Idemitsu Kosan Co Ltd

TSE:5019

Earnings Call Transcript 2021-Q2

[Shunichi Kito, executive]

My name is Kito of Idemitsu Kosan. Before we cover our second quarter results, I would like to address 2 topics: the restructuring of our core business amid the COVID-19 pandemic and our efforts aimed at becoming carbon neutral.

First, I would like to discuss COVID-19. As the number of infected patients is gradually increasing in Japan, the country is entering a phase of engaging in economic activities while coexisting with the virus. Petroleum demand has almost recovered to previous year levels, in line with the resumption of economic activities. On the other hand, extremely difficult conditions are continuing in Europe and the United States. And we feel that we need to keep living with COVID in mind over the next several years in our overseas strategy.

The Nghi Son Refinery, which is subject to significant interest from the market, has had to kick off in an extremely unfavorable environment characterized by margins at historical lows. While we announced our medium-term plan last fall to provide a road map for the medium to long term, we do not make major revisions of our policies. Instead, we will continue to focus on revamping the earnings structure of our core businesses, expanding our growth businesses and creating next-generation businesses.

While we assumed a 30% fall in domestic demand by 2030, it will become important to conduct operations while anticipating a fall in demand from an earlier point in time. We are focusing on reforming internal operations to enhance competitiveness, such as using AI for accident prevention and optimizing maintenance costs. In addition, we believe it is extremely important to enhance international competitiveness through integration with petrochemicals or nearby refineries, which form an industrial complex. To give an example, the termination of paraxylene equipment, among others, was recently announced at the ENEOS Chita Plant.

In response, we are considering a purchase of some equipment for our Aichi refinery. While details have yet to be decided, this refinery is a high-cracking-type refinery equipped with RFCC. Considering the fall in gasoline demand, promoting fuel to chemical appears to be an extremely important strategy to strengthen future competitiveness. This is just one example. We believe there is room for further rationalization and streamlining in the industrial complexes of each region. We feel that it is important to accelerate such efforts.

Next, I would like to discuss our ESG-related initiatives. It has been announced that Japan will aim to become carbon neutral by 2050. The trend towards action to tackle environmental issues also continues to grow stronger on a global scale. The petroleum industry must also treat harmony with the environment as a top priority. We perceive this government policy to be a significant opportunity towards carbon reduction and decarbonization and plan to engage in various proactive measures.

As a professional with a long history of handling hydrocarbons, the petroleum industry has significant CO2-related know-how and a solid infrastructure. We aim to contribute to this decarbonization movement.

In the near future, we will further accelerate our growth businesses, including renewable energy and power, geothermal power generation and the solar business. As I stated at the beginning, the global economic recession creates an extremely difficult environment for the years to come.

We plan to strengthen the following initiatives towards 2050: First, we aim to commercialize lithium battery materials, which will service as the foundation for reusable energy electric vehicles. We also plan to commercialize black pellets to contribute to CO2 reduction through coal-fired power to commercialize biomass fuel sorghum cultures from coal mining sites to expand total power generation for renewable energy to recycle waste plastics and solar panels to develop carbon recycling and other secular businesses to develop manufacturing technology of carbonates, which create raw material for concrete from industrial waste and CO2, to coordinate industry efforts with research institutions such as universities and to proactively participate in venture capital and government funds. Instead of viewing the strong trend towards decarbonization as a fire on the opposite shore or being engulfed by it, we would like to implement specific countermeasures to position ourselves at the center of the movement and become a leader of the trend.

That concludes my opening remarks. Thank you for your attention.

[Noriaki Sakai, executive]

My name is Sakai. I would like to take you through our materials on our financial results. I will start with a summary of our financial results.

