Showa Denko KK

TSE:4004

Earnings Call Transcript 2020-Q3

[Motohiro Takeuchi, executive]

Good evening, everyone. I'm Motohiro Takeuchi, Chief Financial Officer. Thank you for your continued interest for the business performance of our company. And I'd like to express sincere sympathy for those who are affected by novel coronavirus and those who are in the severe living environment due to the spread of COVID-19.

I will explain the results of the third quarter of fiscal year ending in December 2020. Please turn to Page 2.

As for consolidated subsidiaries, former Hitachi Chemical changed into Showa Denko Materials as of the 1st October. And with this, subsidiaries increased by 91 to 152 companies. Equity method applied companies increased by 2, with Showa Denko Materials-related companies to 13.

Exchange rate was JPY 107.6 to $1 for the average from January to September. Yen appreciated JPY 1.16 per dollar year-on-year. Exchange rate used for a variation of assets and liabilities at the year-end was JPY 105.8 per dollar as of September end, with yen's appreciation by JPY 3.8 per dollar. Euro was JPY 120.9 for January-September average. Yen appreciated JPY 1.8 per euro year-on-year.

FX sensitivity in the second half will be -- that JPY 550 million of operating income will be decreased with depreciation of JPY 1 per dollar, including Showa Denko and Showa Denko Materials.

Naphtha price declined drastically to JPY 33,350 per kiloliter, down by JPY 8,900 or 21.1% year-on-year from JPY 42,250 in the previous year. In the third quarter, it was JPY 30,200, up from JPY 25,000 in the second quarter, and feedstock adjustment improved in the third quarter.

Aluminum LME price was affected by global demand decline triggered by economic slowdown in China. And it was $1,660 per ton, down by $169 or 9.2% year-on-year.

Please turn to Page 3. Summary of the third quarter FY 2020 is shown here. Since July, sales and operating income of Showa Denko Materials have been included. Net sales were JPY 636 billion, down JPY 59.6 billion or 8.6% year-on-year.

Inorganics segment sales decreased substantially due to volume decline of graphite electrode affected by global production reduction in steel industry and market price declines.

Petrochemicals segment sales went down due to market price falls caused by plunged crude oil price, and sales of 4 segments of Chemicals, Electronics, Aluminum and Others also decreased.

Sales of newly consolidated Showa Denko Materials segment were JPY 144.8 billion from July to September. And in total, sales were JPY 636 billion. Operating income was minus JPY 15.4 billion with a drastic decline by JPY 124.7 billion year-on-year.

Showa Denko Materials segment marked profit increase through new consolidation, and the Electronics segment profit increased due to hard disk volume growth. But in Inorganics segment, in addition to the volume decline of graphite electrode business, the variation of inventory in accordance with a lower cost of market accounting method with market price decline squeezed profit drastically. And in total, operating income decreased.

Details of net sales and operating income are shown on Page 7 and 8. Ordinary income was minus JPY 36.8 billion, down sharply by JPY 144.4 billion year-on-year. As for nonoperating income and expenses, equity in earnings by affiliates improved by JPY 0.8 billion due to new affiliates in July. Foreign exchange gains or losses worsened by JPY 1.7 billion due to appreciation of yen. Interest, dividends, income and expenses deteriorated by JPY 2.7 billion due to the interest-bearing debt increase with the stock acquisition of Hitachi Chemical. Other is a temporary cost of JPY 16 billion related to financing for Hitachi Chemical acquisition. In total, expenses increased by JPY 19.6 billion.

Special factors that impacted January-September results are described in the next page.

I will elaborate on extraordinary profit and loss on Page 5. But due to the expenses for structural reforms through plant closure in Germany in graphite electrode business, net JPY 7.5 billion of expenses increased. Income taxes decreased JPY 18 billion with less profit to JPY 4.1 billion. Net income attributable to owners of the parent was minus JPY 57.7 billion, down by JPY 138.6 billion year-on-year.

Please turn to Page 4. Let me explain special factors impacted January-September results. In Petrochemicals segment, in the first half affected by naphtha price decline, with crude oil price decline, feedstock adjustment worsened by JPY 8.5 billion. But in the third quarter, price stabilized, and the impact improved by JPY 2 billion. And in total, impact was minus JPY 6.5 billion.

In graphite electrode business, in the first half, we devaluated inventory in accordance with a lower cost of market accounting method with market price decline. But in the third quarter, shipment improved by JPY 2.9 billion. And in total, impact was minus JPY 18.8 billion.

