Lotte Chemical Corp

KRX:011170

Earnings Call Transcript 2024-Q3

[Kim Yong Ban, executive]

[Interpreted] Good afternoon. This is Kim Yong Ban, Head of the IR team at Lotte Chemical. We will now begin the Q3 2024 earnings release conference call for Lotte Chemical. We will start with an introduction of the executives, followed by a presentation of the company's Q3 business performance and outlook then a Q&A session. Please be informed that the presentation will be conducted in simultaneous interpretation and the Q&A in consecutive interpretation.

I will now introduce the executives in attendance. First, from the HQ, Vice President and CFO, Sung Nak-Seon; and Vice President and CFO, Kim Min-Woo.

From Basic Chemical Vice President, Kwak Giseop, Head of the Strategy Management Division; Vice President, Park Kyo Sung, Head of Monomer Division; Executive Vice President, Yoon Seung-Ho, Head of the Polymer Division; Vice President, Bae Sung Soo, Head of Aromatic Division; Vice President, [indiscernible], Head of Business Development Corporate Planning Division.

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

Let me now turn to business results of Q3 2024. Revenue in Q3 was KRW 5.2002 trillion, down 0.9% Q-o-Q. There was operating loss of KRW 413.6 billion, widening from the previous quarter. This is due to the falling spread and rising one-off costs and the increasing loss from Basic Chemical. Pretax income fell by KRW 592.1 billion Q-o-Q as a result of lower valuation gain on equity investment in subsidiaries and decrease in gain on equity method.

Next is the company's financial position. Asset at the end of Q3 2024 was KRW 34.487 trillion, down by KRW 1.228 trillion Q-on-Q. Cash and cash equivalents was KRW 3.6106 trillion, down by KRW 580.1 trillion. Liabilities are KRW 14.8278 trillion, down KRW 511 billion Q-o-Q. Borrowings are KRW 10.7225 trillion, lower by KRW 360.2 billion Q-o-Q. Debt-to-equity ratio stood at 75.4% and net debt-to-equity ratio at 36.1%, largely unchanged.

Next, I would like to go over the performance and outlook by each business. In Q3, the Basic Chemical business recorded sales of KRW 3,628.2 billion with an operating loss of KRW 365 billion, further widening the deficit. Although the raw material price decline in Q3 [indiscernible] due to the decline in selling prices caused by the delay of recovery in demand and currency depreciation. In addition, we incurred the opportunity to cost approximately KRW 90 billion due to the partial maintenance of our subsidiary LC USA and the deficit further widen due to higher ocean freight costs.

Looking ahead to Q4, we expect profitability to improve compared to the previous quarter as ocean freight costs stabilized and one-off effects such as the partial maintenance of the subsidiary are expected to disappear. In the mid to long term, we also expect a gradual improvement in supply and demand with raw material prices stabilizing and a reduction in global capacity expansion.

Next on Advanced Materials business. In Q3, Advanced Materials business recorded sales of KRW 1,121.7 billion and an operating profit of KRW 38.1 billion, achieving operating profit margin of 3.4%. Profitability declined in sales volumes and product spreads narrowed in response to higher ocean freight costs and slow demand from downstream industries.

In the fourth quarter, we saw ocean freight rates to stabilize downwards, but profitability is expected to be flat. We entered the seasonal slowdown and customers make year-end inventory adjustments.

Next is LOTTE Fine Chemical. LOTTE Fine Chemical already announced its earnings on October 31. I will just cover the results briefly. For more details, please refer to the LOTTE Fine Chemical earnings presentation materials.

In Q3 of '24, LOTTE Fine Chemical recorded sales in of KRW 420.4 billion, with operating profit of KRW 10.3 billion, achieving operating profit margin of 2.5%. In Q3, profitability declined due to continued weakness in chlorine relative market and reduced sales of ammonia relative products. In Q4, international prices and sales volume of chlorine and ammonia relative products are expected to increase and green material products will see higher sales, thanks to active promotion activities.

Lastly, LOTTE Energy Materials. It also held a separate earnings call on November 1. I will just briefly summarize the results. In Q3 of 2024, LOTTE Energy Materials posted sales of KRW 211.4 billion, with an operating loss of KRW 31.7 billion, resulting in an operating profit margin of minus 50%. In Q3 reduced sales due to lower demand in downstream currency depreciation and higher inventory values and losses resulted in a shift to deficit.

In -- sales in Americas -- North America are expected to increase in Q4 as new joint venture plant start mass producing for a key customer. However, demand recovery in the European market is likely to be limited due to customer inventory adjustments.

