. Liabilities are KRW 11.6982 trillion, down by around KRW 280 billion Q-o-Q. Borrowings are KRW 8.567 trillion, up by around KRW 410 billion Q-o-Q. Borrowings increased for new investment in the LINE project, among others, but overall debt decreased, thanks to accounts payable and declining materials prices. Debt-to-equity ratio stood at a stable 59%.

Next is a look at results and outlook by our business divisions. The Basic Chemical Division's 2023 second quarter revenue was [ KRW 2.7557 trillion ], operating loss KRW 82.8 billion and operating margin negative [ 3.0% ], returning to an operating loss.

While spreads slightly improved in April and May due to anticipation of China reopening and many turnarounds concentrated in the region, a negative lagging effect was caused by a fall in naphtha prices and sales price fell in June due to weak demand, increasing inventory valuation loss.

In Q3, given the economic uncertainty and supply side pressures, the situation is likely to remain challenging. However, we do not rule out the possibility of a market rebound being triggered by economic stimulus policies in key countries, including China.

Advanced Materials second quarter revenue was [ KRW 1.988 trillion ]; operating profit, KRW 75.1 billion, which is an OP margin of 6.8%. Advanced Materials improved in both top line and profitability Q-o-Q, thanks to increased exports to high-margin areas, including Europe, improved spreads from fall of feedstock prices, decline in transportation and utility prices and increase in sales volume.

In Q3, demand is expected to recover as we enter traditional peak seasonality, but the degree of recovery may remain limited due to the global economic uncertainty.

Next is LC Titan. In Q2, LC Titan recorded revenue of KRW 533.7 billion, operating loss of KRW 111.6 billion. On the supply side, more supply came in from outside the region such as U.S. and Middle East, and supply from new capacity online in Southeast Asia also entered the market. On top of this, demand remained soft due to lower utilization by downstream customers, leading to narrowing spreads, increased inventory valuation loss and increase in size of loss of the company. In Q3, reinforced profitability improvement is likely to be limited due to supply side pressure.

Next is LC U.S.A. In Q2, LC U.S.A recorded revenue of KRW 149.8 billion, operating profit KRW 7.8 billion; OP margin, 5.2%, returning above BEP. It is no longer suffering from the one-off issues caused by the shutdown last year and LC U.S.A's revenue has rebounded under normal operation. Also [ SM ] prices have stabilized, leading to better spreads contributing to an operating profit of KRW 7.8 billion.

In Q3, unusual heat wave in North America has increased electricity demand, driving natural gas prices up. FM prices have also turned around and profitability is expected to decline.

Next is Lotte Fine Chemical. Lotte Fine Chemical already announced its tentative second quarter results on July 31. So I will only go over briefly the highlights. And for details, please refer to Fine Chemicals own presentation materials. Second quarter revenue of Lotte Fine Chemicals was KRW 531.2 billion, operating profit, KRW 69.1 billion and OP margin of 16%. While overall revenue decreased due to a fall in international ammonia product prices, profitability significantly improved, thanks to increase in sales of key products in Chemical and Green Materials Divisions.

In Q3, we expect revenue of Green Material Divisions to remain steady, supported by active sales strategy, but Chemical division is likely to see a fall in revenue as some products experience weak market conditions.

Lastly, looked at Energy Materials. LEM also announced its earnings separately yesterday through a conference call, so I will only mention the key highlights. LEM second quarter revenue was KRW 198.2 billion, operating profit was KRW 1.5 billion. In second quarter, LEM revenue increased Q-o-Q, driven by increase in copper foil sales, but the customer's new expansion plan, experience delays, causing LEM's utilization to drop and fixed cost burden to increase.

Also, the European subsidy had a one-off cost, causing operating profit to decrease Q-o-Q. In Q3, profitability is expected to gradually improve as customer demand increases and sales volumes expand.

Next is a look at our major CapEx plans. First are some new investment plans that are underway. In order to expand the domestic hydrogen supply chain, we have established a joint venture with Air Liquid, which is Air Liquid [ Enerhy ]. The first project will be to build a high-pressure hydrogen supply center using a byproduct hydrogen in Daesan, Korea. The construction is scheduled to be completed in the second half of 2024.

Also Lotte Fine Chemical is currently building a 10,000-tonne capacity expansion for its major green product, HECELLOSE, with the target completion in second half of this year. The EV battery electrolyte organic solvent project is on course with the [ EC, DMC ] line scheduled for mechanical completion second half of this year and EMC, DEC during the first half of next year. The Daesan EOA expansion is also scheduled to be completed in the second half, and other major projects, as you can see, are on track according to plan.