As for integration cost for Showa Denko Materials, in addition to that in the first half, in July-September, PMI expenses increased by JPY 1.5 billion. In terms of borrowing by JPY 1.8 billion, expenses to change firm names by JPY 0.4 billion. And preferred stock dividend for the third quarter increased by JPY 3.3 billion. In total, special factors in 3 months of July to September were JPY 10.8 billion.

Please turn to Page 5. As for extraordinary profit, as explained in the first quarter meeting, as SHOKO CO. LTD. post gains on sales of fixed assets, it increased JPY 0.3 billion year-on-year. As for extraordinary loss, mainly in graphite electrode business due to restructuring cost of JPY 5.1 billion for the decision to close Meitingen plant in Germany, it was JPY 12.1 billion, up JPY 7.9 billion year-on-year. As a result, net extraordinary loss was JPY 9.7 billion, worsened by JPY 7.5 billion.

Please turn to Page 6. Forecast for amortization of goodwill, et cetera, and cost of goods sold related to inventory step-up belonging to Showa Denko Materials segment is shown here. Depreciation of goodwill and intangible fixed asset is small as JPY 6 billion in July-September and will be JPY 12.7 billion in October-December as squeeze-out procedures will be completed in the fourth quarter and cost of goods sold related to inventory step-up will be posted in the fourth quarter. Combined expenses for the second half will be JPY 30.5 billion, comparable to the forecast in August.

Please turn to Page 7. Page 7 and 8 show sales and operating income by segment in January to September. In this fiscal year, business environment is extremely different from usual affected by COVID-19. Due to time constraints, let me explain mainly the change from April to June to July to September.

I'd like to skip Page 7 and 8 so please refer to them later. And for variance by segment in January to September, I'd like to explain with the chart on Page 9 of operating income breakdown by factor.

Please turn to Page 9. This slide shows the year-on-year operating income variance by factor. Profit decreased drastically year-on-year by JPY 124.7 billion, and more than half of it was attributable to volume by JPY 64.2 billion.

In graphite electrode business, Inorganics segment, which was severely affected by the production cut in electric arc furnace due to COVID-19, sales volume plummeted in European and American market, and that pushed down profit by JPY 53.6 billion. Price changes in inorganics were a decline of JPY 38.6 billion due to much weakened graphite electrode's international market price. And in total, impact was a decline of JPY 34.4 billion.

As for cost reduction in carbon business in Inorganics segment, the review of the repair cost and fixed cost reduction with less production reduced cost by JPY 5.2 billion. In Aluminum segment, improved productivity cut cost by JPY 2.1 billion. In Electronics segment, hard disk productivity improvement cut costs by JPY 2 billion. And as a whole company, impact was JPY 11.2 billion.

In Inorganics, the devaluation of inventory in accordance with law of the cost or market accounting method with declined market price of graphite electrode pushed down JPY 18.8 billion. In Petrochemicals segment, naphtha market price declined for olefin pushed down by JPY 4.5 billion, and Others were down JPY 14 billion.

Please turn to Page 10. This slide shows comparison of the second and third quarter. Net sales almost doubled quarter-on-quarter to JPY 309.4 billion through inclusion of Showa Denko Materials segment. Three segments of former Showa Denko, Petrochemicals, Chemicals and Electronics, increased sales quarter-on-quarter.

As for operating income, special factors in the second quarter, as mentioned on Page 4, decreased sharply. And especially in Inorganics segment, there was a partial reversal from the lower of the cost of market accounting-related negativity, and feedstock adjustment improved in Petrochemical segment. And with substantial improvement of JPY 38.6 billion, operating income was JPY 10.4 billion. In all 5 key segments of former Showa Denko, including Chemicals, Electronics and Aluminum, profit increased quarter-on-quarter.

As for nonoperating income and expenses in July to September, interest expenses increased with the growth of interest-bearing debt. But compared to April-June when JPY 16.1 billion of temporary expenses for financing was posted, it improved substantially by JPY 14.2 billion. With this, ordinary income turned to positive of JPY 6.4 billion, with the improvement of JPY 52.9 billion. And the net income attributable to owners of the parent in July to September was minus JPY 3.1 billion, up JPY 54.2 billion quarter-on-quarter. EBITDA improved quarter-on-quarter by JPY 55 billion to JPY 36.6 billion.

