Sumitomo Chemical Co Ltd

TSE:4005

Earnings Call Transcript 2020-Q3

[Operator]

Thank you very much for participating in the Sumitomo Chemical conference call for fiscal 2019 third quarter financial results.

First, Mr. Sasaki, Executive Officer of Sumitomo Chemical, will give you a briefing of financial results for fiscal year 2019 third quarter. Later, she will be joined by Mr. Tang, General Manager, Accounting Department, for questions and answers.

Before the conference, let me give you some reminders. In the presentation, future projections based on current forecasts may be provided. Please be informed that they may involve risk and uncertainties. Please be aware that the actual results may greatly differ from projections.

We would like to start with the conference call. Mr. Sasaki, please.

[Keigo Sasaki, executive]

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

Now let me start with explanation of financial results for fiscal year 2019 third quarter. Please turn to Slide -- Page 4.

Consolidated results for fiscal year 2019 third quarter, sales revenue was JPY 1,650.7 billion, down by JPY 63.4 billion year-on-year. Core operating income, representing the recurring profitability, was JPY 116.3 billion, decline of JPY 38.7 billion year-on-year.

Nonrecurring items not included in core operating income posted gains of JPY 40.8 billion as changes in fair value of contingent consideration. On the other hand, there were losses of JPY 22.7 billion as impairment loss and restructuring charges of JPY 5 billion. In net, there was a gain of JPY 11.4 billion, which is an improvement of JPY 23.7 billion year-on-year. Majority of changes in fair value of contingent consideration and the impairment loss occurred in the first half of the year.

We will review our business plan including development plan in the cancer sector in pharmaceuticals. Fair value of future debt payment or milestone payments declined, closing reversal of expenses.

On the other hand, impairment loss, which is in process R&D, which is an intangible asset, was posted. As a result, operating income was JPY 127.7 billion, down by JPY 14.9 billion year-on-year.

Finance income or expenses was a loss of JPY 900 million, worsening by JPY 6.5 billion year-on-year, out of which, gain or loss on foreign currency transactions was a loss of JPY 1.9 billion because of stronger yen this term, a worsening of JPY 6.7 billion year-on-year.

Income tax expenses was JPY 60.3 billion, increase of JPY 29.7 billion year-on-year. Major factor for this increase happened in the first half of the year.

As explained earlier, with a review of business plan of pharmaceuticals, there was a reversal of deferred tax assets recognized in the United States. As a result, net income attributable to the owners of the parent in this quarter was JPY 37.6 billion, down by JPY 51.4 billion year-on-year.

Changes in fair value of contingent consideration, impairment loss and reversal of deferred tax assets in pharmaceuticals are offsetting each other. So the main factors for the drop in net income are the decline in core operating income and worsening of gain or loss on foreign currency translation. As far as the exchange rate and naphtha price affecting our results, the average U.S. dollar rate during the term was JPY 108.65 to the dollar. And naphtha price was JPY 42,200 per kiloliter with stronger yen and cheaper feedstock price year-on-year.

Next, our results by segment. Please turn to Page 5. Let me start with the sales revenue. Total sales revenue went down JPY 63.4 billion year-on-year. Looking by segment, sales revenue increased in IT-related chemicals, Health & Crop Sciences and Pharmaceuticals, but declined in Petrochemicals & Plastics and Energy & Functional Materials.

Looking at the factors for the difference in sales revenue, sales price dropped by JPY 128.5 billion. Volume increased JPY 96.4 billion. And the foreign exchange translation of sales revenue of foreign subsidiaries dropped by JPY 31.2 billion.

Next is Page 6. Total core operating income dropped JPY 38.7 billion.

Looking by segment, core operating income increased in Pharmaceuticals, but decreased in Petrochemicals & Plastics, Energy & Functional Materials, IT-related Chemicals and Health & Crop Sciences.

As for the factors for the difference, price was minus JPY 39.3 billion and cost, minus JPY 10.5 billion. And on the other hand, volume, including changes in equity in earnings as affiliated, was plus JPY 11.3 billion.

