Lotte Chemical Corp

KRX:011170

Earnings Call Transcript 2023-Q4

[Unknown Executive]

[Interpreted] Good afternoon. This is [ Yong Hoon Kim ], Head of IR at LOTTE Chemical. Thank you for showing interest in joining our conference call this afternoon. We will now start the 2023 Fourth Quarter Earnings Conference Call of LOTTE Chemical.

I will first introduce the company management present today, followed by a presentation of our full year 2023 and Q4 earnings and outlook for 2024 before taking your questions. The presentation will be simultaneously interpreted, but the Q&A session to follow will be consecutively interpreted.

First, let me introduce our management that are present on today's call. First, we have VP and Chief Strategy Officer, Min-Woo Kim; and VP and CFO, [ Nak-Seon Sung ] present. From our Basic Chemicals side, we have our VP, [ Ki-Sub Kwak ] of Strategic Management; VP, [ Kyung Sun Park ] of Monomer Division; EVP, Seung-Ho Yoon of the Polymer Division; VP, [indiscernible] of the Aromatic Division; and VP, [indiscernible] of our Business Development on the Basic Chemicals side.

We also have from the Advanced Materials, our EVP, [indiscernible], Head of Corporate Planning; from LC Titan, we have our CFO, Jean Ching; and from the Battery Materials, VP, [ Kyung-Hoon Seo ]; and from Hydrogen Energy, we have VP, Yong-Hak Kim present on today's call.

First, our 2023 full year earnings. In 2023, revenue was KRW 19,949.1 billion, which is a 10.4% Y-o-Y decrease. Our operating loss was KRW 333.2 billion. In 2023, with the global economic slowdown and geopolitical risks continuing, the recovery of the petrochem industry was delayed. However, LOTTE Chemical focused on operational optimization, including utilization and inventory control, as well as expansion of our strategic products and regional diversification to reduce our operating loss by KRW 429.4 billion on a Y-o-Y basis.

In the case of our Advanced Materials, despite the supply side pressure from new capacity flowing into the market from key products, it was able to maintain solid performance with improved profits Y-o-Y, thanks to the increase in share of high-end compounding products. LC USA continued to record losses due to drop in MEG prices and LOTTE Fine Chemicals profitability declined Y-o-Y due to soft prices of key chemical products driven by the weak economy. LOTTE Energy Materials has been included in our consolidation earnings for 9 months from April last year when the acquisition was completed until December last year.

Next is a look at our Q4 results. First, the agreement to sell LCPL, the Pakistan PTA production company was terminated in January 2024 and LCPL has been re-included in our consolidation as an ongoing business. Also, the P&L of past quarters have been also retrospectively updated. Q4 revenue was KRW 4,907.9 billion, which is a 0.3% Q-o-Q decrease. Operating loss in Q4 was KRW 301.3 billion. Operating margin is a negative 6.1%. In Q4, lower SM prices worked positively on LC USA's profitability and there was a positive FX effect, but the global demand recovery still was delayed and year-end demand was low due to seasonality and naphtha prices increased, which kept product spreads narrow and inventory valuation loss increased in Q4.

Also, there was some PPA amortization of LOTTE Energy Materials acquired in March 2023, which was reflected at once retroactively in Q4, which added to the quarterly loss. The pretax loss was KRW 506.1 billion decrease in quarter-on-quarter due to impairment loss recognition of the Ulsan Plant Aromatics Division and decrease in related company equity method gains.

Next is the financials. In January 2024, LCPL came back into consolidation due to the termination of the sales agreement and also the Ulsan KP Chemtech has been removed from the balance sheet with liquidation completed in November 2023. Assets as of end of Q4 2023 was KRW 33,205 billion, which is an increase Q-o-Q by KRW 252.9 billion.

Cash and cash equivalent was KRW 3,913.9 billion, a decrease by KRW 826 billion on a Q-o-Q basis. Liabilities was KRW 13,235.7 billion, which is an increase of KRW 387.5 billion Q-o-Q. Borrowings was KRW 9,827 billion (sic) [ KRW 9,828 billion ], which is an increase of KRW 360 billion Q-o-Q. Borrowings and debt increased mainly due to new investments such as the LINE Project and the aluminum foil joint venture in the U.S., but our debt-to-equity remains stable at around 66%.