Now that completes our presentation on our second quarter results and third quarter outlook. And now our CSO, Min-Woo Kim, will comment on some key issues and future business outlook.

[Min-Woo Kim, executive]

[Interpreted] Good afternoon. This is Min-Woo Kim, the CSO at Lotte Chemical. I thank everyone in the investment community for joining this call and showing so much interest in the company. First off, I regret having to report somewhat disappointing numbers to our investors who were anticipating a positive turnaround in company results.

Under the early part of last quarter, actually, we were seeing a visible improvement in industry conditions with product spreads improving, driven by factors such as China reopening. However, the economic recovery has been slower than expected and demand has not been recovering as much as we expected.

Under such circumstances, oil prices fell in early May, causing price of naphtha, a major feedstock, to fall, triggering a negative lag effect in input costs. However, due to the weak market, the drop in feedstock price was immediately reflected on key product prices, which in turn led to inventory valuation loss, increasing the size of the company's operating loss versus the previous quarter.

From mid-to-long-term industry cycle perspective, new capacity expansions are decreasing and our outlook of a gradual increase in utilization rates and better profitability remains valid. That said, in the near term, global economic uncertainty is likely to continue in the second half, and therefore, we remain cautious about predicting the exact time of a rebound.

Recently, oil price is climbing as oil-producing countries are announcing production cuts, but the higher feedstock prices are not being immediately reflected in product prices. While the market situation is not worsening further, it is hovering around BEP depending on feedstock price, and it is necessary to note that most petrochemical companies are operating at low utilization.

As such, we do not yet see a clear market rebound momentum. But if the recently reported Chinese stimulus policies lead to an active demand recovery, this may open the door for a possible fast-paced market rebound. While the industry condition remains challenging, Lotte Chemical continues to focus on operational optimization and portfolio improvement.

In the Basic Chemicals, we have been reducing the share of high competition commodity-grade products and increasing the share of high-end products, including solar panel material and battery separator polymers. We are also strengthening the EO add-up business, including organic solvents for battery electrolytes. We're also increasing LPG input for better feedstock economics and optimizing our utilization flexibly depending on market situation to maximize our profitability.

In Advanced Materials, we are continuously generating profit by leveraging our ability to develop and supply customer-specific high-end compound products and expect to maintain the current trend in the second half. Also, the growth and profitability of Lotte Fine Chemical, which is -- is possible because of Lotte Chemicals' previous portfolio diversification efforts.

We will continue to focus on increasing the share of non-commodity products and also on business rationalization by exiting from projects in Korea and abroad that we do not find profitable and does not fit our strategically, such as the example of the Pakistan PTA equipment divestment early this year and the divestment of the China EO facility in the second quarter.

The petrochem industry situation is even more challenging than past down cycle because it is affected by not only the conventional industry dynamics such as capacity expansions, but unconventional factors such as the pandemic, weak global demand and feedstock prices propped up by the war. Despite the challenges, Lotte Chemical is generating over KRW 200 billion of EBITDA cash flow quarterly, maintain stable financial conditions with a debt-to-equity ratio of around 60%.

The key investment projects already underway are being executed as planned and new investment projects are being reexamined and rescheduled with a conservative view to reflect the delay in industry rebound.

The company will continue to focus on enhancing competitiveness of our existing businesses and make investments in new growth areas such as battery materials, hydrogen and recycling to deliver results that meet your expectations. Thank you.

[Operator]

[Interpreted] [Operator Instructions] The first question will be presented by Hyunryul Cho, from Samsung Securities.

[Hyunryul Cho, analyst]

[Interpreted] Now my first question is about the lagging effect. So for example, I understand that for both Basic Chemical and LC Titan, because of the drop in the naphtha prices and also because of the inventory valuation loss, there were some lagging effect. So then I wonder what was the extent of it that was reflected in the second quarter's earnings results?

And the second question is about the capacity addition. So because of the continuous capacity addition since 2020, I understand that the market continues to remain sluggish. Then for next year, I understand that there are some mixed views about the capacity addition for ethylene in particular.

Some are saying that there is going to be a big increase. Some are saying no. So what is the company's outlook regarding the capacity addition for ethylene next year? And also, so compared to this year, in particular, what is the company's forecast for the capacity increase for major products in 2024 and 2025?

