Lotte Chemical Corp
KRX:011170

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Earnings Call Analysis

Q2-2024 Analysis
Lotte Chemical Corp

LOTTE Chemical's Q2 Results Reflect Improved Demand but Ongoing Challenges

In Q2 2024, LOTTE Chemical reported sales of KRW 5,248 billion, a 3.2% increase from Q1, alongside an improved EBITDA of KRW 207.9 billion, reflecting better operational efficiency and demand growth. However, operating losses of KRW 111.2 billion underscored ongoing challenges due to falling feedstock prices and rising inventory valuation losses. The company expects continued revenue growth into Q3, forecasted at approximately KRW 150 billion due to increased chlorine-based and green material sales. To enhance cash flow, LOTTE aims to adjust investment plans, targeting a total cash improvement of KRW 1.9 trillion by 2025. A dividend of KRW 1,000 per share is also slated for payout on August 9.

LOTTE Chemical's Financial Performance Overview

In the second quarter of 2024, LOTTE Chemical reported revenues of KRW 5,248 billion, marking a 3.2% increase quarter-over-quarter (Q-o-Q). However, the company also faced an operating loss of KRW 111.2 billion, although this was an improvement of KRW 24.1 billion compared to the previous quarter. This mixed financial performance can be attributed to several factors, including improved downstream demand for consumer electronics and mobility, but was limited by increased inventory valuation losses and one-time maintenance expenses in overseas subsidiaries.

Key Business Segments Performance

Breaking down the financial results by business division, the Basic Chemicals segment generated sales of KRW 3,606.9 billion, experiencing similar operating losses as in the first quarter. The Advanced Materials division saw revenues of KRW 1,134.4 billion with an operating profit of KRW 75.7 billion, leading to an operating margin of 6.7% due to increased demand for its products. In contrast, the Fine Chemical division achieved a modest operating profit of KRW 17.1 billion from KRW 422.1 billion in revenue, benefitting from the growing market for chlorine-based products.

Expectations for Q3 and Future Guidance

Moving into the third quarter, LOTTE Chemical anticipates a slowing of revenue growth due to declining demands across industries and continued policy volatility. For the Advanced Materials, while expectations are set for a high sales volume due to upcoming shopping seasons, challenges from new Chinese capacities and heightened shipping costs may impede profitability. Management projects a meaningful improvement in cash flow by pushing back existing investment plans, projecting improvements in cash flow of KRW 1.9 trillion by 2025 through various optimizations.

Strategic Actions and Financial Prudence

To combat uncertainties in the market, LOTTE is focusing on improving cash flow and maximizing operational efficiency. This includes reducing non-strategic investments, securing approximately KRW 400 billion through working capital projects, and maintaining an asset-light strategy, expected to yield about KRW 2.3 trillion in cash by 2025. The emphasis on shareholder return remains strong, with a dividend payout ratio of 72% for 2023 and an interim dividend of KRW 1,000 per share on August 9, 2024.

Challenges and Operational Risks

The company warned of persistent challenges stemming from delayed recoveries in market demand and rising shipping costs. Losses on inventory valuation amounted to KRW 31 billion due to price fluctuations in feedstock, while operational shutdowns resulted in an opportunity loss of approximately KRW 27 billion. As they navigate through these hurdles, LOTTE's management underlines their commitment to enhancing operational efficiencies and prioritizing high-margin product lines.

Earnings Call Transcript

Earnings Call Transcript
2024-Q2

from 0
K
Kim Yong Ban
executive

[Interpreted] Good afternoon. I am Kim Yong Ban, Head of IR at LOTTE Chemical. Let me now begin the LOTTE Chemical's Earnings Conference Call for Q2 of 2024. Today, we will introduce the senior management members present. And then after explaining the business results for Q2 and outlook for Q3, we will proceed to a Q&A session. All the presentations will be made through simultaneous interpretation. And for Q&A, we will have consecutive interpretation.

Let me now introduce the senior management present here today. First, we have with us Sung Nak-Seon, the Executive CFO; Kim Min-Woo, our CSO; and also [ Kwak Giseop ], Head of Strategy Management Division of Basic Chemicals and [ Park Kyo Sung ], Head of Monomer Division; and Yoon Seung-Ho, Head of Polymer Division; [ Bae Sung Soo ] Head of Aromatic Division; and [indiscernible] from the Business Development Division of Basic Chemicals.

