Sumitomo Chemical Co Ltd

TSE:4005

Earnings Call Transcript 2023-Q2

[Operator]

As at this time, we will now start the Sumitomo Chemical Conference Call for Fiscal 2022 Second Quarter Financial Results. Thank you very much for attending.

Today, Mr. Sasaki, Managing Executive Officer, will give you a briefing on financial results for FY 2022 second quarter and the revised the full-year outlook. Later, he will be joined by Mr. Yamauchi, Executive Officer and General Manager of Accounting Department, to take questions.

Mr. Sasaki, please.

[Yoshizumi Sasaki, executive]

Thank you very much. I'm Sasaki from Sumitomo Chemical. Thank you very much for attending the Sumitomo Chemical conference call despite your very busy schedule. I'd like to thank the investors and analysts for your daily understanding and support to the management of this company. I'd like to thank you all for that.

Now let me start with the briefing of the financial results of fiscal year 2022 second quarter and the revised the full-year outlook.

Please turn to Page 4 of the slide. Before talking about FY '22 first half financial results, first, let me talk about our business environment. In the upper part of the slide, under economic conditions, because of the weakening of the yen, the profitability of exports from Japan and overseas businesses improved. On the other hand, because of the crisis in Ukraine and high inflation, the sharp rise in raw material and fuel prices has put pressure on our business results. At the bottom of the slide, you can see the business environment of the key business sectors. The weather chart shows our perception of favorable and unfavorable conditions.

In Petrochemicals, downstream demand was weak and the product market was stagnant. On the other hand, because the market for refined petroleum products was tight because of the situation in Ukraine, Petro Rabigh's results were strong. In automobiles, auto production continued to decline because of shortages in semiconductors and the lockdown in China. For displays, because stay-at-home demand has fallen and consumer sentiment has soured due to inflation concerns, sales of TV sets and smartphones were stagnant. Demand for panels for TVs, in particular, fell sharply due in part to the adjustment of intermediate inventories. In semiconductors, strong demand for materials continued with the expansion of the market.

In Crop protection, in addition to strong demand, higher selling prices in South America was a tailwind for profits. For methionine, market prices improved, but the rise of raw material and fuel prices outpaced the improvement and profitability continued to be difficult. In Pharmaceuticals, sales of our main product LATUDA continued to be strong.

So next I'd like to talk about the financial summary. Please turn to Page 5. Financial results of FY 2022 second quarter, sales revenue was JPY 1,528.6 billion, up JPY 203.4 billion year-over-year. The core operating income, which expressed a recurring earning power was JPY 115.6 billion, down JPY 33.3 billion year-over-year.

The nonrecurring items not included in core operating income worsened by JPY 50.4 billion year-on-year as losses of JPY 55.1 billion, such as impairment losses were posted. Impairment losses were mainly released on the 6 of October. This is related to the patent rights of KYNMOBI, a treatment for off episodes associated with Parkinson's disease as the consolidated subsidiary, Sumitomo Pharma. As a result, operating income was JPY 60.6 billion, down JPY 83.7 billion year-over-year.

Finance income was JPY 66.2 billion, up JPY 63.7 billion year-over-year. Out of this, gain or losses on foreign currency transactions was a gain of JPY 82.1 billion because of weakening of yen, resulting in an improvement of JPY 76.2 billion year-over-year. Income taxes was JPY 53.7 billion, up JPY 14.7 billion year-over-year. As a result, net income attributable to owners of the parent was JPY 81.1 billion, down JPY 7.8 billion year-over-year.

As for the exchange rate and Naphtha price, which influences our performance, the average U.S. dollar rate during the term was JPY 134.03 to the dollar. And Naphtha price was JPY 83,600 per kiloliter, yen weakened and feedstock price got higher year-over-year.

Next is the performance by business segment. Please turn to Page 6. Total sales revenue increased by JPY 203.4 billion year-over-year. By segment, except for IT-related Chemicals, sales revenue increased in the other segments. As for year-over-year changes of sales revenue, analyzing by factor, sales price increased by JPY 86.5 billion and volume decreased by JPY 48.7 billion. Foreign exchange translation variance of foreign subsidiary sales revenue increased by JPY 165.6 billion.