Next is the results and outlook by each of our business lines. In Q4, the Basic Chemicals recorded revenue of KRW 2,766.4 billion and operating loss of KRW 166 billion and the size of loss widened Q-o-Q. Higher naphtha prices led to narrower spreads and inventory valuation loss also increased in Q4. Demand is expected to remain uncertain in Q1 this year and market is unlikely to rebound in the near term. But throughout 2024, the global new capacity volume is expected to be less than last year and we look forward to a gradual improvement in supply dynamics on a full year basis.

For the Advanced Materials, revenue in Q4 was KRW 967.3 billion, operating profit of KRW 36.4 billion, which is an op margin of 3.8%. Due to seasonality, downstream demand decreased, leading to a fall in sales volume and increased supply side pressure. [ ASP ] of key products fell, leading to a Q-o-Q fall in profitability. In Q1 this year, downstream demand is expected to show a slow recovery and higher transport cost due to logistics issues may cause a slight decrease in profitability.

And now moving on to LC Titan's business performance. In Q4 2023, it posted sales of KRW 520.7 billion and operating loss of KRW 61.2 billion. Because the customers carried minimum inventory at the year-end, demand decreased and with the contraction in the product spread due to the increased naphtha price, inventory valuation loss expanded, hurting profitability. Because of the delay in petrochemical industry recovery in Q1 2024, only a limited improvement in profitability is expected, but we will respond accordingly by optimizing operation and adjusting utilization.

Next LC USA. It posted sales of KRW 140.8 billion and operating loss of KRW 9 billion and the operating loss has shrunk over the previous quarter. Product spread improved, thanks to the downward stabilization of the ethane price and plus with the increase in the sales volume, the profitability improved. In Q1 2024, profitability is expected to improve further with the downward trend of the ethane price stabilizing and the price of the product rising.

And now I'd like to walk you through LOTTE Fine Chemical. Since it released its interim financial results -- it will release its financial result today, I will just go over the results briefly and please refer to the earnings presentation of LOTTE Fine Chemical for details. It recorded sales of KRW 411.3 billion and operating income of KRW 8.5 billion and operating ratio of 2.1%. Profitability fell Q-o-Q because of spread squeeze caused by continuous weakening of major product prices and increase in feedstock cost. It appears it will take a while for the chlorine products to recover their international market prices, but we will deal with it by defending price and improving costs.

Demand for industrial products in the Green Material Division is likely to stay weak, but we do expect the sales of food and drug products to pick up as the market demand improves. And lastly, LOTTE Energy Materials. It also had a separate earnings call on the 2nd of February, so I will be very brief. Its sales in Q4 2023 was KRW 229.5 billion and operating income KRW 1.3 billion. It recorded the highest quarterly sales due to securing core customers and increased sales to strategic customers. However, due to lower selling price because of oversupply in the market and logistics issues, profitability fell slightly.

In Q1 2024 customers will lower utilization rate due to sluggish demand for EVs and logistics cost will rise, dampening profitability. But starting from Q2, along with structural diversification of customer base and increase in market share, sales will rise significantly, improving profitability. Of the major investment plans, I'd like to explain to you first the projects that have already been completed recently, 10,000 ton capacity increase in Yeosu, Hecellose and EOA capacity increase, as well as EC/DMC line construction for battery electrolyte organic solvent were completed as planned. After commissioning, the plant will go into commercial operation. The EMC/DEC lines for battery electrolyte organic solvent are expected to reach mechanical completion in the first half 2024.

Other projects are well underway following respective schedules. The U.S. aluminum foil JV had incurred an additional investment of [ $80 million ] due to an increase in budget owing to a rise in construction costs in North America and increase in facilities.

This concludes the earnings presentation for Q4 '23 and Q1 outlook for 2024. And now I'd like to hand it over to our CSO, Mr. Min-Woo Kim, to say a few words about the major issues and future outlook.

[Min-Woo Kim, executive]

[Interpreted] Hello, everyone. I am Min-Woo Kim, the CSO for LOTTE Chemical. I'd like to thank the investors and analysts for attending today's earnings call despite your busy schedules. At the outset, I want to mention how we regret to report on Q4 somewhat unsatisfactory performance, which falls short of your expectations. In Q3, thanks to the positive lagging effect of the feedstock price, the amount of loss incurred in the basic petrochemical business contracted, leading to a profitable turnaround in operating income.