From Advanced Materials, we have [indiscernible], Head of Corporate Planning Division. And we have [ Seo Kyung-Hoon], Head of Battery Materials Business Strategy Division; and also, Kim Yong-Hak, Head of the Hydrogen Energy Division.

First, let me go through the business highlights for Q2 of 2024. In Q2, sales posted KRW 5,248 billion, up 3.2% Q-o-Q and operating profit posted a loss of KRW 111.2 billion, improving KRW 24.1 billion Q-o-Q. Due to improving downstream demand, the spread has widened, and sales volume of advanced materials and fine chemical products have increased, while operational efficiency of the basic chemical business has improved and also because of the positive FX impact as well, all contributed to the improvement. However, during the quarter, winter fall in the feedstock prices, the loss on valuation of inventory increased Q-o-Q and the maintenance of the overseas subsidiary also had an impact, limiting the magnitude of improvement.

The pre-tax income is down KRW 35 billion Q-o-Q due to fall in the gains on valuation of investment shares in our subsidiary, and EBITDA is KRW 207.9 billion, up KRW 36.4 billion Q-o-Q.

Next is on the financial highlights. As of the end of Q2 of 2024, assets posted KRW 35,709.8 billion, up KRW 579.7 billion Q-o-Q. Cash and equivalent asset posed KRW 4,205.1 billion, down KRW 186.7 billion Q-o-Q. Liabilities is KRW 15,338.8 billion, up KRW 629.3 billion Q-o-Q and borrowings [ did ] KRW 11,082.7 billion, up KRW 325.2 billion Q-o-Q. Because the borrowings related to new [ products ] such as the LINE project, [ as well as the ] acquisition of construction assets, liabilities and assets increased with a debt-to-equity ratio at 35% -- 35.3% and net debt ratio posting approximately 33.8%.

Next is the business results and outlook by business division. In Q2, the Basic Chemicals posted sales of KRW 3,606.9 billion and operating losses of KRW 139.2 billion, similar to Q1. With entry into the high season and owing to the positive FX impact, [indiscernible] spread has increased, but the maintenance of LC USA and the scheduled turnaround at LC Titan has led to an opportunity loss of approximately KRW 27 billion. In addition, loss on valuation of inventories up Q-o-Q resulting in a slight fall in profitability.

In Q3, due to a reduction in new capacity add-on volumes, globally, gradual improvement in supply and demand is expected, but due to the delays in demand recovery in light of the freight cost, profitability is expected to remain unchanged.

Next is Advanced Materials. In Q2, the Advanced Materials sales posted KRW 1,134.4 billion, operating profit KRW 75.7 billion and operating margin was 6.7%. Sales and profitability have improved on the back of increasing downstream demand, resulting in a widening spread for ABS and PC and also thanks to the rising exchange rate.

Q3 is traditionally a high season for the business with the shopping season coming up. But with the Chinese new capacity volume hitting the market and owing to the rise in the maritime freight cost, profitability is expected to remain weak or stagnant.

Next is LOTTE Fine Chemical. LOTTE Fine Chemical already released its earnings on July 30th, so I will only briefly go through the financial results. Please refer to LOTTE Fine Chemical's earnings release for more details. LOTTE Fine Chemical's revenue in Q2, '24 was KRW 422.1 billion, with operating profit of KRW 17.1 billion and operating margin of 4.1%.

Revenue and profitability improved, thanks to increased sales of chlorine-based products and expansion in the green materials industry. Revenues is expected to keep increasing in Q3 on the back of rising international prices and sales volume of chlorine-based products and growing sales of green material products in food and pharmaceutical materials.

Last is LOTTE Energy Materials. The company also had its earnings release yesterday morning, so I will be brief. In Q2 '24, LOTTE Energy Materials posted revenue of KRW 262.7 billion and operating profit of KRW 3 billion. In the second quarter, despite slowing growth in the EV market, we achieved the highest quarterly sales by diversifying customers and expanding strategic customer market share in North America.