This concludes the presentation of the '24 Q3 results and outlook. Now CFO, Sung Nak-Seon, will discuss Lotte Chemicals key issues and future outlook.

[Nak-Seon Sung, executive]

[Interpreted] Great. Thanks. This is Sung Nak-Seon, the CFO of Lotte Chemical. I would like to extend my sincere gratitude to all the investors and capital market participants for taking the time to attend our earnings presentation amidst your busy schedules. We regret to report that our performance in the third quarter did not meet the expectations of our investors.

In Q3, product spread declined due to the delayed recovery in demand and the currency depreciation, wide one-off costs from the partial maintenance of overseas subsidiary and higher ocean freight costs to widen our losses compared to the previous quarter. In Q4, we anticipate that ocean freight costs will stabilize and the one-off factors that occurred in Q3 will be removed.

From a medium- to long-term industry cycle perspective, we expect that supply and demand will gradually improve as global supply pressures ease international [indiscernible] rates are cut and the economy recovers. However, we can acknowledge that in the short term, geopolitical risks and the ongoing downturn in the chemistry industry may continue to pose challenges.

In response, as we mentioned in the previous earnings call, we are focusing our efforts on areas where we can exert more control to secure financial soundness. As part of these efforts in October, we secured approximately KRW 700 billion through the sale of our US LCA shares with our PRS disagreement as disclosed. Additionally, we plan to expedite the sale of our Indonesian SCI shares to secure a total of KRW 1.4 trillion through further PRS transaction.

In line with our ongoing basic chemical asset light strategy, we have also decided to liquidate our Malaysian [indiscernible] of copper manufacturing subsidiary, LUSR. We will continue to actively evaluate and execute strategic withdrawal from noncore low-profit businesses.

On the operational efficiency front, we will continue to generate liquidity from working capital, optimize planned operations and reduce cost through our operational excellence project, which was implemented at the Yeosu site in the first half of the year and expanded to the testing site in the second half. We will continue to identify additional areas where we can generate FCF in our day-to-day operations. While prioritizing these short-term activities to improve financial stability, we continue to develop new businesses to enhance our portfolio.

In the Hydrogen Energy business, one of the pillars of our portfolio expansion, we won an additional 40 megawatts from the general hydrogen energy market through both the SK [indiscernible] in September. A total of 80-megawatt of eco-friendly hydrogen power plant, including 20 megawatts from the tender in August last year and 20-megawatt from the RPS will be built at our [indiscernible] site side and we sequentially delivered from 25 September onwards.

Despite the challenging business environment, we will continue to improve the competitiveness of our existing businesses and prepare for sustainable growth. At the same time, we will do our best to meet the expectations of our investors by safely implementing our announced shareholder return policy. We ask for your continued support. Thank you.

[Operator]

[Interpreted] [Operator Instructions]

[Interpreted] The first question will be provided by [indiscernible] from [indiscernible] Securities. .

[Unknown Analyst]

[Interpreted] I have 2. Now first is a simple one. Now with the LC USA increasing its natural gas production, then this is likely to mean that the ethane price is going to fall in the near future. And does this mean that the company's profitability will also be increasing from the fourth quarter of this year or potentially in the first half of next year?

And the second question is, it seems like there are a lot of planning in the pipeline about a new investment as well as facilities increase, for example, line, et cetera. But then given the current capital efficiency of the company as well as the current financial structure, does the company believe that these projects will be able to move on smoothly without a hitch?

[Unknown Executive]

[Interpreted] This is Kwak Giseop from the Strategy Management Division responding to the first part of your question. Now first of all, about the ethane price in the U.S., last year, it was $186 per tonne. This year, it is $150 per tonne. As you can see, due to the increase in the natural gas stock, the ethane price has come down.

And after the shutdown in the cracker in the Q3, the LC USA is currently -- its plant is currently in normal operation. And as a result, we do believe that there is going to be an improvement in the profitability in the fourth quarter, leading to a turnaround.

[Nak-Seon Sung, executive]

[Interpreted] This is Sung Nak-Seon, the CFO, responding to the second part of your question. Now regarding the investment, whether they will be able to continue on schedule, I would like to inform you that our capital planning is reflective of all the needs for the investment already. So for the investment plan for the first half of next year, they will move on as scheduled.

[Operator]

[Interpreted] The following question will be presented by Woo-Jae Jeon from KB Securities.