In the second quarter, the total of operating income and equity income decreased by JPY 73.9 billion year-on-year to a loss of JPY 25.1 billion. The significant year-on-year decrease was mainly due to a large negative inventory impact of JPY 57.7 billion. Operating income and equity income, excluding this impact, was JPY 32.6 billion. This still represented a JPY 37.1 billion year-on-year loss, mainly due to increased losses from equity method investment losses from NSRP. No changes have been made to our dividend forecast of JPY 120 for the fiscal year with an expected JPY 60 per share for both interim and fiscal year-end dividends.

This slide shows our performance forecast for the full fiscal year. Based on our crude oil price assumption of $40, we anticipate inventory impact losses of JPY 50 billion, leading to a JPY 30 billion downward revision in operating income and equity income. On the other hand, operating income and equity income, excluding inventory impact, was revised upward by JPY 20 billion to JPY 45 billion. We also aim to reflect changes in the operating environment resulting from the COVID-19 pandemic and basic energy plan trends into our medium-term plan so that we can disclose it as early as possible.

This next slide shows key topics for the current fiscal year. The first topic is the impact of COVID-19. Sales of the 4 core fuel products recovered in the second quarter relative to the first quarter with 88.8% year-on-year performance in the first half. We expect a recovery to 97.6% in the second half. On the other hand, we expect difficult conditions to continue with respect to jet fuel. The COVID-19 impact was the main reason for deteriorated earnings in other segments, leading to a softer petrochemical market and a fall in resource prices.

With respect to NSRP, capacity utilization of the refinery remains stable. As crude oil prices recovered in the second quarter, earnings have improved relative to the first quarter. This slide introduces our initiatives amid the COVID-19 pandemic. We reduced costs by JPY 5 billion in the first half and expect a total reduction of about JPY 10 billion for the full fiscal year. We also anticipate to reduce investments by about JPY 20 billion, mainly by reviewing maintenance and renewable investments. However, we will continue to consider selective investments in our growing businesses.

We have been able to stabilize supply while engaging in committed infection prevention measures at manufacturing, logistics and sales stages. We also continue to make flexible adjustments to employee work styles in light of the pandemic. The next topic is our operating environment. Crude oil price, coal spot price and exchange rate are shown here. The current fiscal year is drawn in red, while the previous fiscal year is drawn in gray.

Page 7 shows our income statement. Net sales decreased year-on-year due to the fall in the crude oil price. As stated earlier, the fall in operating income and equity income was mainly due to inventory impact and NSRP. Extraordinary income decreased by JPY 23 billion due to the reversal of gains from step acquisition relating to the integration.

I would now like to move on to segment information. Figures are shown here. A step chart is provided on Page 9. Details on changes in each segment will be explained in the following slides. The first segment is the Petroleum segment. The bar graph on your left shows sales volume, which decreased by about 1.7 million kiloliters year-on-year in the first half, with an impact of JPY 19.1 billion. The graph on your right shows product margins, with the red line, including the impact of time lag, while the gray line excludes such impact. There was a JPY 0.7 per liter improvement relative to the previous year for a positive impact of JPY 8.1 billion.

With respect to other factors, synergies and affiliates had a total positive impact of JPY 22.9 billion. This figure is composed of plus JPY 4.7 billion from integration synergies, plus JPY 11.2 billion from affiliates, minus JPY 13.9 billion from equity income, minus JPY 10.6 billion from reduced jet fuel sales volume and plus JPY 31.5 billion from refinery fuel costs, et cetera, which mainly included a refinery fuel cost reduction of JPY 12.2 billion and a positive impact of JPY 16 billion from a delay in expense recognition.

Next is basic chemicals. Segment operating income decreased by JPY 16.3 billion year-on-year, most of which was due to pricing factors resulting from reduced margins. Margins for each product are as indicated on this slide. The functional materials segment reported a JPY 7.5 billion decrease, mainly due to reduced lubricant oil demand due to the COVID-19 pandemic and reduced polycarbonate margins. Power and renewable energy reported a JPY 0.9 billion decrease, mainly due to reduced earnings from the solar business.