Next, our result by segment, Page 7. In the Petrochemicals & Plastics segment, sales revenue was JPY 518.3 billion, down JPY 58.6 billion year-on-year. Core operating income was JPY 27.4 billion, down JPY 24.4 billion year-on-year.

For sales revenue, shipments of Rabigh products increased. But with lower feedstock price, such as naphtha, market prices of petrochemicals and synthetic resin dropped. Market prices for MMA and caprolactam also stayed at a low level, causing a drop in sales revenue.

For core operating income, in addition to the decrease in profit margin of MMA and caprolactam, equity earnings of affiliates at Petro Rabigh and Singapore's PCS decreased, causing a drop in core operating income.

Please turn to next page. Energy & Functional Materials segment. Sales revenue was JPY 190.6 billion, drop of JPY 24 billion year-on-year. Core operating income was JPY 17.7 billion, down JPY 2.6 billion year-on-year.

For sales revenue, in addition to lower market price for aluminum, there was a decline in the selling price of cathode materials. Also, there was a decrease in shipments of cathode materials and lithium-ion secondary battery separators, causing a drop in sales revenue.

For core operating income, there was an increase in shipment volume after the prior year's periodic plant maintenance in the Chiba Works but with a decreasing profit margin of aluminum and decrease in shipments of cathode materials and lithium-ion secondary battery separators, core operating income dropped year-on-year.

Please turn to the next page. In IT-related Chemicals segment, sales revenue totaled JPY 304.9 billion, up JPY 4 billion year-on-year. The core operating income was JPY 18.7 billion, down JPY 3.6 billion year-on-year.

As for sales revenue, in terms of sales prices, polarizing films and touchscreen panels declined. But in terms of volume, increase in demand led to increased shipments, which pushed up sales revenue. In core operating income, increase in shipment volume was more than offset by the negative impact of decline in selling prices, which resulted in a drop in the core operating income.

Please take a look at Page 10. In Health & Crop Sciences segment, sales revenue totaled JPY 218.5 billion, up JPY 5.8 billion year-on-year. The core operating income was minus JPY 13.6 billion. This was the worsening of JPY 17.5 billion year-on-year.

In sales revenue. The market price dropped for methionine, but the expansion in production capacity implemented in the previous fiscal year resulted in increased shipments. On the other hand, crop protection chemicals declined in shipments due to the extreme weather in North America. As a result, we have seen increase in sales revenue. On the other hand, as for core operating income, the profit margin declined in methionine and cost increased because of production capacity increase resulted in shipment decline in crop protection chemicals and resulted in declining profit.

In Pharmaceuticals segment, sales revenue was JPY 382.2 billion, up JPY 10.4 billion year-on-year. Core operating income was JPY 67.6 billion, up JPY 8.3 billion year-on-year. In sales revenue in Japan, in addition to NHI price revisions, long-listed products dropped in shipments. But in North America, LATUDA, among others, saw a steady increase in sales, which pushed up sales revenue. In core operating income in addition to shipment volume increase, SG&A expenses dropped, which resulted in the increased profit. That is all for segmental results.

Next page is about nonrecurring items breakdown. This is just as described at the outset, so I'd like to skip this slide. So now let me move on to consolidated balance sheet.

As of the end of December 2019, the total assets stood at JPY 3,673.6 billion, up JPY 502 billion from the end of March 2019. One of our consolidated subsidiaries, Sumitomo Dainippon Pharma, entered strategic alliance with Roivant Sciences, which was the main reason. With this alliance, goodwill and intangible assets and others under noncurrent assets significantly increased. Furthermore, IFRS 16 lease was applied, which resulted in increasing property, plants and equipment.

Interest-bearing liabilities totaled JPY 1,388.4 billion, up JPY 548.9 billion from the end of fiscal 2019. This was due to the procurement of a bridge loan related to the payment of the consideration for strategic alliance in Sumitomo Dainippon Pharma as well as our company's issuance of hybrid bonds.

Equity was JPY 1,337.7 billion, down JPY 14.2 billion from the end of March 2019. This was mainly because yen's appreciation led to reduction of other components of equity. As a result, equity attributable to owners of parent to total assets came in at 26.5%, down 5.0 percentage points from the end of last fiscal year.

