Asahi Kasei Corp

TSE:3407

Earnings Call Transcript 2018-Q3

[Kiyoteru Kadokura, executive]

Welcome to the conference call on Asahi Kasei Corporation's earnings for the third quarter that ended December 31, 2017. We will begin with a presentation from Mr. Shuichi Sakamoto, CFO, and then take questions.

Other participants from Asahi Kasei are Daichi Arima, from Corporate Accounting and Control; Toshiyasu Horie, from Petrochemicals Strategic Business Unit or SBU; Yukifumi Kuwaba, from Performance Polymers SBU; Akira Fukuda, from Separators SBU; Hideharu Takashima, from Asahi Kasei Microdevices Corporation; Toru Tomioka, from Asahi Kasei Homes Corporation; Tadahiro Hama, from Asahi Kasei Pharma Corporation; and Kiyoteru Kadokura, from Investor Relations.

First, Mr. Sakamoto, please.

[Shuichi Sakamoto, executive]

Thank you very much for joining us for the earnings briefings for the third quarter of FY 2017. In the October to December quarter. Earnings were steady, thanks to shipment volume growth for each business category on the back of firm demand, higher market prices of petrochemical products and the weaker Japanese yen.

For the first 3 quarters from April to December, net sales, operating income, ordinary income and net income all increased from the same period last year to highest-ever levels, thanks to shipment volume growth, improved terms of trade and the tax reform in the United States.

Accordingly, we have upward revised the full year forecast for all these figures from the previous forecast published in November, although there are some uncertainties regarding the foreign exchange rate and crude oil prices. We are, thus, expecting the best year ever.

Please now turn to Slide 4 of the presentation material. Net sales in the first 3 quarters came to JPY 1,484.5 billion, up JPY 127.7 billion or 9.4% from the same period previous year.

Operating income came to JPY 149.2 billion, up JPY 35.1 billion or 30.7% year-on-year.

Strong sales for business categories under the Materials segment, firm performance of Critical Care, improved terms of trade for acrylonitrile or AN and synthetic rubber were main drivers of this growth.

The weaker yen helped, too. Ordinary income came to JPY 160.5 billion, up JPY 42.2 billion or 35.6%, thanks to equity in earnings of affiliates.

Net income attributable to owners of the parent came to JPY 140.3 billion, up JPY 50.7 billion or 56.5%, thanks to the unloading of strategic shareholdings and reduced tax expenses due to the U.S. tax reform.

All of these sales and income figures are the highest ever for the first 3 quarters. The domestic naphtha price averaged at JPY 44,600 per kiloliter during the October to December quarter. For the first 3 quarters, the average was JPY 39,933 per kiloliter. This is higher by JPY 7,633 per kiloliter than the first 3 quarters a year before.

The foreign exchange rate averaged at JPY 112 to the dollar during the first 3 quarters, meaning the yen weakened by JPY 5 to the dollar from the same period previous year.

With regard to financial position, total assets and equity both increased from the end of March. The increase in equity brought the debt-to-equity ratio down by 0.04 to 0.31.

Slide 5 shows the income statement. Net sales during the 3 quarters came to JPY 1,484.5 billion. Gross profit came to JPY 482 billion. Gross margin improved by 0.9 percentage points year-on-year to 32.5%. The product to feedstock spreads improved and that lowered the cost of sales ratio, mostly for chemicals.

SG&A came to JPY 332.8 billion, up JPY 18.8 billion year-on-year, mostly due to R&D expenses and an increase in headcount to reinforce sales activity.

Operating income came to JPY 149.2 billion for an operating margin of 10.0%, up 1.6 percentage points from a year before. The total of nonoperating items came to a net income of JPY 11.4 billion, up JPY 7.1 billion year-on-year. This is thanks to equity and earnings of affiliates such as PTT Asahi Chemical Company Limited, whose AN or MMA or methyl methacrylate operations were firm.

The total of extraordinary items came to a net income of JPY 10.8 billion. Income before income taxes came to JPY 171.4 billion. Total income taxes came down year-on-year for onetime reasons yet again.

