ENEOS Holdings Inc

TSE:5020

Earnings Call Transcript 2023-Q3

[Takeshi Saito, executive]

Good afternoon. First of all, thank you for gathering at this time of the day. I am Saito, President. I'd like to take this opportunity to thank our shareholders and investors for your continued support and advice in the business activities of the ENEOS Group. Today's presentation is for the third quarter of the fiscal year, and I would like to explain our second Mid-Term Management Plan, which we have been working towards since the time [ I assumed ] the office as President. But unfortunately, it is now difficult to achieve the profit targets of the second Mid-Term Management Plan. So I would like to explain our view on the business environment and future prospects. Let me go over the materials. First, please refer to Page 3. This is our business environment. Regarding resource prices for upstream operations, crude oil prices are currently on a downward trend, but the average price through the third quarter was $20 to $30 higher than the previous year, leading to an increase in profits in the oil and natural gas E&P business.

In the copper price, the average price has fallen about $0.50 from the previous year, although the price has been on an upward trend since November, resulting in a decrease in earnings in the metal resources business. Next, regarding petroleum product market conditions, real margins continue to be favorable. Exports in particular, remain high, especially for diesel oil and jet fuel due to -- in part to geopolitical factors. However, in the third quarter, both domestic and export margins were significantly reduced due to the time lag caused by the decline in crude oil prices. In the petrochemical product market, the real spread, which takes into account the fuel consumption of our main product, PX has been negative, an unusual situation, partly due to the impact of the lockdown in China. Regarding FX, the yen depreciated to JPY 150 per dollar in October, but subsequently appreciated. Basically, the petroleum product margin are continuing to be good, but a large negative time lag about JPY 90 billion occurred in the third quarter due to a decline in the oil price.

As for the refinery operation, we have not yet recovered to the planned level, but utilization is continuing to improve. In addition, we have identified the refinery equipment that has a large impact and are implementing additional measures that are expected to have an effect in the very short term, and we expect to realize a significant improvement at least in the next fiscal year. I visited the site myself and I have some confidence. Lastly, this is our forecast for the current fiscal year. In addition to the negative time lag in the third quarter I mentioned, the improvement for refinery operations was less than planned. Energy earnings are expected to go down by about JPY 120 billion from the forecast announced in November. As a result, it has become quite difficult to achieve the second midterm profit target of JPY 970 billion for the 3-year period. So this is the reason for today's announcement. I will have more details again on later slides. The year-end dividend forecast of JPY 11 per share remains unchanged. Please take a look at Page 4. Here are the highlights of the third quarter results. Operating income was JPY 249.8 billion, a decrease of JPY 280.3 billion year-on-year.

Inventory valuation was negative JPY 178.4 billion year-on-year due to the down trend in oil price from the second quarter of this fiscal year, while the previous year saw a large positive impact during the [ rising price fees ]. Group operating income, excluding inventory valuation, decreased by JPY 101.9 billion mainly due to lower income in the Energy segment. The Energy segment posted a large loss of JPY 76.3 billion, a significant JPY 120.2 billion decrease from the previous year due to the large negative time lag in petroleum product margins caused by the falling oil price explained earlier as well as deteriorating petrochemical market conditions and increased electricity procurement costs. The graph on the lower right shows quarterly profit and loss. Excluding the time lag, the profit/loss in the third quarter improved from the second quarter due to an increase in volume of clean oils and margin improvement. In addition, as I mentioned earlier, the impact of the refinery trouble improved from the previous year, but the improvement in profit and loss due to the recovery operation was limited.

Next is the E&P segment, which reported an increase of JPY 24 billion due to higher resource prices and a weaker yen, despite an absence of profit from the sale of the U.K. business. In the Metals segment, despite an increase in production volume in Caserones and a positive impact of yen depreciation, earnings declined slightly from the previous year due to lower copper prices and other factors. Please refer to Page 5, full year forecasts. The operating income forecast for FY 2022 is JPY 320 billion, a decrease of JPY 240 billion from the JPY 560 billion announced in November. The inventory valuation is JPY 120 billion less than the November forecast as a result of lowering the assumption for crude oil prices and appreciation of the yen in light of the recent actual situation.