And then the third question is about the new businesses, including the battery materials. So for the aluminum foil, now I understand that the mechanical completion is slated for the second half of next year. Now then afterwards, if there is going to be production in the amount of 360,000 tonnes in 2025 as planned, then how much of that is going to translate into revenue?

And also for [ HECELLOSE ], now I understand that the production of it could be outsourced to Fine Chemicals. Then how is this process going to be? And then also revenue -- so under which company will the revenue be captured?

[Yong-Seok Kim, executive]

[Interpreted] Now this is Kim Jung Uk from the Monomer Division, responding to the question about the expected capacity addition in 2024. Now for ethylene in 2023, the capacity addition was 10 million tonnes. And in 2024, it is projected to be halved to 5 million tones. So this is expected to be the kind of capacity addition that is going to underperform the increase in demand.

But we see that the picture is a bit different from propylene. In 2023, the capacity addition was 10 million tonnes. In '24, it is expected at 13 million tonnes, meaning that the capacity addition is likely to outpace the demand growth.

For other major products, we expect the picture to be similar to that of ethylene, meaning that the capacity increase in 2024 is likely to be much less than what we have seen in 2023. So that also means that the expected capacity addition is likely to under pace the expected demand growth for each of these products. So that means that for the company, it's likely that the market condition, especially the demand supply dynamics are going to improve.

[Gyo Hyun Kim, executive]

[Interpreted] This is Kim Gyo Hyun from the Battery Materials Strategy Division responding to your question about aluminum foil. And the question was about the revenue expectation about aluminum foil. Now for the U.S. plant, now -- for the U.S. company, so the capacity is expected at 3.6 million tonnes with 2 lines, and we are expecting about KRW 150 billion per line. So of course, it would depend also on other conditions, including the exchange rate, but still just based on the simple arithmetic, it would mean about KRW 300 billion for the 2 lines.

So in the beginning, it would be about KRW 80 billion from LINE 1, and then it would gradually increase to about KRW 300 billion by 2028.

[Unknown Executive]

[Interpreted] And this is [indiscernible], from the Business Development Division of Basic Chemical, responding to your question of HECELLOSE. And so, for the HECELLOSE, the revenue is going to be recognized under Fine Chemical. And then for the Basic Chemical, then there is going to be the sales of the [ LTPO ] and also the fee or the commission for the production.

[Unknown Executive]

[Interpreted] This is Cheong [indiscernible], Vice President of the HQ Corporate Planning Division, responding to your question about the reverse lagging effect. So for both Basic Chemical and Titan, the naphtha price fell and also what was the extent of the reverse lagging effect, that was reflected. So in the second quarter, the price of naphtha that was reflected was $88. And -- so it amounted to KRW 90 billion for Basic Chemical and then KRW 22 billion for LC Titan.

[Min-Woo Kim, executive]

[Interpreted] And this is Kim Min-Woo, the CSO, and I would like to make some additional comments about HECELLOSE. Now for HECELLOSE, the feedstock is EO, which is Ethylene Oxide. So what we are trying to do is try to reduce the production of ethylene glycol with EO, and then we would actually increase the production of EO derivatives. So it is part of our business strategy.

Now for Fine Chemicals, the business of HECELLOSE, this is key to our plan to expand the green material business. And then for the mid-to-long term for us to -- so in our view, the better location to expand the HECELLOSE business would be Yeosu rather than Ulsan. And that is why we plan to increase the lines in Yeosu plant because this is more conducive for the transport of the ethylene oxide. So that is why there have been consultations between the 2 companies to increase the production of EO derivatives from the Yeosu plant so that we will be able to lay the foundation for expanding the HECELLOSE business.

[Operator]

[Interpreted] The next question will be presented by [ Yoon San Bek ], for Samsung Securities.

[Unknown Analyst]

[Interpreted] So my question is about the Lotte U.S.A, and I -- it's -- I regret to say that we see that the profitability of the company has fallen considerably. And I do understand that, that is in part attributable to the ethane prices, but I also believe that there are some structural factors, for example, the falling profitability of MEG, for example. Then -- so, let's say, what would be the company's strategy to improve the profitability of the facilities and the equipment in the U.S.?

So because -- for example, the plan -- for example, increase in the EOA facilities. So there would be these -- there are these EG facilities in the U.S. And so, what would be the company's plan to improve the profitability, for example, expanding the downstream and so forth?

[Yoon-Seok Kim, executive]

[Interpreted] This is [ Kim Yong-Seok ] from the Strategy Management Division of Basic Chemicals. And now regarding your question about what we are considering in order to improve the profitability of the EGE facilities, I must say that at this time, nothing is under plan specifically. And for the U.S. business, because there was a high initial investment, there is also high depreciation and amortization, which has also affected the operating profit margin.