In the previous year, after the absorption of core operating companies, Asahi Kasei Fibers Corporation, Asahi Kasei Chemicals Corporation and Asahi Kasei E-materials Corp. by Asahi Kasei Corporation, we reviewed the recoverability of deferred tax assets as part of tax effect accounting. This time, again, by applying tax effect accounting, the business tax cut in the United States has resulted in a reversal of deferred tax liabilities that we previously recognized in conjunction with acquisitions of ZOLL and Polypore.

As a result, total income taxes during the first 3 quarters have come down by JPY 1 billion year-on-year to JPY 29.5 billion. Net income attributable to owners of the parent came to JPY 140.3 billion, up JPY 50.7 billion or 56.5% year-on-year.

Slide 6 shows extraordinary income and loss. Total extraordinary income came to JPY 15.6 billion, up JPY 5.7 billion year-on-year, thanks to a gain on sale of investment securities associated with the unloading of strategic shareholdings.

Total extraordinary loss came to JPY 4.8 billion, an improvement of JPY 2.1 billion year-on-year.

As a result, net extraordinary income came to JPY 10.8 billion, up JPY 7.8 billion year-on-year.

Slide 7 shows the balance sheet. Total assets at the end of December 2017 was up JPY 168 billion from the end of March. Firm sales and the end of the period falling on a holiday led to an increase in cash and deposits as well as trade receivables. Investment securities also increased in line with the market value of owned shares.

Total liabilities increased by JPY 17.5 billion. Noncurrent liabilities came down due to the reversal of deferred tax assets related to U.S. tax reform. But current assets such as trade payables increased due to the end of the period falling on a holiday.

Net assets increased by JPY 150.5 billion, thanks to the JPY 140.3 billion in net income attributable to owners of the parent.

Slide 8 shows cash flows. Cash flow from operating activities came to a net inflow of JPY 154 billion, mostly from the pretax income of JPY 171.4 billion.

Cash flows from investing activities came to a net outflow of JPY 69.1 billion. Free cash flow was a net inflow of JPY 85 billion.

Cash flows from financing activities came to a net outflow of JPY 43.1 billion due to cash dividends paid. As a result, cash and cash equivalents at the end of the period came to JPY 191.3 billion.

Using Page 10, I will explain the sales and operating income by segment. Sales and profit increased year-on-year for all segments of Materials, Homes and Health Care. I will go over results by business category using Page 13 and subsequent pages.

Please turn to Page 13. Fibers posted an increase in sales and a slight increase in operating income. Although there was an impact of higher feedstocks costs, performance of such products as Lamous microfiber suede used for automobile interior and others was strong.

In Chemicals, both sales and profit increased. The petrochemicals increased sales and operating income due to improvement in terms of trade for AN, acrylonitrile, and MMA, methyl methacrylate, and others. In terms of the actual market price and price spread for 9 months between April and December, on average, AN was $1,637 per ton and propylene was $908, resulting in a spread of $729. The AN spread in the third quarter was $865, contributing to the increase in profit.

In the performance polymers, sales and profit increased owing to improvements in terms of trade for synthetic rubber and from sales of engineering plastics. The performance materials and consumables posted higher sales and operating income due to increased shipments of ion exchange membranes and electronic materials and others.

In Electronics, both sales and operating income increased. The separators saw higher sales and profit with a sharp increase in shipments of each battery separator product, especially lithium ion battery separators. The electronic devices posted higher sales and profit with firm sales of electronic devices for camera modules and magnetic sensors for household appliances.

In Homes, sales and profit increased. The order-built homes posted lower sales and operating income as a result of a decrease in the number of Hebel Maison apartment buildings delivered and an increase in SG&A expenses such as advertising expenses.

In contrast, the real estate and the remodeling operations increased sales and profit. Both the rental management and the condominium construction in the real estate operation performed firmly, and the performance of the remodeling operation was solid.

In the order-built homes, the value of new orders declined year-on-year between April and September, but increased by 16.4% year-on-year between October and December and was on par with the previous year between April and December.