Operating income, excluding inventory valuation has been revised downward by JPY 120 billion, mainly in the energy business. The main reasons for the downward revision are the negative time lag in petroleum products, which was explained in the third quarter cumulative earnings is not expected to be resolved by the end of the period in addition to the fact that refinery operations did not improve to the expected level. These effects are expected to reduce total operating income by JPY 240 billion to JPY 320 billion. By segment, the JPY 10 billion E&P improvement and the deterioration in the Metals offset each other, leaving a downward revision of JPY 120 billion in Energy. Excluding inventory valuation in Energy, the outlook for operating income is grim with a loss of JPY 50 billion. Please see Page 6 for an explanation of the measures being studied and implemented in light of the deteriorating business environment and performance. So let me go over the main issues and measures in the energy business. As I've mentioned many times before, refinery operation hasn't recovered to the planned level. So I am very frustrated by this situation. However, from the second half of the fiscal year onward, in addition to the existing measures, we are taking additional measures that are expected to have an immediate effect. And I'll explain the details individually later. In the petrochemical business, we're forecasting losses for the fourth consecutive fiscal year due to the prolonged slump in the petrochemical market. Currently, this business has a profit structure that is highly dependent on market conditions in Asia and the high volatility of this business is an issue. In response to this situation, we are working on measures such as sales structure to mitigate the impact of market fluctuations and we're taking measures to enable a flexible production system. Next is electricity business. It's mainly an electricity retail business. But due to the soaring and high price of JEPX, it is expected to be in the red for 3 consecutive fiscal years, which became independent as a subsegment in fiscal 2020, we are facing a difficult business environment as well.

In response to this situation, we've been working to increase the ratio of negotiated transactions to reduce our dependence on the spot market. Since last fiscal year, abolishing the ceiling price of the fuel cost adjustment system as explained in the first half results briefing and decisively reviewing unprofitable contracts, as such, we've been working on short-term profit and loss improvement measures, which are bearing fruit in the second half. In addition, although not mentioned, the Goi Thermal Power Plant, which is a joint project with JERA and has top-class cost competitiveness is scheduled to start operation in 2024 to '25 during the next midterm. Construction is currently underway. In the material business, the elastomer business, which we took over this fiscal year, is expected to contribute to profit as planned. We'll continue to build up business synergies by combining R&D technologies to realize further growth as the core of the material business. And next is expenses. The expenses necessary for countermeasures against the refinery troubles have been given top priority as the very first item on the list. On the other hand, we've reduced other expenses and plan to keep them at the same level as previously announced. We'll continue to tighten the [ reins ] towards the end of the fiscal year. In addition, a dedicated organization has been working since April last year on business process reforms to achieve drastic cost reductions, and we've almost completed the plan. Although the reform plan includes some in-depth measures that have caused some internal confusion, we intend to begin the full-scale implementation phase of the plan from the third Mid-Term Management Plan, and we are determined to create positive effects.

Finally, with regard to cash flow in light of the recent severe business environment, we've revised some of our capital investment plans by narrowing them down based on priorities, thereby, curbing the deterioration of cash flow. Please refer to Page 7. This is a profit forecast for the second Mid-Term Management Plan, which was announced in May 2020 and has been affected by many changes in the business environment that are difficult to predict, including the prolonged expansion of the COVID.