[Woo-Jae Jeon, analyst]

[Interpreted] I have 3 questions. First is about the maintenance in the LC USA. Could you elaborate on the causes of the maintenance? And is there any likelihood of this repeating itself in the future? And related to this, I believe that the maintenance would have also affected the utilization rate. So what does the company see as impact in the fourth quarter in terms of the utilization?

And then for the new products, next year, we see that, for example, hydrogen shipping as well as hydrogen generation is planned for the first half of next year. So what is the expected revenue for each of the new products and also for the PNAC product, has the company secured any customer base in the IT sector yet?

[Unknown Executive]

[Interpreted] This is Kwak Giseop from the Strategy Management division of the Basic Chemical responding to the first part of your question. Now the maintenance in the LC USA was required by the failure in the cold box in the cracker. And to make sure that -- so because the company puts safety first, we have consulted this with the vendor, and we got the view that it would be best rather than to continue with the operations, it would be best to go ahead and repair and provide maintenance for this facility, and that is what we have done. And given that we have given sufficient time and effort for repairing this facility in accordance to the views [indiscernible] the vendor, we do not believe that the problem will be repeated.

[Unknown Executive]

[Interpreted] This is Kim Yong-Hak from the Hydrogen Energy Division responding to your second part of your question about the hydrogen shipping center as well as the hydrogen generation.

First of all, the shipping center business will be conducted by Lotte Chemicals subsidiary, the LOTTE Air Liquide [indiscernible]. And the revenue will be KRW 31.5 billion, operating profit KRW 9 billion, operating profit margin, 30%. The sales have been 100% completed. So this means that we will be seeing the operating profit as early as next year and at the latest by 2026.

And about the hydrogen generation, this will be conducted by LOTTE [indiscernible], another subsidiary of ours. And in the first half of next year, 20 megawatts will be completed. And this will translate into KRW 42 billion in revenue, KRW 6 billion in operating profit and 15% of operating profit margin.

[Min-Woo Kim, executive]

[Interpreted] This is Kim Min-Woo, the CSO. TMAC is a product of the Fine Chemicals. So obviously, you would have to refer to Fine Chemical for details of the response. But allow me to provide my response to the best of my knowledge.

Now TMAC that is produced by Fine Chemical will be used for the PMAH that will be produced by Hyundai Chemical, which is a 50% owned subsidiary of Lotte Chemical. So the TMAC that is produced by Hyundai Chemical is used mostly for semiconductor cleanser as well as display. So most of the customers are the semiconductor companies of Korea. .

So in terms of production ramp-up capacity -- ramp-up planning, this would obviously be tied to any ramp-up planning by the customer as well as the qualification planning. So for any potential ramp-up of the TMAC would then be linked to potential ramp-up of the TMAH. So to conclude my response, then you can -- I can say that we have secured our customer base.

Please go ahead with your further questions.

[Operator]

[Interpreted] The following question will be presented by Gino Kim from Eugene Investment & Securities.

[Unknown Analyst]

[Interpreted] I have one question, and that is about the Chinese energy efficiency environment regulation. Now according to this regulation, what percentage of the facilities does the company expect to be -- to see shutdown? So if you could give any specific number, please?

[Unknown Executive]

[Interpreted] This is Park Kyo Sung from the Basic Chemical Monomer Division. Now basically, the facilities that are noncompliant to the Chinese regulations in terms of the ethylene capacity would be about 30%. So this is part of the Chinese government effort to integrate the -- their industry from refinery to the chemicals between the public and the private sector. So they are conducting a large-scale project for this purpose. And what they're trying to do is to scrap the facilities that are either outdated like over 30 years old, or too small in scale, for example, with ethylene supply capacity of less than 300,000 tonnes per year.

And also they are planning to integrate the facilities into larger scale facilities in the petrochemical and the refinery industry and by restructuring and upgrading the facilities, what the Chinese government is aiming for is to improve the cost efficiency and also to enhance the productivity.

As I mentioned earlier, the noncompliant facilities in terms of the ethylene production capacity would be about 15 million tonnes, and this would be more than offset by the over 20 million tonnes of new incremental facilities to go into operation for the 3 years from 2026 to 2028. But then we do intend to keep an eye on any consequences from the regulations impact as it could potentially limit the additional supply capacity coming out of China.

[Yoon Seung Ho, executive]

[Interpreted] And this is Yoon Seung-Ho from the Basic Chemical Polymer Division, adding my comments to this in terms of the potential impact on the polymer business. So because of the regulation, it is also likely that by 2030, under the polymer products than the for PE, about 12 million tonnes per year of facilities and for PP, 6.5 million tonnes per year of facilities would be shut down.