Although the value of unit homes declined, demand for apartment buildings remained firm and the value of new orders for multidwelling homes increased.

In the construction materials, shipments of Neoma Foam phenolic foam insulation panels and other products remained firm. But due to the impact of higher feedstock costs, sales were up, but operating income was flat year-on-year.

Please turn to Page 14. In the Health Care, sales and profit increased. The pharmaceuticals saw a decrease in both sales and operating income. Shipments of Teribone osteoporosis drug increased but the competition from generics affected the business, particularly Flivas, agent for treatment of benign prostatic hyperplasia. In the medical devices, sales and profit increased.

In addition to firm performance of each business, there was an effect of the weaker yen. The Critical Care posted higher sales and profit, resulting from larger shipments of defibrillators for professional use and firm performance of LifeVest wearable defibrillator.

Moving on to the forecast for fiscal 2017, Page 16. Comparing to the previous full year forecast announced last November, we have made upward revision to all items of sales, operating income, ordinary income and net income attributable to owners of the parent. We now expect record highs for all items. Operating income has been revised upward by JPY 12 billion due to improvement in terms of trade of AN and increase in the shipments in the separators and Critical Care businesses.

After reviewing the deferred tax liabilities due to the effect of the U.S. tax reform, tax expenses decreased by approximately JPY 16 billion. In view of this and other factors, net income attributable to owners of the parent has been upwardly revised by JPY 29 billion. Annual dividend for fiscal 2017 is forecasted to be JPY 28 per share, the same as announced at the second quarter earnings briefing. The final amount will be announced at the full year earnings briefing after being further considered based on the full fiscal year results, in line with the company's dividend policy.

Assumptions for this forecast are: domestic naphtha price, JPY 46,900 per kiloliter in the second half and JPY 42,250 for the full year; and exchange rate of JPY 111 to the dollar for both the second half and the full year.

As for the second half and full year forecast by business category, I would like to mainly talk about the operating income using Page 18. Compared with the previous forecast announced in November, upward revision has been made for the Chemicals, Electronics, Health Care and Critical Care.

For the Fibers, the previous forecast has been retained as there is no major change in the business trends of each product. In the chemicals, the petrochemicals saw an AN market price climb in the aftermath of disruptions at competitors' plants in the U.S. resulting from hurricanes. Added with the anticipation of solid performance in the performance polymers and performance materials and consumables, we have made a JPY 9.5 billion upward revision from the previous forecast.

Assumptions for the market price and spread for the fourth quarter are: AN, $1,800 per ton; and propylene, $1,090, for the price spread of $710.

The Electronics business has been revised upward by JPY 1.5 billion. Among them, the separators has been upwardly revised. The main factor is the increase in the shipments of dry process separators for lithium ion battery. Although the electronic component is affected by the slowdown in demand for smartphones in China, we have revised the forecast upwards in light of strong demand for non-smartphone applications such as home appliances and the effect of the yen's depreciation.

In the Homes, in order-built homes operations, the number of buildings delivered is expected to progress as planned, while the real estate and remodeling businesses are solid. So we have kept the previous projection. In the construction materials, we anticipate that each business will remain solid and have kept the previous forecast.

The Health Care has been revised upward by JPY 1 billion. The pharmaceuticals has been revised downward in anticipation of shipment of Recomodulin, recombinant thrombomodulin and others falling short of previously forecasted sales plans and increased fixed costs due to accelerated R&D.

The medical devices has been upwardly revised in anticipation of improvement in cost of sales ratio coming from differences in product mix and recording of onetime licensing income.

The Critical Care has been revised upward by JPY 1 billion. The main factor is the continued steady increase in shipments of defibrillators for professional use.

This concludes my presentation. Thank you for your kind attention.

[Kiyoteru Kadokura, executive]

Let us now take questions.

[Takato Watabe, analyst]

Watabe from Morgan Stanley MUFG Securities. First, on Electronics, you said both separators and electronic devices did well. But sales for the business category in Q3 was down compared with Q2, while operating income slightly increased. Can you tell us why and what the outlook is for Q4, please?