But in Q4, due to the regular maintenance of the suppliers, the naphtha price strengthened while the product demand weakened, delaying the spread improvement, worsening profitability and ultimately recording a minus with a larger inventory valuation loss. And the loss incurred -- and the loss increased due to a one-off factor of applying some of LOTTE Energy Materials PPA amortization retroactively. But as we have reiterated, looking at the mid- to long-term industrial cycle, we have bottomed out in the second half 2022. Although there was added global capacity of approximately 10 million tons of ethylene both in 2022 and 2023, LOTTE Chemical's operating loss reduced from KRW 760 billion in 2022 to KRW 330 billion a year later.

Uncertainties in the major business environment persist, such as volatility in logistics cost and high feedstock cost due to the geopolitical risks in Europe and the Middle East. Therefore, it's not easy to specify the turnaround time. With 4.2 million tons of ethylene coming on board in 2024, which is less than half of last year, hopefully, the market and the business environment will gradually improve. The company's actual borrowings increased due to the recent large-scale investment and delay in market recovery, but the debt ratio is being maintained at a fair 60% level. We will exert best effort possible for making on schedule and on budget investment in projects for corporate value enhancement and portfolio upgrade.

In order to expand the company's core new business of Battery Materials, we will continue to implement the policy of securing the global optimum production hub for aluminum and copper foils. We will also be proactive in the Hydrogen Energy business. We will align in a timely manner the demand side of the market development to the dynamic business environment such as production hub strategy for securing green ammonia and developing hydrogen fuel cells. To heighten the competitiveness of petrochemical business, we will focus on product upgrades such as increasing polymer strategic products and strengthening EO derivative business, and rationalize less profitable businesses that are not aligned to the strategic direction.

Despite the challenging industry situation, the company is creating on average more than KRW 200 billion of cash every quarter. We are very much aware, however, of the investors' concerns about the delay in market recovery. For the sake of financial soundness, we will review investments other than the core investment and essential recurring investment with a more conservative lens, adjust the time frame as need be, and depending on the visibility of market recovery, we will execute the investments within EBITDA. Lastly, a few words on 2023 year-end dividend. The company aims to maintain a dividend payout ratio of 30% on a separated income basis to accommodate the need for dividend stability to enhance shareholder value, we determine the dividend considering both payout ratio and dividend yield ratio.

Although we are going through the toughest times, posting a negative profit for an unprecedented 2 consecutive years amid the rapidly deteriorating petrochemical market, we are committed to honoring the trust given us by the shareholders. Following from last year, we have internally reviewed this year again a DPS at KRW 3,500. The final decision will be made at the general shareholders' meeting in March, so please make note of that. As we shared with you through the disclosure in October last year, we will extend the shareholder return policy period for another 2 more years, during which we will faithfully implement shareholder return policies, including share buyback of KRW 300 billion as had been promised.

As part of such effort, we have completed the buyback of KRW 50 billion in 2022 and another KRW 50 billion in 2023. Challenging times have prolonged, but the investment for competitive business improvement and achieving our vision will continue. At the same time, we will execute shareholder return policy faithfully to meet your expectation.

Thank you for your support. Thank you very much.

[Operator]

[Operator Instructions]

[Interpreted] The first question will be presented by Sunghyun Hwang from Eugene Investment & Securities.

[Sung Hyun Hwang, analyst]

[Interpreted] I have 2 questions. The first question is about recent news that China may start to import -- to impose import duties on chemicals made, originating from Taiwan. If that happens, what kind of positive effect does the company expect? Do you think that there will be any impact on supply and demand? I would appreciate if you could answer that by product. Second question is about Standard Energy, where you've already made an investment.

My understanding is that Standard Energy is pursuing mass production. Related with that, can you share with us the schedule time line or the size of the vanadium electrolyte supply that the company expects to make in connection with Standard Energy? I also understand that Standard Energy is collaborating with KEPCO to do some tests regarding ESS. Can you give us some updates and any positive impact that may have on the company?

[Seung-ho Yoon, executive]

[Interpreted] To answer your first question, this is Seung-Ho Yoon of the Polymer Division. As you mentioned, starting from January 1st, China started to impose an import duty of 6.5% on block PP products originating from Taiwan. Our information is that within China, Taiwanese originating PP block accounts for about 22%.