And this is going to be equivalent to about 18% of the total PE production coming out of China as of 2030 and 11% of total PP production by 2030.

[Operator]

[Interpreted] The following question will be presented by Hyunkoo Chang from Heungkuk Securities.

[Hyunkoo Chang, analyst]

[Interpreted] Now I have 4 questions. First is about the ethylene supply and demand next year. So what is the company's outlook for the ethylene demand and supply next year?

And second question is about the Chinese market. So since the economic stimulus package provided by the Chinese government in September, are there any changes in the market situation in China? Or if not, then will there be any such changes or uptick in the situation in next year, 2025?

And the third question is, now with the reelection of Trump, how will this bode for the Asian petrochemical market? Will this be negative or positive?

And the fourth question is the PRS contract that the company has with the U.S. -- regarding the U.S. subsidiary, it is the MEG production subsidiary, not ECC. So does this mean that the company is also planning to shift away from the MEG downstream, meaning that there will be another direction for the downstream business?

[Unknown Executive]

[Interpreted] This is Park Kyo Sung from the Basic Chemical Monomer Division. I would like to respond to your first question about the global ethylene new capacity buildup as well as supply and demand outlook.

Now the ethylene capacity buildup for this year is all coming out of China. So in the first half of this year, there was a small-scale capacity buildup in the volume of 800,000 tonnes coming from 3 companies whose capacity buildup plan was delayed from last year.

And for the second half of this year, total 4.2 million tonnes of capacity buildup was planned, out of which 3 million tonnes has been deferred to next year.

Now of the capacity buildup plan among the major global companies, some of the petrochemical integration planning by Middle Eastern countries is also being delayed -- is being reduced.

For example, the Saudi Arabian Aramco actually has canceled its plan to construct a new plant, a new chemical plant and instead opted to invest more in Asia by investing in joint venture in the region in a way to handle the demand [indiscernible]. And for the next 4 years, from next year to 2028, the global capacity buildup for ethylene is going to be 33 million tonnes and of which 6 million tonnes will be coming from the Middle East.

And for the next 4 years, the global ethylene demand is projected to grow by 4% to 5% per annum reaching about 26 million tonnes per year by then -- 26 million tonnes, yes by then.

But then the incremental supply is going to outpace the demand, meaning that it is going to keep the utilization rate at around 80% to 85%.

[Yoon Seung Ho, executive]

[Interpreted] This is Yoon Seung-Ho from the Basic Chemical Polymer Division responding to the second part of your question. Now China has announced a series of stimulus policies this year. So in the first half of this year, there was a stimulus on infrastructure as well as facilities and also the trade-in policies for electronic consumer, electronic goods as well as automobiles. And then coming into September and October, they cut rates and also try to stimulate domestic demand in areas like real estate.

And then for the -- in October, China's PMI, we see that the PMI has gone over 50%, moving -- exceeding the level in the past 6 months. So we see that perhaps impact was not that large, but then yes, there was some visible impact. And also for the spread for PE and PP, we are also seeing a widening spread compared to August and September.

Now having said that, the consumer sentiment in China still remains sluggish due to the low disposable income as well as lack of the asset or the wealth effect coming from the real estate. And it is -- and we cannot expect the kind of stimulus packages that we have seen in the past.

But then additional stimulus policies are expected December and on. So for the industry overall, then it is likely that in 2024, there is going to be some more positive effects to be gained from the stimulus policies.

[Unknown Executive]

[Interpreted] This is Kwak Giseop from the Basic Chemical Strategy Management Division, responding to your third question.

Well, for the time being, it would be quite difficult for us to predict the kind of impact that the Trump second term is going to have on the Asian [indiscernible] market. But then what the market has already seen from the previous experience, the policies that we can likely to expect. For example, the deregulation on fossil fuel and also increased production of energy are likely to drive down energy prices. That obviously is going to be positive for the refining and petrochemical industries. But on the flip side, stronger protectionism in the form of increased tariffs are likely to weigh down on trade and exports.

So as you can see, there are going to be a complex set of factors, meaning that this could potentially drive up uncertainties in the market. So the company will remain attentive to any trends or changes in the market situation and we'll be ready to respond agilely and quickly whenever necessary.

[Nak-Seon Sung, executive]

[Interpreted] This is Sung Nak-Seon, the CFO responding to your fourth question. The PRS was executed as part of the asset-light initiative, and there is no additional investment that is being planned by LC USA in the downstream.