And last year, despite one of the worst market conditions, the EBITDA for the year was at 17%. And this year, it is also maintaining 20% level.

And the company believes that once the depreciation and amortization is completed, then it will be able to achieve adequate operating profit margin.

[Operator]

The next question will presented by Woo Jae Chun from KB Securities.

[Woo Jae Chun, analyst]

[Interpreted] I have 2 questions. I see that for Advanced Materials and the LC U.S., the earnings results have improved the most. And I wonder whether it is because of the difference in the sales regions? So what are the major -- what is the major geography of sales of these 2 companies?

And then also, what is the -- what are the main regions of sales for the Basic Chemical and LC Titan where we see the earnings results not as good as expected?

And then also for the aluminum foil and organic solvent and also the separator membrane, so what is the company's acquisition of the customers? If you could just let us know about your business landscape in terms of the market share in these products?

[Nak-Seon Sung, executive]

[Interpreted] This is Sung Nak-Sun from the Corporate Planning Division of Advanced Materials. I would like to first explain about the differences in geography. Now in China, we see that the self-sufficiency rate of ABS and PC is 140%. Now last year, about 50% of our PC went to China. But since then, we have tried to expand our geography more into Southeast Asia as well as Europe. And as a result, now, about 15% of our sales occur in China.

[Unknown Executive]

[Interpreted] And this is [indiscernible] from the HQ Corporate Planning Division, and I would like to make some additional comments. Now for the U.S. business, the performance improved also, let's say, from the base effect because starting from the end of last year and throughout the first quarter, because of the [ cold spell ] there was about KRW 23 billion in loss. And now this particular loss was mostly eliminated in the second quarter. So that is one factor.

Another is about the difference in the feedstock, which is ethane in the U.S. The price is about $200, which is about 1/3 or 1/4 of naphtha. So even if they sell the same moment of MEG, that means that the profitability is going to be much better.

And then you also asked about the difference in the performance from Basic Chemical, LC Titan and the U.S. business. Now for both the U.S. and LC Titan, they also have the same product, which is MEG. And let me make a correction. So it's not Titan, but it's Basic Chemical that has MEG, which is the same product as the U.S.

And now performance for Basic Chemical and Titan were not as high as expected. And the reasons are as explained earlier, the sluggish demand and supply dynamics and also the slower-than-expected recovery in demand following reopening of [indiscernible] as well as increase in the feedstock prices.

[Gyo Hyun Kim, executive]

[Interpreted] Now this is Kim Gyo Hyun, from the Battery Materials Strategy Division, and I would like to respond to your question about our customer acquisition in the battery materials. And I would like to respond in the order of the revenue share, in other words, separator organic solvent and aluminum foil.

Now for the separator membrane materials, since the launch of our commercial sales in 2021, we have continued to increase our customer base so much so that this year we are expecting a 100% growth year-over-year. And thanks to our product competitiveness, we expect that the revenue will continue to grow.

For organic solvents, we are currently discussing long-term agreements with not only domestic battery makers but also global EV makers. And we believe that for about 30% of the volume, we will be able to conclude the agreement within the year.

And then for aluminum foil, we are going -- so our projection is based on the Lotte aluminum revenue as reference. So then for the U.S. revenue, then, of course, aside from the Lotte aluminum, we are also going to -- so for Lotte aluminum, we are going to expand beyond SDI also to LG Energy Solutions and [ SK ON ]. So the certification or approval has been completed, and we will continue to increase the production to also provide the supplies to these additional customers.

[Operator]

[Interpreted] The next question will be presented by Sung Hyun Hwang, Eugene Investments and Securities.

[Sung Hyun Hwang, analyst]

[Interpreted] I have 2 questions. First is about the recommendation coming out of China regarding the energy efficiency in June. And we see that the benchmark standard is quite strict. So then some -- in the case of non-compliance crackers, then they are also saying that they're going to shut them down starting in 2025. So does the company expect any impacts from this recommendation in China?

And then the second question is about the MOU that was signed with the -- in the U.S. with the energy company. And then -- so -- and that was, I understand about the reduction in emission for Scope 2. So then in terms of -- so that is the MOU with energy -- Entergy. And then so I understand that, that is about the reduction in emission in Scope 2. So then -- I wonder then what is going to be the impact of -- so what are the regulations or the rules regarding ethylene crackers? And what does the company expect that the impact is going to be?