[Hideharu Takashima, executive]

For electronic devices, the underlying trend is still firm. On a quarter-on-quarter basis, however, smartphone-related demand peaked in Q2 and has come down slightly since. Sales, therefore, have come down slightly, which in turn brought down operating income. In addition, depreciation kicks in heavier in the latter half of the year. On the other hand, outsourcing expenses are coming down as we have downward revised future demand expectation. This has a positive effect on operating income.

[Akira Fukuda, executive]

For Separators, both sales and operating income were up in Q3 from Q2. Sales growth comes from increased shipments of lithium ion battery or LIB separators for automotive use as well as of Daramic lead-acid separator. For Q4, we expect both sales and operating income to be lower than Q3. Sales of LIB separators are affected by production adjustments at a major consumer electronics company on top of the usual seasonal factor. Operating income is affected, in addition, by fixed expenses increasing toward the end of the period and an increase in upfront expenses for future production.

[Takato Watabe, analyst]

Is it correct to say that the dry process LIB separator is outperforming expectation, while the wet process LIB separator is in line?

[Akira Fukuda, executive]

Yes.

[Takato Watabe, analyst]

Now on petrochemicals, centering on AN. Earlier, you provided your assumption for market prices of AN and propylene in Q4, which is pretty much where they currently are. Apparently, you expect the current supply-demand environment to continue. Can you tell us why?

[Toshiyasu Horie, executive]

With regard to market prices in Q4, we expect supply to remain tight. Supply from the U.S. may recover from the impact of the hurricane, but with large-scale maintenance turnaround scheduled in Asia in the quarter, we do not expect much improvement on the supply side. On the demand side, the Chinese New Year this year takes place a little later than usual, so we do not know the full impact yet. So far, however, there has not been much change. Things are still good, and we expect the spreads to stay close to current levels, at least until March.

[Hidemitsu Umebayashi, analyst]

Umebayashi from Daiwa Securities. For Health Care, Q3 operating income was up. And according to your presentation material, operating cost and others in Q3 improved by JPY 1.8 billion year-on-year. Did you mean that this is almost all royalty income?

[Kiyoteru Kadokura, executive]

We recognized licensing income in Q3, which is part of that JPY 1.8 billion. Other than that, the difference is within normally expected levels for devices and pharmaceuticals combined.

[Hidemitsu Umebayashi, analyst]

Next, on Homes. It appears that orders have significantly recovered. Can you explain what is behind the recovery? In addition, since you are maintaining the initial forecast from the beginning of the year, although Material prices are rising, can you tell us about that, too? How is progress in your cost reduction efforts?

[Toru Tomioka, executive]

With regard to the recovery in new orders, one key factor is the time it takes before the customers sign a contract. In the first half, that time was getting rather long. In the second half, however, we have been able to reduce that thanks to training of sales personnel. The promotion campaign to commemorate 50 years of production of Hebel autoclaved aerated concrete provided a boost, too. Work style reform is also making a difference. In the first half, there were some teething challenges, but now the benefits are kicking in. Material prices are in line with expectation. Costs reduction is also in line. Logistics costs are slightly higher but within expected range.

[Mikiya Yamada, analyst]

Yamada from Mizuho Securities. First, on Health Care, did you mean earlier that the royalty income for devices was for JPY 1.8 billion? Can you also tell us more about Recomodulin, why sales fell short of your previous forecast of November, how the Phase III clinical trial overseas is going and what the sales outlook is, please?

[Kiyoteru Kadokura, executive]

First, on the licensing income for devices, that income is part of the JPY 1.8 billion increase due to operating cost and others. We do not disclose the exact amount.

[Tadahiro Hama, executive]

Shipment volume for Recomodulin in the first 3 quarters has come down year-on-year. The share of Recomodulin among anticoagulants is still growing. However, with better recognition and understanding among physicians on its efficacy and use, the amount administered per case and the duration of use have come down in some cases. And this has happened throughout this financial year. This drug is unique and needs some efforts to get recognition. It's use goes across different clinical departments. Marketing efforts are, therefore, quite challenging, but we are continuing promotional efforts to increase volume. That is for the domestic Japanese market.