In each case, we've been pursuing the goal of achieving JPY 970 billion earnings for the 3-year period, taking various measures to achieve targets, especially the profit and loss set forth in the midterm plan, while benefiting from the tailwind of market conditions. However, it was difficult to formulate a counter measure to absorb the negative time lag in the third quarter and the deterioration caused by the refinery trouble. And as a result, we had to make a judgment that it would be difficult to achieve the 3-year profit target and made an announcement today. It is true that we are greatly affected by the external environment. On the other hand, it is also true that the impact of troubles has been significant. We believe that the early recovery and establishment of stable refinery operations, which is the pillar of our core business is essential for our future growth. So after this, the Vice President, Miyata, who is in charge of the manufacturing department will give a detailed explanation of the current situation and measures. And then last but not least, please see Page 8, shareholder returns. There is no change from the previously announced plan for the year-end dividend of JPY 11 per share. So this concludes my explanation.

[Miyata Tomohide, executive]

My name is Miyata, Vice President, and I apologize to analysts and investors for the prolonged problems at the company's refineries. Improving the reliability of the system is one of our most important management issues, and we are aware that we've received many severe comments from you. Today, I'm here as a representative responsible for the manufacturing division. And I thought I should explain in details in an easy-to-understand manner, the background to date and the specific measures being considered and implemented. Please see Page 10. The graph on the left side shows the utilization ratio of the distillation units and the graph on the right shows the impact of losses on the results after the third quarter. As you can see, the utilization ratio has gradually improved. And although there were some special factors such as the earthquake which was explained at the second quarter results briefing has been on an improving trend this fiscal year. As Saito explained earlier, we have not yet recovered to the planned level, but we are currently implementing additional measures that are expected to have an immediate effect. And this year, I visited the refinery to see the production facilities in person and communicate with the director, [ staffs ] on site and through such actions, I have a first-hand sense that measures are being taken without fail.

A simple background explanation of the troubles is provided at lower left. And roughly speaking, small trouble started to occur with issues in workers and facilities, including potential ones. And as we address them, the inspection and repair cycle, which was supposed to play a critical role for stable operations had gradually become not viable, and this led to more troubles. On top of this, we face troubles caused by special factors, and we understand this has led to the frequent troubles. As announced at the last financial results briefing, measures compiled by the company-wide project have been implemented since last fiscal year, and these measures helped us to achieve some improvement explained earlier. Since the second half, we have started to implement additional measures developed with knowledge of external specialists at each refinery. We have already completed repairs to address troubles caused by special factors in sulfur recovery lines to continue stable operations, and we will take fundamental measures such as comprehensive renewal of relevant facilities during the major regular repair period next fiscal year. But combining these measures, we intend to realize early recovery and more stable operations. Next Medium-Term Management Plan will start in next fiscal year. And I am confident that the impact of the unscheduled shutdown of refineries will be significantly reduced. Please refer to Page 11. I will explain an overview of our measures. On this slide, 3 representative examples are provided and all of them are the [ addressed ] troubles originate from workers and facilities explained earlier.

First one is reinforcing repair based on reassessment. We have decided to reinforce repair by reviewing priorities based on the troubles so far. For instance, a trouble like the fire incident at the electric room of the Negishi refinery in November really occurred in our facilities before. However, considering a significant impact, we are reassessing the risk of the same facilities at other refineries and reinforcing repair as necessary. In addition, for inspection ahead of schedule, the scope of inspection has been expanded to comprehensively identify potential risks. Since last fiscal year, inspections have been conducted starting with areas that have the greatest impact on operations, and this has led to early detection of areas with a need for repair and with the progress in solving the troubles, it has become possible to conduct inspections ahead of schedule. Also, to enhance QA and QC, we are working to improve construction quality through exchanging opinions and sharing knowledge with construction companies. We are incorporating the knowledge of outside specialists according to specific requirement in construction work, and we believe this will help eliminate troubles originate from construction quality.

The impact of the troubles during this Mid-Term Management Plan was quite significant. And we are very sorry, we could not live up to our investors' expectations. We will not let these troubles be nearly a loss but will ensure the future safety based on the lessons learned. While some of the issues and measures require continuous and steady efforts, we will make a remarkable improvement in the status of unscheduled shutdown in next fiscal year and onward by prioritizing our initiatives. That is all from me.