[Yong-Seok Kim, executive]

[Interpreted] This is from the Monomer Division, Kim Jung Uk responding to your question about the energy efficiency benchmark in China. And we believe that this is going to affect the smaller scale NCC, CPOs and EGs rather than the large-sized crackers. So if some of the NCCs are to be shut down, then we believe they're only for the ethylene and propylene, but then also for the downstream butadiene, or BTX. We believe that this is actually going to improve the supply-demand dynamics.

And going beyond that, we believe that it could also improve the supply demand dynamics for EG, which is suffering from chronic oversupply.

Having said that, given the fact that this is likely to go into effect starting from the end of 2025, you would still have to wait and see the actual impact.

[Min-Woo Kim, executive]

[Interpreted] Now this is Kim Min-Woo, the CFO responding to your -- the second part of your question, but now I'm sorry to say that from the head office in Korea, we are not privy to all the details of the rules or regulations in the U.S.

Now as far as I understand, for the LC U.S.A in terms of the renewable energy and the reduction in the CO2 emission now, and also in regards to our MOU with the electricity supplier Entergy, now what we have discovered in the U.S. is that there is an abundant supply of renewable energy with the pricing gap not being too large.

So for us to utilize the power generated using renewable energy source, we believe that, that was going to be helpful in further driving the MEG sales.

And then regarding the MEG, now, for example, there is also the CO2 that is produced in the course of producing the MEG product, and we are also trying to find different ways of dealing with this CO2 that is emitted from the production. And once we can do that, we believe that we could also receive the green energy certification, which is also going to be helpful in perhaps having a premium status for our products and for our customers.

[Operator]

[Interpreted] The next question will be presented by Rui Hua Ong from JPMorgan.

[Rui Hua Ong, analyst]

So I have a follow-up question on HECELLOSE. In the PPT, it says Lotte Chem does the contract manufacturing and Lotte Fine Chem provides the technology and selling of products. Can I just confirm that $145 billion CapEx, is that paid by Lotte Chem or Lotte Fine Chem?

And so does it mean that if the revenue is booked under Lotte Fine Chem, the margin that Lotte Chem gets is basically selling the feedstock like ethylene oxide? That's basically the kind of profit margin I can expect from this project, or is there some other kind of fee involved?

And also you have -- you start off with 10,000 tonnes per annum in capacity. Could you give us some color on 2030, for example, how big do you think this business could grow to?

The second question is on ultra-high molecular weight PE. So you mentioned a pretty strong growth rate of 100% year-on-year volume growth for 2023. Do you think you can maintain that kind of volume growth for 2024 and 2025?

And I think in the past, Lotte main customers were Chinese and a little bit of Koreans. But have you managed to win any new customers, for example, Korean-Japanese joint ventures or any like projects in overseas markets like Europe and U.S.?

[Yoon Seung Ho, executive]

[Interpreted] This is Yoon Seung-Ho from the Polymer Division responding to the second part of your question first. Now for the separator membrane materials, as I explained earlier, we started commercial sales in 2021. And since the start in 2021, we have maintained an annual growth of 100% in 2022. And also we are expecting the same for 2023.

And in terms of our customer base -- and yes, as you have mentioned, it is mostly customers in Korea and China, but then the company continues to try to expand the customer base, for example, working to acquire new customers in Japan, the EU and U.S. And based on this, our goal is to achieve sales of 100,000 tonnes by 2025.

[Min-Woo Kim, executive]

[Interpreted] Now this is the CFO responding to your question about HECELLOSE. Now I would say that my answer is going to mostly correspond to the [ questioners ] understanding already, meaning that the investment will be borne by Lotte Chemical, whereas the revenue is going to fall under Fine Chemical. And for Lotte Chemical, yes, there is going to be the revenue from the sales of feedstock like EO.

But in addition to that, yes, there is also going to be charges for production for Lotte Chemical as well. Let me explain a bit more about the long-term production volume expected for HECELLOSE. The plant that is currently under construction in Yeosu, that is #3 plant. We have #1 and 2 in Ulsan and the capacity for each plant is around 10,000 tonnes.

So then in the city of Yeosu, we have enough space and infrastructure to have additional plants beyond #3. So we could go to #4, #5. So our long-term plan for HECELLOSE is ultimately to go to 50,000 tonnes in total.

[Operator]

[Interpreted] Thank you very much. That concludes the Q2 2023 earnings release conference call by Lotte Chemical. And if you have any further comments or questions, and please contact the IR team. We hope to see you again all in Q3. Thank you.

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