Now let me go on to consolidated cash flow. Please take a look at Page 14. Cash flow from operating activities was JPY 68.3 billion, in revenue, down JPY 4.7 billion year-on-year. Deteriorated operating income was the main reason. The cash outflow from investing activities was JPY 419 billion, up JPY 289.5 billion year-on-year. This was mainly because Sumitomo Dainippon Pharma entered a strategic alliance with Roivant Sciences and paid for the consideration.

As a result, in the free cash flow, there was a net outflow of JPY 355.4 billion, an increase of JPY 294.2 billion from the JPY 61.2 billion in net outflow recorded the year before. Cash flow from financing activities saw an inflow of JPY 463.9 billion, up JPY 395.4 billion year-on-year.

Last but not least, let me explain about the progress in the third quarter against our full year forecast. In the full year forecast announced in October, the sales revenue was expected to be JPY 2.33 trillion; the core operating income JPY 160 billion; the operating income of JPY 170 billion; net income, JPY 50 billion. And 9 months progress rate against these are: core operating income, 73%; the operating income, 75%; and net income, 75%. We have been making steady progress at each level of the profits.

As for the full year forecast, yesterday, Sumitomo Dainippon Pharma made a revision on its full year forecast, and we will be affected by this.

And for other segments, in terms of forecast, Petrochemicals & Plastics is currently already ahead of the full year forecast announced.

On the other hand, as for Petro Rabigh, in its fourth quarter, which is different from financial cycle is October-December period. And since this is a listed company, I cannot say for sure. But generally speaking, oil refinery margin significantly deteriorated during this period, which will probably have been reflected in its earnings results. And we will need to closely watch the future petrochemical market trend.

In Health & Crop Sciences, every year, Q4 is the period when agriculture shipments tend to get concentrated, but the forecast for North America, which is affected by the extreme weather does not allow us to be remained optimistic. So there are several risk factors as described, but we decided to leave our forecast unchanged this time. But going forward, we will cautiously watch the performance trend and review the forecast as needed.

And at this moment, the dividend is left undecided for the end of this fiscal year. But we're going to review it at an appropriate timing, depending on the possible divisions of the forecast.

That is all for the financial results of the quarter. We'd like to entertain questions from all of you. Thank you very much for your attendance, once again.

[Operator]

Thank you very much. Now we would like to have your questions. The first question is of Morgan Stanley MUFG Securities, Mr. Watabe.

[Takato Watabe, analyst]

I have 2 questions. Mostly you talked about the progress and you didn't mention about IT-related Chemicals, so I'd like to hear about that situation, in particular, for Q3, Q4. What is the situation?

And price went down by JPY 20 billion. And to overcome that cost reduction, you don't have that mentioned in the materials. So could you tell me about that?

[Keigo Sasaki, executive]

For IT-related Chemicals, by quarter, looking at the situation, this third quarter, sales revenue and core operating income, compared to previous terms, were slightly low.

And as for the future, fourth quarter itself, for polarizing film, it is a slow period. So we may have some impact from that.

On the other hand, for touchscreen panels, there may be instances of model change in some quarters, but there are other quarters without that influence. But in the fourth quarter, relatively speaking, there's not much -- such influence.

Sales revenue, we expect will be in the direction of improving. So the amount that we have projected, we would do our best to achieve those figures that we have announced. But it's not a situation at the moment where we can say for sure that it will be all right. That is the situation.

[Takato Watabe, analyst]

How about recovering the situation in terms of price?

[Keigo Sasaki, executive]

For price, it is very difficult. But actually, as for the price trend, our price, it's not that it's not declining that much, but in the first quarter or second quarter -- compared to the first and second quarter, the drop in price, we expect to be smaller. So we want to control this part as much as we can.

But at the moment, for OLEDs, it's not in such a situation. But for LCD, cheaper products are available in the market. So in general, we may be affected by that.

[Takato Watabe, analyst]

I wanted to know whether there was any room for rationalization. Now let me ask about Health & Crop Sciences. The loss of Health & Crop Sciences sector is expanding methionine. This quarter, it's not worsening that much. So what is the situation? And what is the situation of America towards the fourth quarter?