In Q3, revenue growth is expected to slow down due to declining demand from all industries and policy volatility, but we plan to respond by expanding global customers, diversifying applications for ESS and hybrid and diversifying our product portfolio, including copper foil for next-generation AI accelerators.

This concludes my presentation of Q2 results and Q3 outlook 2024. And now, I would like to turn over to the CFO, Sung Nak-Seon to discuss key issues and future prospects of LOTTE Chemical.

N
Nak-Seon Sung
executive

[Interpreted] Good afternoon. This is Sung Nak-Seon, CFO at LOTTE Chemical. Let me first thank the investors and capital market participants for taking the time out of your busy schedule to attend our earnings conference call.

First of all, I regret to report that our Q2 earnings did not meet the expectations of our investors, who are waiting for a meaningful improvement in Q2. In Q2, we narrowed our loss, thanks to improved downstream demand for consumer electronics, mobility as well as positive currency effects. However, improvement in profitability was limited due to the lagging effect of the decline in the price of naphtha, which led to increase in inventory valuation loss. There was also a onetime expense for a partial maintenance of an overseas subsidiary.

Looking at the recent environment surrounding the petrochemical industry, we are still expecting a gradual improvement in supply and demand due to lower capacity expansion and expected interest rate cuts, but uncertainties in the business environment, such as delayed recovery in short-term demand and rising shipping costs persist. Under these circumstances, we will focus our execution on areas that we have more control over in the short term to strengthen our financial position.

First, in response to uncertain market conditions and industry demand, we will improve our cash flow by pushing back existing investment plans and reducing items of lesser strategic importance or those that do not align with our strategic direction. At the CEO Investor Day event held in July, we outlined our target to improve cash flow by KRW 1.9 trillion by 2025 through investment adjustments. As of 2024, we plan to further adjust investment in overseas subsidiaries by approximately KRW 150 billion.

Second is to improve cash flow by maximizing operational efficiency. In addition to securing KRW 0.8 trillion in cash by 2025, we plan to secure approximately KRW 400 billion in additional cash this year through securitization of working capital and plant operation efficiency projects. We will also remain on the path of our asset-light strategy, which is expected to generate approximately KRW 2.3 trillion in additional cash by 2025. Further details will be shared in due course, as we make progress.

Finally, let me turn to our shareholder return policy and responsible management. We believe it is of utmost importance to maintain our trust with shareholders, and our strategic direction is centered on enhancing shareholder value. As for dividends, the key part of our shareholder return policy we paid out KRW 3,501 per share, as dividend for the fiscal year 2023, with a dividend payout ratio of 72%, far higher than our policy of 30%. In addition, we will be paying an interim dividend for the first time this year, as part of our shareholder return policy. And as announced in our July disclosure, KRW 1,000 per share will be paid out on August 9th.

In addition, we have completed a total of KRW 100 billion in stock buyback to date. And as part of our responsible management principle, we expanded our management stock purchase in May 2024 following 2023. Business environment today remains challenging, but we will strive to implement the shareholder return policies that have -- that we have committed to at the appropriate time, taking into account the pace of performance improvement and our financial situation. We look forward to your continued support. Thank you.

Operator

[Interpreted] [Operator Instructions]

[Interpreted] The first question will be provided by Jae Sung Yoon from Hana Securities.

J
Jae Sung Yoon
analyst

[Interpreted] My first question has to do with the opportunity cost from the turnaround for the Basic Chemicals and also your losses on valuation of inventory. Can you provide an explanation using specific numbers? And also, I understand that your freight costs had increased in the second quarter compared to first quarter. Has this also had an impact. That is my first question.

My second question has to do with some announcements made during the CEO Investor Day. You mentioned during the Investor Day that there is a possibility of collaboration with Middle Eastern companies. Can you provide an update on those? And in addition to this matter, is there any updates or anything that has changed from -- since the announcements that have been made at the CEO Investor Day?

U
Unknown Executive

[Interpreted]. I am [ Kwak Giseop ], let me take the question about the valuation loss on inventories. For the Basic Chemicals business, in terms of the loss on valuation on inventories, it was KRW 16 billion; and for Titan, it was KRW 14.7 billion. So in total, KRW 31 billion was recognized, as loss on valuation on inventory.