Please turn to Page 11. Petrochemicals segment sales were up JPY 6.1 billion quarter-on-quarter to JPY 46.8 billion, and operating income was up JPY 8.5 billion to JPY 5 billion. Olefins utilization has been 90% up to the second quarter. But since July, it has been fully utilized, and sales increased due to volume increase and market price increase in major products, including ethylene. And due to feedstock adjustment improvement with naphtha price increase, profit increased substantially. In -- organic chemicals and SunAllomer, profit decreased due to price increase in ethylene and propylene, respectively.

Chemicals segment sales were up JPY 5.2 billion quarter-on-quarter to JPY 41 billion due to volume increase in many products. Operating income was up JPY 1.6 billion to JPY 4.3 billion.

In electronic chemicals, reflecting robust semiconductor sector, high level of shipment comparable to that of second quarter was sustained. Other businesses, including basic chemicals and industrial gases, posted profit growth with volume increase.

Electronics segment sales increased JPY 3.1 billion quarter-on-quarter to JPY 24.1 billion. Operating income went up JPY 2.3 billion to JPY 3 billion.

In hard disks, hard disk dry production reduction was cleared on the side of customers who had been constrained by lockdown posted by COVID-19, and media shipment for data center increased. They resulted in the increase in sales and profit.

In compound semiconductors, export for Taiwan was robust, and profit was sustained at the second quarter level. In lithium-ion battery materials, increased shipment of SPALF packaging materials pushed up sales, and profit were sustained quarter-on-quarter. In SiC epitaxial wafers, despite a slow recovery in export, demand for domestic railway was firm, and sales were flat quarter-on-quarter, but profit increased.

Inorganics segment sales were down JPY 3.3 billion quarter-on-quarter to JPY 18.3 billion, and operating income was up JPY 20.4 billion to minus JPY 3.3 billion.

In ceramics, sales and profit declined due to reduced shipment of abrasives with reduced production of automotive and steel sectors. Titanium oxide, which recovered in spring, is now stalled, affected by another adjustment of MLCC.

In graphite electrode, affected by slowdown of global steel production and slackened supply/demand by customers' inventory drawdowns, we enhanced production reduction which still continues, and sales volume stays at the second quarter level. And as market price slightly declined quarter-on-quarter, sales declined. Market prices are slightly below our expectation in August.

As for operating income, in the second quarter, we devalued inventory in accordance with the lower cost of market accounting method. And in the third quarter, we posted a reversal in line with sales volume, and profit improved remarkably. We expect supply/demand of graphite electrode will be optimized at the year-end with progress in customers' inventory adjustment.

Please turn to Page 12. Aluminum segment sales were down JPY 0.1 billion quarter-on-quarter to JPY 19.6 billion, and operating income was up JPY 0.2 billion to minus JPY 0.1 billion.

In aluminum rolled products, high-purity foil for capacitors showed recovery in the second quarter, but production adjustment in aluminum electrolytic capacitor mainly for industrial machineries has been prolonged. And due to volume decline, sales and profit decreased.

In aluminum specialty components, production and shipment are in low level. But due to partial volume recovery for autos, sales and profit increased.

In aluminum cans, domestic sales declined quarter-on-quarter. But in Vietnam, despite unexpected impact by COVID-19 second spike in August, as the impact of restriction of outing in the second quarter was extremely severe compared with the second quarter, sales increased, and the total sales increased slightly and profit increased.

As for Showa Denko Materials segment, we began to include sales and profit from the beginning of the third quarter. Sales were JPY 144.8 billion, and operating income was JPY 2.8 billion. In this segment, backed by the market growth of data centers, among others, electronic materials such as polishing slurry for CMP, the chemical mechanical planarization and printed wiring board materials such as copper-clad laminated wood have been firm. But affected by COVID-19, auto market deteriorated and maritime materials, including the plastic mold products and carbon anode materials for lithium-ion battery, have been sluggish. Operating income includes amortization expense of JPY 6 billion for goodwill upon acquisition of shares.

Others segment sales and profit decreased as market price of metal ceramics of SHOKO CO. LTD. weakened.

Please turn to Page 13. This chart shows operating income quarter-on-quarter variance breakdown by factor. From April to June, operating income improved JPY 38.6 billion to JPY 10.4 billion in July to September. Major factors were JPY 24.6 billion by lower of the cost of market impacting graphite electrode and JPY 8 billion by naphtha-related factor petrochemicals. Volume improved JPY 4.9 billion. And price factor mainly comes from market price decline in graphite electrode, but the impact is minor.