[Mikiya Yamada, analyst]

With regard to the overseas clinical trial, in FY 2017, enrollment has been increasing steadily. The overall schedule has not changed and we are still aiming at approval in 2024, but increased enrollment means more expenses incurred this year than was expected in November. But it is still 2024 that you are targeting, is that correct?

[Tadahiro Hama, executive]

Yes, that is unchanged.

[Mikiya Yamada, analyst]

Now on Chemicals. Earlier, you explained market conditions for petrochemicals. What about other operations? For performance polymers, can you tell us about terms of trade for synthetic rubbers such as S-SBR? How have shipments and terms of trade been from Q3 to Q4 so far? And what do you expect going forward into the next financial year? No foreseeable issues, is that so for engineering plastics, too? In addition, with regard to performance materials and consumables, the consumables business has been so strong for 2 years in a row. What is behind this? What is the case for performance materials? Is all this sustainable? And will it continue?

[Yukifumi Kuwaba, executive]

With regard to synthetic rubber, terms of trade in Q1 was unusual. We raised sales prices in Q1 following the rise in the feedstock butadiene prices in Q4 FY 2016, but then butadiene prices quickly came down. Butadiene prices have been stable since then and we do not expect much fluctuation in the second half or into the next financial year.

[Mikiya Yamada, analyst]

In terms of shipment volume, in the first half, users were holding off of purchases, expecting prices to come down. In the second half, volume has returned to a growth track. We expect firm figures in the second half and into FY 2018. Engineering plastics sales are firm. The main use is for automotives. And while things are a little slow in the United States, auto sales and production have both been firm in other markets such as China. Feedstock costs are on the rise recently, but that is duly translated into sales prices, albeit with some delay.

[Kiyoteru Kadokura, executive]

With regard to consumables, shipments of Saran Wrap cling film have stayed at high levels since FY 2016. In addition, the tight supply-demand balance has resulted in higher sales prices. Among performance materials, shipments of ion exchange membranes have increased on the back of strong demand for caustic soda. For electronic materials, smartphone-related demand has been strong this year for all products. The continued transition in product mix towards higher value-added business has also made a positive contribution during the first 3 quarters.

[Mikiya Yamada, analyst]

With regard to synthetic rubber, one of your competitors recently booked impairment losses related to their overseas plant. Can I take it that Asahi Kasei does not have any challenges regarding production volume or profitability?

[Yukifumi Kuwaba, executive]

Yes, that is correct.

[Shinobu Takeuchi, analyst]

Takeuchi from SMBC Nikko Securities. On Slide 22 of your presentation material, your Q4 operating income forecast for Chemicals declined by JPY 11 billion from Q3. Can you provide more detail, in particular, the breakdown into petrochemicals, performance polymers and performance materials and consumables, please?

[Toshiyasu Horie, executive]

Market prices for AN were too high in Q3. We, therefore, expect the spread in Q4 to be tighter than Q3, although still relatively wide, which means AN-related income will come down quarter-on-quarter. This is the main reason behind the operating income decline for petrochemicals as a whole.

[Yukifumi Kuwaba, executive]

We expect demand to grow quarter-on-quarter for both synthetic rubber and engineering plastics. For synthetic rubber, however, operating income will be down due to maintenance turnarounds. Engineering plastics income is to grow on the back of firm shipment volume. But for performance polymers as a whole, we are expecting a slight decline in operating income.

[Kiyoteru Kadokura, executive]

With regard to performance materials and consumables, we expect operating income to decline quarter-on-quarter. The largest factor is seasonality associated with Saran Wrap for which shipment increases towards the end of the calendar year, followed by a reactionary slowness in the January to March quarter. This year is no exception. For electronic materials, the Chinese New Year brings down smartphone-related demand in Q4. Shipment volume of ion exchange membranes is subject to quarterly fluctuations, and this time, we expect Q4 to be down from Q3. All combined, performance materials and consumables are the second largest contributor after petrochemicals to the operating income decline for Chemicals in Q4.