[Tanaka Soichiro, executive]

I am Tanaka. I will explain details of the financial results for the first 9 months for FY '22 as well as the full year forecast. Pages from 13 to 17 have already been covered by the earlier explanation, so I will skip them. First, I will explain Page 18 for changes in operating income for the first 9 months by segment. This page is about operating income, excluding inventory valuation for the Energy segment, which was a loss of JPY 76.3 billion, down JPY 120.2 billion year-on-year. I'll explain the factors behind this change by subsegment. From the left, Petroleum Products recorded a decrease of JPY 79.7 billion year-on-year. The impact of sales volume increased by JPY 9.7 billion, mainly due to increased clean fuel sales as the impact of COVID-19 was mitigated. On the other hand, margins and expenses deteriorated by JPY 89.4 billion. This includes a negative impact of approximately JPY 90 billion due to the time lag for margins of clean fuel and export, and this was the main factor. Excluding the time lag, the margins of clean fuel and export were recognized as a substantially positive figure, but this was offset by increased fuel costs due to higher oil prices, the impact of higher purchase prices for items other than crude oil such as ETBE and the impact of the decline in naphtha prices.

Next is Petrochemicals, which recorded a year-on-year decline of JPY 30.1 billion. This deterioration was due to worsened market conditions for chemicals such as paraxylene and benzene. Electric Power decreased by JPY 20 billion year-on-year due to higher procurement costs resulting from the JEPX price rose to JPY 22 from JPY 11 in the same period of the previous fiscal year as well as the impact of the time lag and fuel procurement. In Materials, margins and the lubricants business deteriorated mainly due to the time lag. But the elastomers business, which began operating as ENEOS Materials on April 1, 2022, contributed to profits, resulting in a year-on-year increase of JPY 9.6 billion. Please turn to Page 19. Operating income of the oil and natural gas E&P segment was JPY 95.6 billion, up JPY 24 billion year-on-year while the impact of sales volume was minus JPY 5.5 billion due to a decrease in sales volume. Crude oil price improved by JPY 38.8 billion due to a significant rise in oil and gas prices and exchange expenses and others increased by JPY 22.1 billion, mainly due to the yen depreciation.