Next is Page 7. Total core operating income decreased by JPY 33.3 billion year-over-year. By segment, with exception of Energy & Functional Materials and Health & Crop Sciences, core operating income in other segments decreased. Analyzing the factors, in terms of price, it was minus JPY 30.5 billion and cost minus JPY 6.5 billion. On the other hand, volume variance, including changes in equity and earnings of affiliates was plus JPY 3.7 billion.

Next is the performance by segment. Please turn to Page 8. Essential Chemicals & Plastics segment. Core operating income was JPY 23.3 billion, down JPY 18.8 billion year-over-year. In price variance, terms of trade deteriorated because increases in sales prices have not kept up with increases in raw material and fuel prices for products such as synthetic resins, MMA and various industrial chemicals. For volume variance, shipments decreased due to a drop in demand, particularly in automotive applications, despite improvements in operations at Petro Rabigh, an equity method affiliate.

Next page, please. Energy & Functional Materials segment. Core operating income was JPY 13.4 billion, up JPY 900 million year-over-year. For price variance, for aluminum and cathode materials, terms of trade improved in line with market prices. On the other hand, for resorcinol and synthetic rubber, terms of trade deteriorated due to increases in raw material and fuel prices. And in volume variance, in addition to continued strong shipments of lithium-ion secondary battery separators, income from exports increased due to the weakening of yen.

Next page, please. IT-related Chemicals. Core operating income was JPY 26.4 billion, down JPY 3.1 billion year-over-year. For price variance, for displays-related materials, selling prices fell for polarizing film and touch-screen sensor panels. For volume variance, displays shipments decreased due to factors such as the waning of stay-at-home demand and deteriorated consumer sentiment due to inflation. On the other hand, semiconductor-related materials, shipments increased alongside increased overall demand. In the segment as a whole, core operating income increased on exports and foreign currency conversion gains due to the weakening of the yen.

Next page, please. In Health & Crop Sciences segment, core operating income was JPY 36.3 billion, an increase of JPY 17.9 billion year-on-year. As for price variance, terms of trade improved due to increased sales price for crop protection products in South America. On the other hand, market prices for methionine improved; however, terms of trade deteriorated due to increased raw material and fuel prices. As for the cost variance, expenses relating to business expansion increased such as the immediate launch of INDIFLIN and development expenses for the new pipeline products.

With regards to volume variance, due to increased shipments of crop protection products in South America and India and the segment as a whole experienced an increase in net income on exports and profit from foreign currency conversion due to the weaker yen.

Next page, please. As for the Pharmaceutical segment, core operating income was JPY 25.2 billion, a decrease of JPY 24.8 billion year-on-year. As for the price variance, sales prices decreased in Japan due to the NHI drug price revisions. As for the cost variance, there were increase in SG&A in Sumitomo Pharma subsidiary, Sumitovant Group related to sales promotion activities for ORGOVYX and GEMTESA. As for the volume variance, in addition to sales growth of products such as LATUDA, ORGOVYX, GEMTESA, onetime gain was recorded on the licensing contract for sales of ORGOVYX in Europe. On the other hand, there has been a lump-sum revenue for the collaboration and license agreement for joint development and commercialization in the same quarter last year. Therefore on a year-on-year basis, core operating income decreased.

Next page, please. I will not go into the main contents and amounts of non-recurring items since it has been mentioned at the beginning. I will now explain the contents of the consolidated balance sheet. Total assets at the end of September 2022 was JPY 4,682 billion, up by JPY 373.9 billion from the end of the previous fiscal year. This was due to an increase in inventories and cash and cash equivalents.

Interest-bearing debt was JPY 1,392.9 billion, up by JPY 42.4 billion from the end of the previous fiscal year. Equity was JPY 1,888.7 billion, up by JPY 186.7 billion from the end of the previous fiscal year. As a result, equity attributable to owners of the parent to total assets, the so-called shareholders' equity ratio was 29.5%, an improvement of 1.2 percentage points from the end of the previous fiscal year.

Next I will explain consolidated statements of the cash flows. Please see Page 15. Cash flows from operating activities had an inflow of JPY 83.5 billion, an increase of JPY 6.3 billion year-on-year. Cash flows from investing activities had an inflow of JPY 15.6 billion, an increase of JPY 80.7 billion year-on-year. This is mainly due to sales of investments and collections of loans. As a result, free cash flow had an inflow of JPY 99.1 billion, an increase of JPY 87 billion from JPY 12 billion year-on-year. Cash flows from financing activities had an outflow of JPY 24.7 billion, a decrease of outflow by JPY 2.5 billion year-on-year.