[Shinobu Takeuchi, analyst]

On performance polymers, you said that you are expecting a slight decline in operating income. On the other hand, your assumption for domestic naphtha in Q4 is higher at JPY 49,200 per kiloliter. Does that mean you are raising sales prices in a timely manner following feedstock costs?

[Yukifumi Kuwaba, executive]

Yes, that is correct.

[Shinobu Takeuchi, analyst]

What about capacity utilization for AN? How was Q3? And what do you expect in Q4?

[Toshiyasu Horie, executive]

Capacity utilization in Q3 for AN production across the group was roughly 90%, which is higher than the 80% to 85% where it had been before. We plan to keep it around 90% in Q4, too.

[Shinobu Takeuchi, analyst]

Is that because capacity previously affected by hurricanes may be coming back online but not yet in full?

[Toshiyasu Horie, executive]

We expect the supply-demand balance in Asia to remain mostly unchanged because of maintenance turnaround scheduled in this region.

[Shinobu Takeuchi, analyst]

I see. My second question is on Critical Care. Can you comment on the performance groups of LifeVest and the increase in the headcount for expanding the business operation? Also, I understand the FDA, the Food and Drug Administration, has issued safety communication. Should we assume that this is not having an effect on the business performance?

[Kiyoteru Kadokura, executive]

Regarding Critical Care, that's all business. Defibrillators for professional use have greatly increased shipments since the beginning of the year. As explained previously, a competitor has suspended the sale of some products, helping ZOLL grow its market share and that situation continues. As for LifeVest, growth is expected as planned. In addition, this year, ZOLL is hiring people almost in accordance with the plan. Accordingly, SG&A expenses are growing almost as projected. You also asked about FDA's safety communication issued recently. It is not impacting the business nor is it expected to in the future either.

[Go Miyamoto, analyst]

Miyamoto from UBS Securities Japan. The first question is on Electronics. You have upwardly revised the operating income forecast but kept the sales forecast unchanged. Would you explain the reason behind it?

[Akira Fukuda, executive]

For the separators, both the sales and operating income forecast has been revised upward. Lithium ion battery separators expect higher sales, mainly due to increased shipments of dry process products. Daramic lead-acid battery separators also expect some shipment increase. With this upward revision of sales, operating income forecast has also been revised upward.

[Hideharu Takashima, executive]

For electronic devices, sales forecast is downwardly revised in light of the slowdown in the Chinese smartphone market. Meanwhile, non-smartphone applications such as household appliances for China have been steady. And added with the decline in commissions paid on outsourced production, operating income has been revised upward.

[Go Miyamoto, analyst]

This might be getting too minute, but which is a greater factor for the JPY 1.5 billion revision of the operating income, electronic devices or separators?

[Kiyoteru Kadokura, executive]

We do not disclose the breakdown.

[Go Miyamoto, analyst]

I understand. A follow-up question. I believe that the operating rate of dry process separators is running higher than expected. Previously, you were projecting a full capacity operation at around the end of the second half. What was the operating status as of the third quarter?

[Akira Fukuda, executive]

Dry process is already running at full capacity. Preparation in underway for a capacity increase.

[Go Miyamoto, analyst]

So it's full capacity for both the third quarter and the fourth quarter, correct?

[Akira Fukuda, executive]

Yes.

[Go Miyamoto, analyst]

The second question is on Chemicals. Could you describe the changes from the second quarter to the third quarter for each operation?

[Toshiyasu Horie, executive]

From the second to the third quarters, petrochemicals profit increased significantly due to a large improvement in the spread of AN.

[Yukifumi Kuwaba, executive]

For the performance polymers, the synthetic rubber and engineering plastics increased shipments from the second to the third quarters. There were maintenance turnarounds in the engineering plastics in the third quarter, which accounted for the decline in profit, while synthetic rubber felt the impact of a slight price hike of styrene and deterioration in the terms of trade. Overall, profit for performance polymers was on a downward trend.