In the case of the opportunity loss related to the turnaround in the case of LC Titan, it was KRW 8.6 billion and for LC USA, it was KRW 18.5 billion. So in total, KRW 27 billion was recognized, as opportunity loss in relation to the [ TA ].

So let me take the question also about the rise in the maritime freight cost. In order to respond to the unfair trade practices of China, the U.S. government had announced that they are going to raise the tariff rates against the Chinese-made products. And since this announcement has been made, there has been an increase of transportation volume from China to United States.

So because of this, there has been a shortage of freight space to -- from Korea. And also, in the month of June and July, there has been a rapid hike in terms of the maritime flight cost. However, the increase in the maritime flight cost was mostly reflected in the month of June. And compared to the first quarter, the impact on the second quarter is not that large.

Also, after the mid-July, the Shanghai freight index is showing also a downward trend is stabilizing. And internally, we are adjusting the export price condition terms in order to ensure that the rise in the fight cost is reflected in the sales price

In order to ensure that there is no carryover of sales due to logistical disruptions, we are thoroughly managing our shipments and also expanding our early sales in order to minimize any impact on the third quarter.

M
Min-Woo Kim
executive

[Interpreted] This is the CSO, Kim Min-Woo. Let me take the second question. So when it comes to the asset light strategy that we are pursuing, simply put, it means that we are going to downsize the Basic Chemical business that we have to an appropriate level.

And internally, we have almost nearly completed the listing up of our portfolios and items that needs to be evaluated based on those priorities. So based on that context, we are contacting a number of different investors, and for some of the projects, significant progress has already been made.

However, given the market situation, such as the interest rate level and also the delay in the recovery of the market due to these myriad of factors, the market environment at present is not really feasible for selling off commodity assets like the Basic Chemicals. However, among the assets that are held by the company, given that there are certain promising locations in the emerging markets of these assets and also the attraction of minor investment perspective, some of the investors are actually showing an interest in our assets.

So for some of the projects, yes, we are in the early discussion stage. And so, there are a lot of things and developments going on. But at the moment, there is no specific details that we can share with the market. So as soon as we have reached some conclusions, we will make sure that we share this information with the market.

N
Nak-Seon Sung
executive

[Interpreted] So I am Sung Nak-Seon, the CFO. At the CEO Investor Day, what we have announced was KRW 2.3 trillion for the asset-light strategy and also for the investment-related reduction KRW 1.9 trillion and KRW 800 billion for operational efficiency.

For the KRW 2.3 trillion for the asset-light strategy as has been noted by the CSO, it is currently under discussion. And for this year's reduction of new investment, which was estimated at KRW 1 trillion already 50% of that has been achieved. And the KRW 800 million -- KRW 800 billion that was planned for operational efficiency, already KRW 450 billion of that has been achieved.

With regards to operational efficiency, we have set up an additional goal of KRW 430 billion.

With regards to the investment that had been planned for the second half, it is going to be canceled or deferred to as has been planned. And so, the free cash flow will be improved as planned. And in the case of the asset-light strategy, although it will take some time, we will make the effort to ensure that it is achieved within the year. [Interpreted] The following question will be presented by Woo-Je Chun from KB Securities.

W
Woo Jae Chun
analyst

[Interpreted] I have an additional question about the freight cost. So I would like to know what share of your vessels are contracted vessels? And if the share of contracted vessels is high, do you normally renew your contract every 6 months? And is the renewal of the contract done in the first quarter and the third quarter? That is my first question.

And my second question has to do with domestic demand for chemical products. My understanding is that the demand is very sluggish for chemical products domestically? And what is your outlook for the chemical products in the second half, both for domestic and for the export volumes?

U
Unknown Executive

[Interpreted] My name is [ Kwak Giseop ], so let me take the first question. With regards to the contract of the vessels for exports, we engage mostly in term contracts, and it is contracted on a quarterly basis. So the term is set rather short. This allows to respond very flexibly to the ongoing market situation. That is all. [Interpreted] I'm Yoon Seung-Ho, I'm Head of the Polymer Business Division. Let me answer your second question. In case of LOTTE Chemical in various different applications, we are currently the #1 player in the PE and PP market. After 2021, with the increase of supplies from the new capacity add-ons domestically and also with the sluggish demand continuing, intensified competition is being played out in terms of sales for domestic users. So our strategy is to shift away from the selling of low-margin products and increased share of our sales of high-profit products. And so, we will leverage the strength that our company has to the maximum and continue to defend our position in the domestic market. For your information, the domestic market takes up 45% of our total sales of PE and PP.