Others, JPY 4.5 billion includes the third quarter profit of Showa Denko Materials, which was newly consolidated, JPY 2.8 billion.

Please turn to Page 14. This shows a consolidated balance sheet. Showa Denko Materials became a consolidated subsidiary, and the end of the second quarter is regarded as the date of acquisition. And these results are included in the consolidated financial statements. There is no major change from the end of the second quarter to the end of the third quarter. As of the end of third quarter, due to consolidation of Showa Denko Materials in total assets, mainly cash and deposit, notes and accounts receivable, inventories, tangible fixed assets and goodwill increased as they did at the end of the second quarter. And total assets increased by JPY 995.6 billion from the end of the previous fiscal year to JPY 2.072 trillion.

As for total liabilities, besides notes and accounts payable increase due to increasing interest-bearing debt for stock acquisition of Hitachi Chemical, they increased by JPY 788.9 billion to JPY 1.3458 trillion. Interest-bearing debt increased JPY 694.5 billion to JPY 997.7 billion.

Since third quarter, we included leasing liabilities in interest-bearing debt and, retrospectively, adjusted the balance as of the end of December.

As for net assets, due to quarterly net loss and the dividend payment for the previous year, retained earnings decreased. But noncontrolling interest increased due to issuance of preferred shares for noncontrolling shareholders, along with share acquisition of Hitachi Chemical, and total net asset increased by JPY 206.8 billion to JPY 726.2 billion.

Please turn to Page 15. From the end of the second quarter, there is no major change in balance sheet-related indices. Interest-bearing debt increased, along with the share acquisition of Hitachi Chemical, up JPY 694.4 billion from the end of the previous fiscal year to JPY 997.7 billion. As for D/E ratio, we started to add the amount equivalent to 50% of the buyer preferred stocks to interest-bearing debt and remaining 50% to the equity capital from the third quarter, and we represent the net D/E ratio deducting cash and deposit. As a result, net D/E ratio as of the end of the third quarter increased 1.35 points over the end of the previous year to 1.01x. Equity ratio is 20.2%.

Chart on Page 16 shows a change in consolidated interest-bearing debt and net D/E ratio from the third quarter. From Page 17 to 19, year-on-year comparison of July-September are shown for reference.

And Page 20 shows quarterly summary. Please take a look later. From Page 21 to 24, quarterly operating income by segment is shown by bar chart.

Please turn to Page 21. Petrochemicals profit improved substantially from the second quarter when it was affected by crude oil price plunge in March and came close to the previous year's level.

Please turn to Page 22. In Chemicals segment, profit in the third quarter went up year-on-year. In Electronics segment, profit increased markedly year-on-year.

Please turn to Page 23. In Inorganics segment, we hit the bottom in the second quarter when a massive devaluation based on the lower of the cost of market accounting was posted and came back to the recovery track. In the Aluminum segment, we came back to the moderate recovery track, supported by auto production recovery after bottoming out in the second quarter.

Please turn to Page 24. Showa Denko Materials segment was consolidated in the third quarter. And in the preamortization base goodwill of JPY 6 billion, it generated operating income of JPY 8.8 billion.

Page 25 and onward show topics by segment. Please refer to them later.

When I talked in August, I had to explain the very severe conditions of naphtha in petrochemicals and lower of the cost of market accounting method in graphite electrode, in addition to volume decrease by COVID-19, and many of you must have held concerns. But as shown by profit chart before, in the third quarter, we began to feel a touch of recovery in most of the businesses. In electronics sector, steady production continues both in logic and memory. And petrochemical facilities are fully utilized. Oil price has been stabilized on $40 range. Market price of graphite electrode is slightly weaker than expected. But finally, we began to see the inventory optimization of customers. We are confident that the environment for volume increase and bottoming out of market price in the next fiscal year is being ready. Auto production recovery is more than expected, though some difference is observed by company.

We are compiling long-term vision to materialize the integration with Showa Denko Materials promptly. And we'd like to provide you with our objectives of integration with former Hitachi Chemical and the expected synergy effect and so on. We plan to hold a meeting on December 10 to offer information conducive for investors' judgment, and we'd like to sustain your interest in our company's management. Thank you very much for joining us today.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]