[Kiyoteru Kadokura, executive]

Performance materials and consumables posted a profit increase from the second to the third quarters. The situation was almost opposite to that projected for the third to fourth quarters described earlier. Consumables centering on Saran Wrap cling film posted a quarter-on-quarter profit increase, thanks to the year-end demand surge while ion exchange membranes saw a shipment concentration in the third quarter. So in terms of quarter-on-quarter increase, the latter made a greater contribution.

[Go Miyamoto, analyst]

Does that mean that the rising raw materials prices and inventory valuation were not significant factors in the quarter-on-quarter profit increase?

[Toshiyasu Horie, executive]

Gradual price increase of naphtha did have a positive impact on the third quarter operating income as an inventory valuation factor. But the improvement in terms of trade made a greater contribution to the increased profit.

[Yukifumi Kuwaba, executive]

Regarding the influence of raw materials, higher starting price affected synthetic rubber, while engineering plastics felt the impact of polypropylene price rise from the second to the third quarters.

[Kiyoteru Kadokura, executive]

Performance materials and consumables did not feel a particularly large impact of raw materials price or inventory valuation.

[Atsushi Ikeda, analyst]

Ikeda from Citigroup Global Markets Japan. The first question is on separators. Shipments of dry process separators are growing considerably. Is this particularly because the electric vehicle market in China is expanding? Also, you have announced capacity expansion but the investment amount seems rather small at JPY 7.5 billion for wet process and dry process combined. What is the reason behind it? And can you also talk about the shipment trend?

[Akira Fukuda, executive]

First, the trend in dry process. This is not limited to dry process but applies to wet process as well. But in terms of individual customers or concrete projects, the situation varies. For some, shipments are increasing over the original plan, while for others, shipments are below the plan. Overall, dry process shipments are on the rise as, in addition to robust automotive applications, new applications such as energy storage systems or ESS are starting up. As for capital expenditure and investment for capacity increase, especially for dry process, we are making the best of the manufacturing facilities we had acquired with the Polypore acquisition and are making very efficient capacity investment. Regarding shipments for combination of the dry process and wet process, a year-on-year increase of roughly 30% is continuing.

[Atsushi Ikeda, analyst]

Is that increase driven by ESS? Also, are automotive applications growing more than your expectation? Would you comment on that? Also, with the ESS project in Australia awarded to a Korean battery manufacturer, there must be a plus. Can you give us an update on these situations?

[Akira Fukuda, executive]

Automotive is growing more or less as originally planned. ESS has grown beyond our initial expectations and that is the main factor that is expanding the overall sales volume of separators.

[Atsushi Ikeda, analyst]

Understood. One last question on acrylonitrile. This year, a newly constructed factory will start operation in China. But given that the increment in supply is small compared to the total capacity, I think that the supply and demand balance will continue to be considerably tight in 2018. What is your current view?

[Toshiyasu Horie, executive]

Regarding the newly constructed plant in China, initially, it was set to start operation from as early as the beginning of the year. But now, we are told that permission for new operation is being delayed due to stricter environmental regulations and safety rules. Therefore, there is no definite information on when the new factory in China will start the operation at the rate of 130,000 tons per year. Meanwhile, with regard to the demand, if the domestic demand in China is kept strong, ABS resin and crude oil prices will also rise. So the demand for other applications of AN should also be very strong. So overall, we expect growth to continue to be around 2% to 3%. Therefore, at the current rate of demand growth, we believe that the additional supply of 130,000 tons from the new plant in China will be absorbed by the market growth. And so for now, we do not expect major changes in fundamentals.

[Atsushi Ikeda, analyst]

Then, do I understand correctly that given maintenance turnaround of AN manufacturers in the fourth quarter, tight supply will continue, and therefore, you do not see a risk of market price plummeting, even with the new plant construction in China?

[Toshiyasu Horie, executive]

In terms of risk, we think that domestic demand in China could become a risk depending on the outlook of the economy and the monetary policy in that country and others. However, as such a signal cannot be seen yet, we do not anticipate any big change for now.