[Keigo Sasaki, executive]

For Health & Crop Sciences sector, at the moment, yes, we are having losses. There are several factors. One is methionine. Sales price is not going up. So we want to do our best about it. To maintain the sales price, we are seeing some signs of change. Our competitors in December -- or in November/December, some declared force majeure, some have this closed, but others have continued. And with this situation in Europe, stock price is going up -- started to go up in some places. So I think these are signs of change. Our contract price will not be reflecting that immediately, it may take some time to be reflected, but these are some of the factors that we can look forward.

On the other hand, for overseas crop protection chemicals, for this, at the moment, there's nothing we can say about it. As usual, in the fourth quarter, there will be a concentration of shipments. So some extent of profit can be expected.

On the other hand, there are also reasons for concern. Last year, spring, there was an influence of climate and the acreage decreased and our shipments declined. But despite that, in North America, how much of a distribution inventory has been consumed? That's not very clear. So from January to March of this year, shipments could be influenced by that, so such risks could be possible.

So at the moment, to achieve our forecast, it's not something that we can be so optimistic about. Thank you very much.

[Operator]

So Mr. Watabe, does that answer your question?

[Takato Watabe, analyst]

Yes.

[Operator]

Now let's move on to the next question. Mr. Yamada from Mizuho Securities.

[Mikiya Yamada, analyst]

Yamada from Mizuho Securities.

First question. Maybe this is a question that should be addressed to Sumitomo Dainippon Pharma. The strategic alliance with Roivant, what will be the impact on the balance sheet and Pharmaceuticals downward revision? Would that be directly reflected in your performance? Should we expect same amount of impact in your performance?

[Keigo Sasaki, executive]

Well, for Roivant, the strategic alliance with Roivant, what would be the impact on the balance sheet? That was the question. There is no documented material, so I can just explain verbally. For the total assets -- the impacts on total assets, there are several factors. What will be most marked will be the following: the goodwill and intangible assets. I think there's an item called that. With regard to that, JPY 230 billion, approximately, will be the impact. The strategic alliance with Roivant, you paid for consideration and intangible assets posting would be worth that amount.

And then there's a direct investment in Roivant that was made. And under noncurrent assets, there's item others, which posts more than JPY 100 billion. So in terms of impact on balance sheet, those are the factors. But obviously, there's payment, so that would increase the liabilities and this has been announced. JPY 270 billion in bridge loan was procured and this has affected the interest-bearing liabilities. So that's about it.

[Mikiya Yamada, analyst]

Well, so what has increased? If you look at the financial results, goodwill has increased. So most of the amount is the goodwill. So it is not subject to amortization and direct investment is in -- is reflected in others. Is that correct? Or as for goodwill and intangible assets?

[Keigo Sasaki, executive]

So this is just a tentative treatment, and we have posted all the amount in the goodwill. And once we know the more detailed breakdown, some may be posted under -- in process R&D. But tentatively, for now, we have posted whole amount in -- under goodwill. And as for direct investment in Roivant, as you have rightly understood, the others under noncurrent assets has posted the whole amount.

If that is the case, in the Pharmaceuticals, the Sumitomo Dainippon Pharma downward revision was because of SG&A and R&D. So depending on the amortization of the intangible assets, there could be more loss. Well, when the amortization will start, that is the question. For example, in process R&D, those are posted under that. That will be started to be amortized after the listing, so it will not immediately affect the performance.

[Mikiya Yamada, analyst]

Okay. Then another question is about lithium-ion battery is -- this has not been good up until third quarter, but have you seen signs of improvement in third quarter only? And what will be the forecast for the fourth quarter?

[Keigo Sasaki, executive]

Well, a separate -- related question. In the third quarter, the tentative adjustment in inventory was done. And so this was different from the previous quarters. But that was just a tentative phenomenon. But if you look at this for the -- throughout the year, we won't be seeing too much impact from that.

So in total, on balance, the shipment will be on par with the average years.

[Mikiya Yamada, analyst]

So you can expect a recovery in the fourth quarter?

[Keigo Sasaki, executive]

Yes, that is correct.

[Operator]

Mr. Yamada, are you satisfied with that?