Next I will explain the revision for fiscal year 2022 outlook. Please go to Page 17. In the same manner as the explanation of the first half results, I will begin with an outlook of the business environment surrounding our company. As for the economic conditions, we expect raw material and fuel prices to remain high in the second half of the year as well. In addition there are concerns that the economy will enter a recessionary phase as policy rate hikes in various countries and curb economic activities.

Next, the weather chart shows the changes in the business environment and the key areas of each business segment from the first half to the second half of the fiscal year. As for Petrochemicals, the supply-demand balance for refined petroleum products, which was a factor in Rabigh's strong first half performance is expected to ease and market prices are expected to decline.

In Automobiles, we expect a recovery in production as companies are launching recovery production to make up for the production reduction in the first half of the year. In Displays, a panel inventory adjustment is expected to be prolonged due to sluggish demand for TV sets and demand for related materials is expected to decline accordingly. In Semiconductors, we expect the market to continue to expand; however, we believe there are downside risks in some memory semiconductor areas.

In Crop Protection, we expect an increase in shipment as the new product INDIFLIN will be fully launched in South America, while North America and Japan will be in the demand season. As for methionine, we expect the business environment to remain challenging due to high raw material and fuel prices. In Pharmaceuticals, we will continue to focus on expanding sales of new products as the exclusive sales period for LATUDA will end in February 2023.

I will now explain the details of the revision of the performance forecast. Please go to Page 18. The full-year forecasts have been revised from the figures announced in May. Sales revenue is expected to increase by 1.9% from the previous forecast to JPY 3,180 billion, and core operating income is expected to decrease by 5% from the previous forecast to JPY 190 billion. Operating income is expected to decrease 36.1% from the previous forecast to JPY 115 billion. Net income attributable to owners of the parent is expected to decrease 16% from the previous forecast to JPY 105 billion. So it's an increase in revenue and decline in profit.

The assumptions for the exchange rate and naphtha prices are as shown, of which the average exchange rate for the second half of the fiscal year, which is October to March, is JPY 140 to the U.S. dollar and the naphtha price is JPY 75,000 per kiloliter.

As for the core operating income, I'll explain by segment in the next slide. The forecast for core operating income and net income attributable to owners of the parent, it decrease due to deterioration in core operating income and the impact of impairment losses recorded in the second quarter. So at the operating income level, it will be a 36% decline. The net profit due to the foreign exchange variance, the degree of the decline is going to be smaller.

On Page 19, its forecast for sales revenue and core operating income by business segment. As for the full-year results by segment, as I mentioned earlier, in the key points of the forecast, while sales of Crop Protection products in South America has been strong in the Health & Crop Sciences, the deteriorating terms of trade in Essential Chemicals & Plastics and lower shipments in the IT-related chemicals have caused the company's overall core operating income to fall below the previous forecast. For the other company-wide expenses, the performance improvement items are included. This concludes my explanation of the financial results.

I will now like to take your questions. Thank you very much for joining us today.

[Operator]

[Operator Instructions] From Morgan Stanley MUFG Securities, Mr. Watabe.

[Takato Watabe, analyst]

My first question is about Health & Crop Sciences. In the first quarter, the generic price got up, which was positive. But because of the seasonal differences, there were some points difficult to understand. So I wanted to know what was that movement. And the recent demand trend for Crop Protection, you mentioned that South America is doing well, but could you give a breakdown by region and also your market prospect of methionine?

[Yoshizumi Sasaki, executive]

For Health & Crop Sciences segment, as you mentioned in your question, the first quarter, as you say, it was very good in the segment as a whole. Core operating income, JPY 21.9 billion in the second quarter, JPY 14.4 billion. In the second quarter, on the 6 of October -- as of 6 of October, we saw -- we expected that it would be better. But in South America, shipments towards the end of September, there were some controls in making shipments intentionally because generic price was becoming weaker. So taking that in consideration, we intentionally controlled shipments. As a result, the second quarter was slightly lower. However, throughout the year, for the controlling shipments, we will be able to recover. That is the situation in South America.

For North America, I think it's still to come, it's yet to come. But it is affected by the price of crops. And if the price is maintained at a certain level, the farmers' desire of [ purchasing ] will not be badly affected. So we will keep watching. And now North America will enter the demand season. So we will focus on sales. And for the income market, we believe the trend of expansion will continue on an annual basis, 6% to 7% level expansion is expected. So we will also focus in this market.