Please turn to the next slide. The oil E&P segment reported a JPY 6.2 billion decrease, mainly due to the JPY 5.9 billion impact from a delay in sales recognition and a fall in the Brent crude oil price. While production volume in the coal segment fell slightly due to rain, most of the decrease resulted from the JPY 15 billion negative pricing impact from deterioration of the coal market.

Our balance sheet is shown on Page 13. Total assets decreased by JPY 172.4 billion year on year to JPY 3,714.5 billion. A fall in the crude oil price-led to a decrease in receivables and inventory, leading to a decrease in working capital. Combined with net losses and dividend payments, net assets decreased by JPY 62.4 billion. Interest-bearing debt increased by JPY 47.6 billion due to dividend payments and provision of working capital to NSRP. Funds provided to date to support NSRP's working capital totaled about JPY 90.0 billion.

Page 14 shows our statement of cash flows. We reported cash flows from operating activities of JPY 48.3 billion as an increase from decreased working capital was partially offset by net losses, tax payments and funds used to support NSRP. Cash flows from investing activities were negative due to investments in the U.S. solar business, among other factors. In summary, cash outflow, JPY 80 billion, resulting from operating and investing activities were funded by borrowing as well as cash on hand.

Our ESG topics for the first half are shown on Page 15, for your reference at a later time. Just one comment. We achieved an AA MSCI rating in September as shown at the bottom of this slide, placing us near the top of the list within the industry.

A description of our earnings outlook begins on Page 16. On this page, previous assumptions announced in May are shown on your left, while the assumptions for the current forecast, as shown on your right. In the Petroleum segment, we made an upward revision of demand for the 4 core products in the second half. Demand for jet fuel has been reduced further as the difficult market environment continues. A further market decline is reflected in the basic Chemicals segment. We anticipate a recovery in demand for lubricant oil and functional chemicals in the functional materials segment. No changes have been made to power and renewable energy. In the oil E&P segment, we increased our crude oil price assumption, while decreasing our coal price assumption.

Page 17 shows the assumptions for our performance forecasts and our consolidated income statement. Our Dubai crude oil price assumption from October onward is $40, while the exchange rate assumption remains unchanged at JPY 105 to the U.S. dollar.

In our income statement forecast, net sales were revised upward by JPY 400 billion to JPY 4.3 trillion. Our operating income forecast is JPY 35 billion, including a negative inventory impact of JPY 50 billion, as stated earlier. As our equity income forecast is a loss of JPY 40 billion. Our total forecast for operating income and equity income has been revised downward by JPY 30 billion to a loss of JPY 5 billion. Extraordinary income has been revised upward due to a partial sale of rights in the Barents Sea, which we recently announced. Our net income forecast is as shown on this slide.

This next slide provides additional information on the inventory impact. The graph shows price trends in Arabian light. Our second half crude oil price assumption was revised down by about $7 from $46.5 to $39.8, as shown here. As a result, we forecast inventory revaluation losses of $50 billion.

The next slide shows segment profits. An overview of changes in each segment will be provided in the step chart on Page 20. Operating income in the petroleum segment was revised upward by JPY 12 billion, an increase in forecasted sales volume led to a JPY 6.1 billion increase. The remaining JPY 5.9 billion increase resulted from affiliates and overhead expenses, which I will explain in detail.

Income from affiliates was revised upward by JPY 10 billion. Equity losses led to a JPY 5 billion decrease. Reduced jet fuel sales volume led to a JPY 4.6 billion decrease and a reduction in overhead expenses led to a JPY 5.5 billion increase. Income from basic chemicals was revised downward by JPY 6 billion due to an expected decrease in product margins. Income from functional materials was revised upward by JPY 10 billion due to an expected recovery in lubricant oil demand and an expected increase in income from functional chemicals. A review of the crude oil price led to an upward revision in oil E&P income, which was partially offset by an expected fall in coal prices.

That concludes our overview of second quarter results and our performance forecasts. Thank you for your attention.