[Mikiya Yamada, analyst]

Thank you very much.

[Operator]

The next question is from Nomura Securities, Mr. Okazaki.

[Shigeki Okazaki, analyst]

My first question is about the Petrochemicals. From the second to third quarter, profit is increasing. So what is the background for that? Was there a onetime factor? And for Rabigh, for example, Phase I periodic maintenance shutdown and the start of Phase II. Could you tell me about that?

[Keigo Sasaki, executive]

First, for Petrochemicals sector, as a whole, profit. Looking only at the third quarter, it was JPY 10 billion. In the second quarter compared to second quarter, it is quite good. But this difference is that the Petro Rabigh's profit and loss is influencing. There's influence of oil refining margin. And the third quarter, there is a 3-month difference in the financial settlements. So from July to September, Petro Rabigh's profit and loss is affecting our third quarter as a equity in the earnings of affiliates.

And Petro Rabigh's operations at the moment, this is a listed company, so we cannot say anything else in addition to what they have announced.

For the second phase, I think I explained it. Previously, the so-called CRT was cleared in the end of October. And after that, in particular, there were no major troubles. We don't have such information of major troubles. And for the first phase, the aim there to stabilizing the operations, and operations are good at the moment.

[Shigeki Okazaki, analyst]

And for Rabigh, from second quarter to the third quarter, about JPY 80 billion improvement factors existed. And besides that, was there any influence in the market situation?

[Keigo Sasaki, executive]

Yes. Rabigh's numbers are public numbers. So they are right. And as for others, from the current situation, there are some petrochemicals with margin erosion, so this is also influencing.

[Shigeki Okazaki, analyst]

For IT-related Chemicals, from Q2 to Q3, television and polarizing film and glass and film touchscreen panels, what is the general direction?

[Keigo Sasaki, executive]

For IT-related Chemicals. First, for polarizing film, as I mentioned earlier, in the fourth quarter...

[Shigeki Okazaki, analyst]

Excuse me, from second to the third quarter was my question.

[Keigo Sasaki, executive]

From the second to the third quarter, for example, for TVs. I think there is a certain decline, very large, high-end products, we're doing very well. But in these areas, the volume of TV sets is not increasing, so in that sense, some price decline and the declining volume is being seen because of that influence. That is the situation from the second to the third quarter.

On the other hand, the mobile ones or the medium and smaller sizes for this. For OLED, there are more changes in models, so there are plus and minuses. But for OLEDs, the situation is not that bad. And for LCDs, there are also cheaper products coming. And in that sense, our products are facing difficulties.

So from the second to third quarter, we are seeing a decline. That is the general direction.

[Operator]

So Mr. Okazaki, did that answer your questions?

[Shigeki Okazaki, analyst]

Yes.

[Operator]

Let us move to the next question. SMBC Nikko Securities, Mr. Takeuchi.

[Shinobu Takeuchi, analyst]

I'm Takeuchi from SMBC Nikko. First question is about Energy & Functional Materials. You talked about separators, in the third quarter investment adjustment was an impact. So 9 months cumulative basis, what's the kind of drop that you've seen in the sales volume?

[Keigo Sasaki, executive]

Well, with regard to volume, we have not disclosed the numbers, so it's very difficult to answer your question, but in the -- if you look at the third quarter alone, in terms of image, about 10% impact may have been seen. If you understand that way, that will be the general reduction.

[Shinobu Takeuchi, analyst]

While in the fourth quarter, you're expecting a recovery so that probability is decently high. Is that correct?

[Keigo Sasaki, executive]

Yes, that is how we look at that.

[Shinobu Takeuchi, analyst]

Energy & Functional Materials segment as a whole, there are seasonal factors, but in the fourth quarter, the profit tends to go down if you look at the track record.

But in this fiscal year, there is a decline from third to fourth quarter, but there is a recovery in separators. So compared to other years, the third quarter and fourth quarter, the comparison between these 2, they will be more even compared to other years. Is that correct?

[Keigo Sasaki, executive]

In the fourth quarter, as I said, there are segments that would see recovery, and we believe that, that will be the case. But as a whole, if you ask us whether there would be that much recovery, then there are several uncertain factors. It is, therefore, as a whole, in the fourth quarter -- for instance, the full year forecast that we are announcing, we are not that confident that we can achieve that, at this moment, at least. That is our position.