For methionine, in terms of price, the price is getting weaker. In the first and second quarters, gradually, we are seeing a decline. So including our sales strategy by changing the sales strategy, we want to sell as much as possible to places where the price is higher. And so feedstock price, I believe, will stabilize. So profitability will virtually improve. So this is the overall outline.

[Takato Watabe, analyst]

One question for confirmation. In the first quarter, the price difference was plus 70 and 0 in the first half and second quarter, then year-on-year, there seem to be a deterioration. So is that because of methionine?

[Yoshizumi Sasaki, executive]

Yes, that is right.

[Takato Watabe, analyst]

My second question is about IT-related Chemicals. So your weather chart was green, I have impression that this is better. There was a drop in Displays, but the one variance in sales compared to that is the long variance of traffic not that bad. And the profit compared to first and second half is nearly flat. So what is your view about the situation?

[Yoshizumi Sasaki, executive]

For IT-related Chemicals, we believe it is slightly bad, slightly poor. In the beginning of the year, the assumptions that we had compared to what we announced in May, we see it certain worsening. For the previous year, the situation is deteriorating but as I explained before, for Display-related area, there is quite a large level of worsening. In particular, in China, there is a lockdown in China. And there seems to be a negative desire of making purchases, televisions and mobile in both areas, I think the difficulties will continue.

On the other hand, for semiconductors, we believe semiconductors will continue to do well. But there are some reasons for concern, which is inflation or recession, might have some influence of semiconductors. We are not yet seeing such signs, but we are feeling some concerns about it. The figures comparing the first and second half, as you see, it's not worsening, but it's slightly lower compared to the outlook we made in the beginning of the year. So though the situation may be worse, Q3 is peak and Q4 because of the season may decline, but comparing first and second half, it is flat. Yes, you are right.

[Operator]

Mizuho Securities, Mr. Yamada.

[Mikiya Yamada, analyst]

My first question is regarding to Health & Crop Sciences. Related to what was asked right now, in September, you said that you are going to curb the shipment in South America. If that is so, in the second half, I feel that the profit can be more weighted there. Are you assuming that the methionine is going to deteriorate quite a bit?

So the Health & Crop Sciences, I would like to know the trend between the first and second half in more detail?

[Yoshizumi Sasaki, executive]

First of all, North America, it will be increasing from now. So the third quarter or the fourth quarter, they will have a good performance. On the other hand, for South America, the peak is around September. July and September will be the peak is what we think. So in that sense, seasonality-wise, it will start to decline from now. South America's importance has changed from several years ago. Compared to South America, the business is larger in North America. So in that sense, the second half, in a way, Crop Protection products will be slowing down is what is reflected is how you can look at this.

Before, you said the first quarter to the second quarter -- sorry, from second quarter, you will be curbing or suppressing the shipment is what was mentioned. That is not going to push up the second quarter. Even though it is pushing it up, it's only remaining at this level. From second quarter to the third quarter, there is a timing difference. So that is incorporated. However, we believe that it is going to be around this level. That is how we are looking at it. INDIFLIN, is that going to be sold and considering other elements, it's going to be at this level?

[Mikiya Yamada, analyst]

My second question. You were saying that there will be a recovery in the automobiles, but Energy & Functional Materials between the first and second half, we're not seeing that much of a momentum. That is due to the raw materials and fuel prices increasing, and that is going to impact the profitability. But in volume-wise, it's going to increase, though can we have an expectations toward the next fiscal year? Is there other element that is pressing the performance or the profitability?

[Yoshizumi Sasaki, executive]

The first half was JPY 13.4 billion core operating income. And against that, second half is JPY 6.6 billion. So when you compare the first and second half, there will be quite of a slowdown is how we are looking at this. The second half, this is what happens usually. The fourth quarter especially tends to slow down from the past. And there is such a trend that exists. And within this situation, automobiles are due to the lack of semiconductors. Recently, it was not performing well continuously. However, we believe that such situation is going to be slightly improving. That's the expectations we have. But we are not looking at it as such a strong recovery. Of course, we have expectations. However, the reality is that we cannot incorporate it as such a short thing.