Given that there would be this additional import duty imposed on block PP from Taiwan, this we believe is likely to improve the price competitiveness of block PPs originating from Korea and also increase the chances of block PP produced in LC Titan Malaysia becoming a replacement. Also for your information, in the makeup of RPP rather than block PP, LC Chemical's block PP is mainly sold as [indiscernible] or a random which is higher value add.

[Kyung-hoon Seo, executive]

[Interpreted] This is Kyung-Hoon Seo of the Battery Development Division, I'll take your second question was about -- which was about Standard Energy. Currently, the standard, organization standard for vanadium batteries have been established and Standard Energy's technology is currently undergoing certification under that standard. Considering that, we are expecting that Standard Energy will be able to start commercial sales of its products within this year.

You've asked about the supply of our vanadium electrolyte to Standard Energy. LOTTE Chemical already invested around KRW 13 billion last year for the facility. It has been already completed. It started commercial production from last year and we expect to also continue supply of the vanadium electrolytes this year.

You've also asked about the testing and the proofing project that's going on using the vanadium batteries for ESS. There were reports in the media of this last November. The project is continuing, ongoing. It's participated by Standard Energy KEPCO and LOTTE Chemical is also a party to that project.

Also my understanding is that there are also other testing and proofing projects going on, but I hope you will inquire Standard Energy directly for further details.

[Operator]

[Interpreted] The next question will be presented by Peiji Liang from JPMorgan.

[Peiji Liang, analyst]

My first question is, could you share with us the one-off impact in fourth quarter and the breakdown by division? For example, how much negatives from your raw material, feedstock lag, inventory loss, maintenance, et cetera? Second question is, could you share first the CapEx breakdown by division for 2023, 2024 and 2025? So early on you mentioned that given the weak cash generation and potentially weaker outlook for certain divisions, you might review investments for some projects aside from your core investment areas. So could you give us a sense of which projects or which areas would be under review?

For example, would it be a LINE Project maybe delayed or maybe after acquiring Iljin, maybe you'll reassess some of the battery fall expansions. So maybe could you just give us a sense of what kind of reviews you're considering? And lastly, earlier you made some comments on vanadium battery. I think previously, there was a loose target to increase your revenue to maybe like KRW 320 billion by 2030. And I think for 2025, I have like KRW 30 billion in my model. Could you give us a sense of what kind of margins you're expecting to get from that?

[Unknown Executive]

[Interpreted] This is the -- this is Ki-Sub Kwak of the Strategic Management division. I'll take your first question about the detailed breakdown of the lagging, the feedstock lagging effect and the inventory valuation loss. Most of that in Q4 was recognized in our Basic Chemicals and LC Titan which has the larger sizes.

In terms of the inventory valuation loss, the impact for the Basic Materials -- Basic Chemicals was a decrease of operating profit by around KRW 60 billion and [Technical Difficulty] also saw a similar impact of around KRW 60 billion decrease in its operating level.

And then there was the lagging effect from the decrease in naphtha prices. That lagging effect at our Basic Chemicals Division was a decrease of its operating profit by around KRW 60 billion and LC Titan saw a decrease of its operating profit by around KRW 60 billion due to this lagging effect.

Our CapEx for 2024 is KRW 1 trillion on LC -- LC Chem -- LOTTE Chemical LC standalone basis and KRW 3.6 trillion on a consolidated basis. In terms of our CapEx and investments, our basic policy going forward is to maintain tight financial control over the new expansions and operating investments that need to be made, but to focus more on the future growth areas such as batteries and hydrogen businesses, and to adjust some of the investment plans that we have for our existing businesses.

[Min-Woo Kim, executive]

[Interpreted] This is the CSO, Min-Woo Kim. I'd like to add on a few comments for our CapEx.

What I wanted to add was about the LINE Project. I think during the question you've suggested perhaps that, that may be up for review. However, regarding the Indonesian cracker investments and the joint venture with GS, these are projects that have already been completed in terms of EPC or construction is ongoing. Given the fact that, that has already been made, we think that at this point our best decision is to pursue these projects on schedule to complete them as originally planned.

Now regarding the other projects, we are reviewing the other projects from point -- from the starting point again, we are reviewing them with a fresh look. During your question, you've also mentioned the Energy Materials investment. We are aware that the downstream outlook has turned negative recently, and so while we will make the investments into the projects under Energy Materials, we may revisit and adjust, for example, the timing of when the investments are executed.