Operator

[Interpreted] The following question will be presented by Jin Ho Lee from Mirae Asset Securities.

J
Jin Ho Lee
analyst

[Interpreted] I'm Lee Jin Ho from Mira Asset Securities. I have 2 questions. So according to my understanding, there seems to be a difference between the sum of the operating profit of different business divisions and your total operating profit. So where does this difference come from? That is my first question.

And also, the LC Titan operating profit. Well, even compared with the olefin, it seems that your P&L has deteriorated significantly. What is the reason for this? That is my second question.

N
Nak-Seon Sung
executive

[Interpreted] I'm Sung Nak-Seon, the CFO. So let me take up the question about the difference in the operating income. So there is -- seems to be a difference between the total sum and also the disclosed the consolidated basis numbers. So the reason why there is a difference is because the -- there is [ PPL ] write-off for LEM and the Fine Chemical. And so that number is about KRW 55 billion on a quarterly basis, and that's the reason why there seems to be a difference.

U
Unknown Executive

[Interpreted] Yes. Let me ask the second -- answer the second question. I'm [ Kwak Giseop ] from the Strategy Management Division of Basic Chemicals. There are 2 reasons why there's a difference between the performance of olefin and LC Titan. In the case of olefin, the composition of the products that were sold were different from that of LC Titan. In the product portfolio of olefin, it included benzene and BD, these monomer products, which showed a rather strong performance.

The second reason is that for the NCC of LC Titan starting from the month of April for 47 days, there was a turner -- scheduled turnaround that took place and this had a negative adverse impact on the performance.

Operator

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

R
Rui Hua Ong
analyst

So earlier, you mentioned a lot of measures to reduce your CapEx burden and improve the business structurally. So can we get a summary, or can we get your updated CapEx and cash flow guidance over the next 3 years? And I think you mentioned that you are almost done with a list of assets internally that you can downsize. And also, you mentioned that the market environment is not appropriate for selling Basic Chemical assets. Could you maybe share with us how much are you planning to raise from this downsizing? How much cash are you planning to raise from this downsizing of the Basic Chemical asset -- downsizing of the chemical assets. And also, if the market environment is not appropriate for selling Basic Chemical assets, does that mean you're not planning to sell a stake in your naphtha cracker?

And then for the second question, I think Titan has been struggling in terms of its margins for a while, not just even compared to other naphtha crackers in Korea or in the region. So could you share with us, in your opinion, what are some of the biggest reasons why Titan's margins are lower than, let's say, [ LOTTE Chem's ] other naphtha crackers or within the region, for example, lack of specialty downstream, high shipping costs like so -- and then are you taking any measures to improve the profitability.

[Foreign Language]

N
Nak-Seon Sung
executive

[Interpreted] So I'm Sung Nak-Seon, the CFO. Let me take the first question. So yes, in the case of our investment plans, on a consolidated basis, in 2023, our original planned for CapEx was for KRW 3 trillion. But by 2025, actually, that was 2024. The original plan for 2024 was KRW 3 trillion. But by next year, 2025, we're going to reduce that to KRW 1.7 trillion.

And during the CEO Investor Day for 2024 and 2025, we said that for the free cash flow, we intend to reduce KRW 4.9 trillion. Amongst that number, the asset-light strategy takes up KRW 2.3 trillion. Amongst that KRW 4.9 trillion this year, we foresee an improvement of KRW 2 trillion to KRW 2.5 trillion.

M
Min-Woo Kim
executive

[Interpreted] So I'm the CSO. Let me take up the latter part of your question. So basically speaking, we are not yet at a level, where we can talk about -- refer to specific assets or any specific capacity. So we ask for your understanding about this matter. But as has been announced during the CEO Investor Day, reducing the commoditized chemical business within our overall business portfolio is a mid- to longer-term strategy that we intend to pursue going forward.