[Shinobu Takeuchi, analyst]

So what will be the major concern if you look at other products and separators? What should be the products that we should take into account?

[Keigo Sasaki, executive]

Well, we cannot specify those products per se but generally speaking, for example, the automobile applications and others. But there are applications that will be affected by the economic situation. And there are such applications for Energy & Functional Materials.

[Shinobu Takeuchi, analyst]

Okay. Then the profit has declined from second to third quarter. So it's not just separators, but for overall, the volume was weak. Is that correct?

[Keigo Sasaki, executive]

Yes, that is correct.

[Shinobu Takeuchi, analyst]

The second question. In -- at the end of the third quarter, the inventory is what I'd like to ask about. Compared to the end of second quarter, it has significantly increased. So Roivant has not affected that inventory. Is that correct?

[Keigo Sasaki, executive]

Well, inventory has not increased because of Roivant.

[Shinobu Takeuchi, analyst]

Then the monthly turnover has deteriorated so -- but in this fourth quarter, is there any concern that there could be inventory adjustment or production decline?

[Keigo Sasaki, executive]

Well, not that much, but for several products, there might be some reduction in production volume, but those that are increasing. For example, in April/May this year, there are several products that will see periodic cloud maintenance. That is the exception, but there are some products that could be going through production adjustment.

So the inventory and volume is increasing, yes. And for us -- for crop protection chemicals, there are seasonality factors. So we are seeing more in inventory, but these will be shipped out, and inventory is expected to be declined for some products. Thank you.

[Operator]

Let us move to the next question. Mr. Umebayashi of Daiwa Securities.

[Hidemitsu Umebayashi, analyst]

I'm Umebayashi from Daiwa Securities. My first question is about IT-related Chemicals.

From second to the third quarter, profit had declined. And you mentioned about polarizing films earlier, but what is the situation for touchscreen panels?

[Keigo Sasaki, executive]

For touchscreen panels, from the second to the third quarter, there were no major movements for touchscreen panels. Actually, I mentioned that we are looking forward to -- for the fourth quarter, we expect increase towards the fourth quarter.

From other major models, we can expect full-fledged sales and that will happen in the fourth quarter.

From the second to the third quarter, I think there were no major changes.

[Hidemitsu Umebayashi, analyst]

Then the major factor is the worsening of polarizing films. And for semiconductors, there were no influences?

[Keigo Sasaki, executive]

For semiconductor materials, there were no major movements. That is how you can understand the situation.

[Hidemitsu Umebayashi, analyst]

And my second question is about the Petrochemicals, the situation of operations. Singapore's olefin, polyolefin and MMA, these major products, operations, is there anything that is declining?

[Keigo Sasaki, executive]

For Petrochemicals operation situation. For example, Singapore's polyolefin-related items. Well, it is nearly 90% of full operation. This situation is continuing. And as for others, for caprolactam, the spread was poor at some point in time. So utilization -- capacity utilization was reduced to nearly 70%. And for MMA, also, in general, the situation was similar.

In the third and fourth quarter, the situation is not that bad. So that is situation.

[Hidemitsu Umebayashi, analyst]

For MMA, including the increase in capacity, there is a good utilization of capacity?

[Keigo Sasaki, executive]

Yes, you are right. Thank you very much.

[Operator]

So with that, we'd like to conclude Q&A time. Lastly, we'd like to invite Mr. Sasaki from Sumitomo Chemical to give us closing remarks.

[Keigo Sasaki, executive]

Thank you very much for your attendance once again. We are slightly encountering the headwind, but from the target that we've announced at the beginning of the year, we have done some downward revision, but we'd like to work as hard as we can to achieve that revised target. And I'd like to ask for continued support.

Thank you very much, once again, for today.

[Operator]

Thank you very much. The conference call today will be webcasted as an archive on website of Sumitomo Chemical Corporation for the next 3 months, and you can get access to that at any time. So please make use of that.

And I would like to conclude the conference call today, and thank you very much for your attendance.

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