And in addition, the raw material and fuel prices are increasing as well as the logistics costs. So I believe that this part is not going to be easily recovering. And therefore, having this as the assumption, we are showing the numbers you see. So the revenue between the first and second half, there is going to be about a JPY 40 billion plus increase and the raw material in fuel prices increase seems to be passed on to the product prices to a certain extent. But even looking incorporating that element, this is not going to be the forecast.

Well, the sales revenue increasing, the cost behind that is the aluminum and the metal market within the cathode material. So it's not that everything is going to be linked to the sales revenue.

[Operator]

The next question is Mr. Umebayashi from Daiwa Securities.

[Hidemitsu Umebayashi, analyst]

I also had a question for confirmation for Health & Crop Sciences. The September shipment of America is being suppressed intentionally. The reason is because price is declining. The reason for the drop in price, is that a problem of raw material procurement? Feedstock price after getting higher has stabilized or because the situation is stable for seasonal reasons looking at the demand trend? So that was what I wanted to confirm. And feedstock price in China is getting higher, product price is getting higher. Not only in South America, but including in the second half in North America, is the situation similar or is there a drop in South America? Then the price we cannot expect as much in terms of a price in North America. What is the situation?

[Yoshizumi Sasaki, executive]

Basically, it is very rare for us to handle generic products. But in South America, we are handling generic products since the Nufarm. That was a situation. But the generics price, as you know, in the first half, in particular in the first quarter, the price was very high. And as I mentioned in the first quarter, it's not that the high price will continue forever, but it would stabilize at some point in time. So I mentioned we suppressed intentionally because though we expected stabilization, the price went suddenly down in September. But this downward trend is now stable.

So we believe this is a onetime phenomena, but though we expected a smooth decline, there was a sudden decline. So by curbing shipments, we try to mitigate the impact. And in general, price of generics, we assume will stabilize. It is within our expectation.

Then for confirmation in September, there was a sudden drop and then there was a recovery in October or did it remain low? In the North America, there are no generics. So we may not -- don't need to think so much about the price impact. It's just we must be concerned about the foreign exchange relation impact. Generics for South America dropped. Well, that trend surfaced. So if we receive orders at that price, the price will go further down, there is such a risk. So that is what we talked. That was our line of thought. For North America, of course, we don't sell generics in North America, but there is a battle against anti-generic products.

So far, we try to sell in a way that we would not be engaged in price competition. So we will keep watching the situation so that will not be affected so much.

[Hidemitsu Umebayashi, analyst]

And my second question is about essential Chemicals. JPY 23 billion was the core operating income out of the -- on top of that, 2.7% or so was the equity asset income and JPY 27 billion loss is expected by second half. So for Rabigh, about JPY 20 billion might be the losses. So this may be the reason for these figures. So it may be difficult, but for Rabigh, prospects for October to December, could you tell me that as much as you can? And Singapore's operations and margin, what are your views about it?

[Yoshizumi Sasaki, executive]

Under essential Chemicals, as you have mentioned, the impact of Rabigh in Saudi Arabia is large, there's a major impact. But this is also a list of the company. So there are not many things that we can disclose. But as a general point from 3 months from July to September, Petro Rabigh announced their financial results and the margin was not good. Of course, this may be a onetime situation because of a drop in price, maybe there was a negative impact. However the refining margin is very low, including adjustment amount for Asia, that was negative for Rabigh as well. But I don't think we can expect such a situation to continue for a long time.

April-June was very good, but now there was an opposite trend. But we don't think such poor situation will continue for a long time. So this is all I can say as a general perspective. And for Singapore, the economic situation is getting very bad. I think this situation is reflected including MMA and synthetic resin profitability is worsening. So in the first and second quarter and in the second half, there are not so many factors that we can expect improvement. So the same situation may continue.

For solar panels, some unique products for that purpose. I believe they are being able to sell such products. That is the situation in Singapore.

[Operator]

I'm sure that there are people who are raising your hands, but we have come to the closing time. So with this, we would like to conclude the Q&A session. At the end, our Sasaki would like to say a few words.

[Yoshizumi Sasaki, executive]

Thank you very much for attending our conference call today. As explained to you right now, the situation is starting to slightly change. In a sense, the economic situation has come to a turning point is what we can say. However, the medium-term plan or the budget that has been set here, it is set for us that we surely achieve those. Therefore, towards the achievement, we would like to put our full efforts in. So I would like to continue to seek your support and understanding. Thank you very much for today.

[Operator]

With this, we would like to conclude today's conference call. Thank you very much for participating today.

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