So when carrying out these more projects to improve our business structure, I was simply trying to emphasize that the view of the potential buyer regarding the market situation of the petrochemical industry does have an impact is reflected on his buying decision. And so, that was what I was trying to say and not that because of this, that because of the market situation, we will not be able to engage in any sales activities.

So there is a difference in terms of the rate of progress by different projects and by different issues. And so, on a project-by-project basis, when the time is right for us to communicate with the market, we will be sure to do so.

U
Unknown Executive

[Interpreted]. So I'm [ Kwak Giseop ], the Head of the Strategy Management Division of Basic Chemicals. And let me take up your question about why the margins are low for LC Titan in Q2. So as I've already noted, there has been the scheduled turnaround that had taken place in Q2 for LC Titan. And also, in the product portfolio of LC Titan the share of polymer products such as PE and PP is quite high.

In the case of Q2 compared to other products, the polymer products market situation was more aggravated, and this was because of the higher maritime shipping cost. And because of the higher fright cost, the makers within the region, they were not able to export to offshore overseas markets, but they increased their sales in the Southeast Asian markets, and this is the reason why competition in this region had intensified.

In order to improve the margins of the LC Titan business, we intend to increase the share of high value-added products in our product portfolio and also enhance our operational efficiency.

Operator

[Interpreted] The following question will be presented by Dong Jin Kang from Hyundai Motor Securities.

D
Dong Jin Kang
analyst

[Interpreted] Yes. I wanted to ask a question about the [ PPL ] write-off that you mentioned regarding the Advanced Materials. So what is the backdrop to this write-off of KRW 55 billion, and you said that it was done on a quarterly basis. Does that mean that it may continue going forward? And how much of a balance remains for this matter?

N
Nak-Seon Sung
executive

[Interpreted] So I'm Sung Nak-Seon, the CFO. So with regards to the [ PPA ] at the time of acquiring the Advanced Materials business and the LOTTE Fine Chemical, in addition to the book value, we have acquired the PPA.

With regards to the remaining years for the write-off, it would depend on the customer value, but typically, it would take from 15 to 20 years. So with regards to the exact balance that remains, I cannot actually disclose the figures at the top of my head at the moment. And so, we will come back to you through our IR team.

K
Kim Yong Ban
executive

[Interpreted] So if you have any additional questions, please ask them now.

Operator

[Interpreted] The following question will be presented by Hyunryul Cho from Samsung Securities.

H
Hyunryul Cho
analyst

[Interpreted] I'm Cho Hyunryul from Samsung Securities. I have one question. So it seems that the macro indicators are coming from China in the month of June, as well as July is deteriorating, and this is also true for the manufacturing sector in the United States. So both United States and in China, it appears that there is a slowdown in demand. So for the Basic Chemicals business, you have mentioned that you are expecting delays in the recovery of demand. Do you think that going forward into the third quarter and fourth quarter, is it your outlook that profitability will continue to deteriorate in the future.

U
Unknown Executive

[Interpreted] So my name is [ Kwak Giseop ], I'm the Head of the Strategy Management Division of Basic Chemicals. If you look at the product spread and also product sales volume at present, our outlook is that there won't be much difference between Q2 and Q3. However, starting from Q3, our outlook is that there can be a gradual recovery for a wide range of different product categories. And so, compared to Q2, I think in Q3 and Q4, we can expect an improvement

U
Unknown Executive

[Interpreted] So I'm [indiscernible], I'm the Head of the Corporate Planning Division of the Advanced Materials. Despite the downturn in the Chinese economy, going into the third quarter, this is the high season for ABS and PC for the downstream industry for ABS and PC. So we believe that sales will be increasing going into the third quarter.

In the case of the Advanced Materials business, in order to counter the slowdown in demand owing to the economic downturn, what we plan to do is increase our market share for key customers and also enhance the quality of our products to expand the sales.

K
Kim Yong Ban
executive

[Interpreted] With this, we would like to close the Q2, 2024 LOTTE Chemical earnings conference call. If you have any further questions, please contact the IR team. We will meet you again in the third quarter. Thank you.

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

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