[Shigeki Okazaki, analyst]

Shigeki Okazaki from Nomura Securities. I have some questions on Electronics. First, do you expect profit to deteriorate from the third to the fourth quarters? Can you give us the breakdown of that change in terms of separators versus electronic devices and sales volume versus operating cost? I think that the demand for smartphones is currently hurting due to the decline in operation because of the Chinese New Year. When do you expect a recovery? Can you also comment on the possibility of sluggish growth in high-end smartphones affecting your company? And lastly, regarding the automotive applications of lithium ion battery separators, are you seeing any changes in inquiries from customers or demand for the next fiscal year?

[Hideharu Takashima, executive]

First, on electronic devices, from the third to fourth quarters, we expect demand for smartphones to be lower due to the usual seasonal factors and due to dampened demand from smartphones in China as is reported in media. And for future prospect of smartphones, it appears that it will take some time before demand for high-end products to recover in the Chinese smartphone market.

[Shigeki Okazaki, analyst]

On the other hand, should high-end products expand into the other markets such as India that could lead to new business opportunities? In addition, with more advanced features and functions added to middle-range smartphones, there is a possibility of devices used for high-end products being adopted in middle-range products as well. We are closely watching the market development with such expectations.

[Akira Fukuda, executive]

Regarding the third to fourth quarter changes in the lithium ion battery separators, we expect lower sales resulting from a decrease in volume in the fourth quarter due to seasonal factors, mainly in China and the production adjustments by a major consumer electronics consumer or customer. Furthermore, we are expecting a decline in profit due to cost factors. As in other years, we are factoring in concentration of fixed costs at the end of the fiscal year as well as anticipated upfront expenses in relation to the work currently underway to expand production next fiscal year and beyond. As for the prospects for the next fiscal year, inquiries from customers continue to be strong for both dry and wet process types. Currently, we are working on the capacity increase for both processes.

[Shigeki Okazaki, analyst]

Clarification, earlier, you said that increase in the sales volume of lithium ion batteries was roughly 30%. Is that the third year or the third quarter year-on-year volume increase?

[Akira Fukuda, executive]

Yes, that is correct.

[Shigeki Okazaki, analyst]

Lastly, a question on the profitability. Should I take it that with an increase in shipments, the profit level of separators for lithium ion batteries has been improving and that this will currently be the trend expected for the next fiscal year and beyond?

[Akira Fukuda, executive]

Profit is increasing in line with the increasing sales. We expect profit after amortization of PPA to continue into the second half and the full year. And we expect this trend to continue into the next fiscal year and beyond as well.

[Shogo Umeda, analyst]

Umeda from JPMorgan Securities Japan. I have a question for clarification on the separators about the changes in shipments from the third quarter to the fourth quarter. What are the projections for the dry process type and wet process type, respectively? Also, I would like to know whether the average unit price of the separators is changing or is likely to change slightly going forward? There are some media reports that prices of some cylindrical batteries for consumer electronics are rising due to short supply. Have you noticed any change recently in the declining trend of the separator price? In terms of product mix, would more dry process type push down the average unit price of the separators as a whole? And does the composition ratio of automotive applications affect the unit price?

[Akira Fukuda, executive]

Regarding the unit price, there is no particularly dramatic change. Requests from customers for price reduction continue to be intense. And as you pointed out, there is a slight change in average unit price due to product mix. As for the changes in shipment volume from the third quarter to the fourth quarter, the production adjustments on the part of a major consumer electronics applications customer mentioned earlier or the seasonal factors in China are felt mainly in the consumer electronics applications. So this is more a factor in the wet process type.

[Shogo Umeda, analyst]

Understood. So when you say there's a change in the product mix, do you mean that the product mix could hurt the profitability slightly with an increase in dry process type shipments and an increasing fraction of automotive applications?

[Akira Fukuda, executive]

It is not necessary the case that changes in average unit price due to a product mix would affect profitability.

[Kiyoteru Kadokura, executive]

This concludes the third quarter earnings conference call. Thank you for your participation.