As a result, the profit of the oil and natural gas E&P segment increased year-on-year, even with the absence of the profit of JPY 31.4 billion from the U.K. business we sold last fiscal year. Please turn to Page 20. Operating income in the Metals segment decreased JPY 5.8 billion year-on-year to JPY 116.9 billion. From the left, functional materials, thin-film materials and others increased JPY 11.9 billion to JPY 53.3 billion due to the effect of yen depreciation, despite the decrease in sales volume of treated rolled copper foil affected by the zero-COVID policy in China and other factors. In mineral resources, while production at the Caserones Copper Mine in Chile increased year-on-year, profits declined mainly due to lower copper prices resulted in minus JPY 19.9 billion. The smelting and recycling recognized the absence of the profit of about JPY 8 billion due to the sale of LS-Nikko. However, owing to a better international market for its byproduct sulfuric acid and a weaker yen, it was JPY 32.1 billion, almost unchanged from the previous fiscal year. Please turn to Page 21 for balance sheets and cash flows. First, about cash flows. Please refer to the figures excluding IFRS 16 leases in a dotted line box on the right. Cash flows from operating activities for the first 9 months in FY '22 include JPY 171.4 billion for operating income, excluding inventory valuation and JPY 201.3 billion for depreciation and amortization. Also, working capital increased by about JPY 30 billion due to seasonal factors such as inventory buildup of kerosene for winter. In addition, there was an advance payment of income and consumption taxes for FY '23, and this resulted in minus JPY 895.3 billion for others, including working capital and tax payment. As a result, cash flows from operating activities were minus JPY 522.6 billion. Cash flows from investing activities were minus JPY 162.2 billion due to strategic investments, such as the acquisition of elastomers business. As a result, free cash flows were minus JPY 684.8 billion. Net cash flows, including dividend payments and share repurchases were minus JPY 906.9 billion. Next is about balance sheets. Please refer to the chart on the left. Net interest-bearing debt as of the end of December was obtained by subtracting cash on hand from interest-bearing debt and described in a dotted line box. It increased JPY 972.4 billion from the end of last fiscal year to JPY 3,157.4 trillion, reflecting the net cash flow of minus JPY 906.9 billion mentioned earlier and JPY 50.3 billion in assumption of liability for elastomers business. As a result, the net D/E ratio rose to 0.98x from 0.68x at the end of last fiscal year. The net D/E ratio after the recognition of equity credit attributes of the hybrid bonds issued in June last year was 0.89x. Next, I will explain the full year forecast. Please refer to Page 23. As indicated in the dotted line box, an index for January to March, Dubai crude oil is $80, copper is [indiscernible] and the exchange rate is JPY 130. The full year operating income forecast is JPY 320 billion, down JPY 240 billion from the previous forecast. Operating income, excluding inventory valuation, is expected to decrease JPY 120 billion to JPY 220 billion and the profit attributable to owners of the parent is expected to be down JPY 190 billion to JPY 140 billion, and the forecast is revised downward accordingly. Page 24 shows operating income by segment. Details for each segment will be explained in the following slides. Please turn to Page 25. This slide shows operating income excluding inventory valuation effects in the Energy segment. We expect minus JPY 50 billion, a decrease of JPY 120 billion from the previous forecast. In Petroleum Products, the impact of sales volume is now estimated at minus JPY 13 billion due to a decrease in export volume caused by lower refinery operations. For margins and expenses, in addition to the time lag effect of about minus JPY 80 billion due to lower oil prices, we have factored in minus JPY 30 billion due to refinery troubles.

Next, Petrochemicals is down [ JPY 2 billion ], reflecting margin deterioration caused by falling petrochemical market prices. Electric Power is up JPY 2 billion from the previous forecast considering the improvement in sales prices. Materials is expected to increase by JPY 1 billion due to improved performance of Coke.

Please turn to Page 26. Operating income in the oil and natural gas E&P segment is expected to be JPY 100 billion, an increase of JPY 10 billion from the previous forecast due to cost reductions. Next is the Metals segment on Page 27. We expect JPY 120 billion, a decrease of JPY 10 billion from the previous forecast. From the left, functional materials, thin-film materials and others are expected to decrease by JPY 11 billion due to lower sales affected by the economic slowdown in China and other factors as well as the assumption of a stronger yen than in the previous forecast.

In Mineral Resources, copper production volume is expected to decline slightly. However, as we have raised our forecast for the average copper price for the period to [indiscernible], its profit is expected to increase by JPY 3 billion.

Now please turn to Page 28 for the forecast of cash flows for FY '22. Please refer to the figures excluding IFRS 16 leases in the dotted line box on the right. Cash flows from operating activities is estimated as minus JPY 110 billion, including JPY 220 billion for operating income excluding inventory valuation, JPY 270 billion for depreciation and amortization and minus JPY 600 billion in others, such as working capital and tax payment. As noted in the comments on the right, if we eliminate the advance tax payment for FY '23, cash flows from operating activities will be positive JPY 90 billion. Cash flows from investing activities are expected to be minus JPY 360 billion. As noted on the right, we have reduced capital investment and increased asset sales from the figures in May forecast shown on the left. As a result, the forecast for free cash flow is minus JPY 470 billion and free cash flows excluding temporary cash decline factors are minus JPY 270 billion. That is all for the explanation of the full year forecast. From Page 30, references provided for key factors, sensitivity analysis and major progress in the topics since October 2022 for your later review. That is all from me.