So that I think the best way of describing our CapEx strategy is to have a review of each of our investment projects on a project by project basis while we will maintain our mid- to long-term strategy.

[Unknown Executive]

[Interpreted] And then I'll answer your third question about the vanadium batteries. This is [indiscernible] of the Battery Materials Division.

Now the vanadium standard, the industry standard was adopted end of last year. Currently, we're going through certification, which is already a few years later -- delayed than originally scheduled.

Because of this delay in the certification of the standard, there has been a delay in terms of proof of technology and also commercial production. Given that there was a delay in overall time line, we are currently reviewing our vanadium business plans and will communicate with the market once we have details.

[Operator]

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

[Hyunryul Cho, analyst]

[Interpreted] I have 2 questions. My first question is about your outlook of your Chemical businesses. I think during your presentation, you've shared your view that overall at an industry level, the down cycle seems to have been passed and that in 2024, you're expecting your business performance to gradually improve as the supply increases decrease versus the previous years. But can you give us a bit more detailed outlook by product? So across 2024 and 2025, by product, what kind of improvement do you expect?

And in terms of timing, where do you think the improvement will happen first? Which product do you think will start to look better first? Second question is the issue related with LOTTE Construction & Engineering -- LOTTE Engineering & Construction, E&C. There is the issue of the project financing and also the hedge funds is expected to come due in March. There are concerns in the market that subsidiaries and affiliates, including LOTTE Chemical may end up having to support more into LOTTE E&C. If the hedge fund is refinanced at a larger size, it appears inevitable that LOTTE Chemical will have to bear more support for it. What kind of support can the market expect LOTTE Chemical having to bear?

[Min-Woo Kim, executive]

[Interpreted] This is CSO, Min-Woo Kim. I'll answer your first question.

As you mentioned, we do feel that the bottom of the down cycle has definitely passed and that the direction has turned upward. However, there are various factors that may affect the pace as well as the magnitude of improvement.

Also as we have been mentioning for the past several quarters, we are aware that the petrochemical companies within the region are operating at moderated utilization rates, which means that if the market environment improves, there is some capacity utilization that is standing by to come online which may limit the size of improvement that can actually happen at the business end.

Also in terms of the outlook, we think that on the supply side, the supply situation has been improving significantly compared to the past. It's just on the demand side the recovery may not be as strong.

Now during the question, even though you've asked whether we see any differences in recovery timing by product, given the fact that the overall market situation is being impacted by general factors such as the weak economy, delayed recovery of demand, and also rather subdued market sentiment, we do not really see much difference from product to product.

That said, we do think that there is opportunity of profitability being differentiated from product to product due to some recent issues such as the global logistics difficulties that has been triggered due to the Red Sea issue and also the differences in supply and demand region by region.

[Unknown Executive]

[Interpreted] Your second question was about the LOTTE E&C contingency. I -- this is CFO, Nak-Seon Sung, and I'll be answering that question. If we look at the PF contingent liability, that size has reduced from KRW 6.9 trillion as of end of 2002 (sic) [ 2022 ] to -- it decreased by around [ KRW 1 trillion ] during the 2023 1-year period.

Throughout 2024, we expect that, that contingent liability could be further reduced by additional KRW 2 trillion as the loans are switched over to main PF loans and also there is earnings from the sales of the properties. As you mentioned, the fund that was raised through Meritz Securities does come due at March this year. That existing fund size is about KRW 1.5 trillion. Our understanding is that there is the next fund being raised currently at a target size of KRW 2 trillion and that fund is going to be funded. Current plan is by Korean commercial banks, securities companies and LOTTE affiliates.

Even with this additional funds being raised, we do not expect that the contribution from LOTTE affiliates would be large. Also as you may have heard, in order to support the liquidity of LOTTE E&C, LOTTE Chemical has provided a payment guarantee on the KRW 200 billion corporate bond that was issued as of today.

[Operator]

[Operator Instructions]

[Unknown Executive]

[Interpreted] We're having the last call for questions. If you have any questions, please -- we -- please ask for your opportunity. We will wait a few moments before ending the call.

That completes our conference call for 2023 fourth quarter. If you have any further questions, please forward them to the IR team. Thank you.

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