[Operator]

[Interpreted] the following question will be presented by Parsley Ong from JPMorgan.

[Rui Hua Ong, analyst]

This is Parsley. So the first question is, could you give us an update on your CapEx outlook? I see on Page 9 of your slide, you still have quite a lot of new project expansions, but especially in the battery materials space. But given the U.S. election outcome, do you see potential for any changes in your plans?

And then the second question is actually for Lotte, the company's earnings have been weak for quite a while. So could you remind us what are some of your key strategies in this current environment where we have weaker for longer chemicals spreads and uncertain outlook for batteries? Then could you tell us what are your key strategies to improve your business profit structurally and return to profit? And do you have a target on when you expect to return to profit?

The third question is, I see that you have your Indonesia line cracker starting in mid-2025. Could you -- and right now, your other 2 [indiscernible] crackers are kind of loss-making. So could you remind us what is the difference in the cost base for your Indonesia cracker versus your existing other naphtha crackers? Should we expect it to have better margins than the rest? And if so, then where does this margin advantage come from?

[Nak-Seon Sung, executive]

[Interpreted] This is Sung Nak-Seon, the CFO responding to your first question. Now in terms of the investment, so we have the investment reduction plan that we came out with in the first part of the year. So except for the LEM Spain investment, which we have deferred to until 2025, there are no other changes, and we plan to continue as planned. And for next year, we have made additional review to the investment reduction plan and added -- so we have -- we plan to reduce this by KRW 1.7 trillion.

As for the CapEx, we have not determined the reduction plan compared to the medium to long plan after 2025. And the reduction plan will be finalized depending on the financial soundness of the company. Having said that, the CapEx in 2025 will stay within the EBITDA level.

[Min-Woo Kim, executive]

[Interpreted] This is Kim Min-Woo, the CSO responding to the second question. I believe that it would be realistic for me to say that any turnaround to profit in the existing business would be promised on improvement in the market situation. And for the market improvement for the existing products, we believe that there are 2 points for expectation.

First is the potential overall improvement in the demand and supply dynamics. For example, improvement in demand and also the completion of the capacity buildup.

And second, what we have experienced so far is that due to the Russia, Ukraine war, in terms of the procurement of the feedstock, we believe that there is quite a lot of competition with the players who have access to the Russian feedstock.

So then from these 2 perspectives, if there is a market pick up, then this would also mean that for our existing businesses, we could also look forward to improvement in profitability.

Now in terms of our mid- to long-term strategy, we are obviously aligned with the message that our CEO has given to the investors recently. So basically, we will continue to maintain our fiscal soundness as we try to transform our business platform -- our business portfolio. And also for the businesses that have been sluggish for some time, for example, the basic materials, we will also try to lighten the asset in what we call the asset-light initiative.

So I cannot go into detail regarding each and every asset type. But then basically, we have differentiated between the core assets and the noncore assets. So for the facilities that are low in efficiency or for the facilities that we can operate on our own, then we could shut down some of these facilities.

And also for other assets, for example, the Pakistani subsidiary, we could choose to hand over the management rights of this company. And then for LINE, we could also decide to attract part of the -- attract some investment into the company. By doing so, we could also lower our burden -- financial burden on the company.

But again, for these types of asset yields, again, these would have to be linked with the market improvement. And also for the LINE project, this would also be premised on successful start-up. So what we intend to do now is to move ahead as planned in transforming our business portfolio. And as we continue to move forward, whenever the plan is ready for each asset, then we will communicate this to the market in due time.

[Unknown Executive]

[Interpreted] This is [indiscernible] from Basic Chemical Business Development Corporate Planning team. I would like to respond to your third question. Now for LINE, it is designed to accommodate a feedstock [indiscernible] up to 50%. So with such design security in terms of the facilities and also with its geographic proximity to the Middle East, which will help source LPG at a more competitive price. We do believe that we have secured the cost competitiveness for LINE. And also, as for the downstream product, polypropylene, in Indonesia, the rate of self-sufficiency now is 40%.

And even after 2025, when the LINE project and especially the PP plant goes into operation, we believe that the demand and supply will remain tight, meaning that it is going to bode well for the pricing. That is all. Thank you.

[Unknown Executive]

[Interpreted] So that concludes the earnings release conference call for the third quarter 2024 by Lotte Chemical. Thank you very much for your participation. And if there are any further comments or questions, then please contact the IR team. We will see you again at the next earnings conference call for the fourth quarter. Thank you.

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