Good morning. I am Yoo Hoon Shik, IR project leader at SK innovation. Thank you for taking time to join us today on this 2023 Q1 earnings call. Today's presentation has yet to be reviewed by our external auditor. The results are subject to change based on such review. With that, let me invite Mr. Kim Yang-seob, our CFO, to make the presentation. Good morning. I am Kim Yang-seob, CFO of SK innovation. At the outset, I'd like to thank our shareholders and investors for your continued interest in the company. On the call with me today are executives from SK innovation and its major subsidiaries to entertain your questions during the Q&A. Let me walk you through the company's Q1 results in detail. I will start with SK innovation's key business results in Q1 2023, including sales and operating profit.
China's reopening and subsequent visible demand recovery pushed up sales by KRW 6.2 billion quarter-on-quarter to KRW 19,142.9 billion . Operating profit jumped to KRW 1.139 trillion QOQ to record a surplus of KRWY 375 billion, buoyed by improved refining margin and petrochem PX spread. Non-operating profit declined to CNY 154.2 billion QOQ to post a loss of KRW 218.7 billion due to FX related losses following higher FX rates and reduced product derivatives gains.
To elaborate, FX-related losses recorded KRW 110.9 billion, product derivatives gains of KRW 18.9 billion, net interest expenses KRW 177 billion, equity method gains of KRW 68.4 billion, and other expenses of KRW 18.1 billion. Next, let me go over the balance sheet. As of the end of Q1 2023, total assets recorded KRW 71 trillion, 921.6 billion, up KRW 4.7 trillion versus the end of 2022 as tangible and intangible assets increased following overseas facility investments. Liabilities recorded KRW 14 trillion, 409.3 billion, up KRW 3 trillion, 432.7 billion versus the end of last year due to increased borrowings for expanded investments. The debt to equity ratio posted 193%.
Meanwhile, net debt stood at KRW 15,551 billion, up KRW 1,336.2 billion versus the end of 2022 due to CapEx for battery capacity expansion. Next, let me dive into the Q1 performance of each business. First, is refining business. Refining margins improved thanks to OSP decline and inventory related losses also narrowed thanks to a slowdown in rising crude prices , while overseas sales raked in a modest profit. As a result, OP rose KRW 936 billion QOQ to record KRW 274.8 billion. Q2 refining margin outlook appears positive with China's reopening and the arrival of the summer driving season, spurring bullish demand for refinery products. Next, let me move on to the petrochem business.
Increased margins from aromatic market upturn, inventory related gains, and fixed cost decline pushed up OP by KRW 197.3 billion to CNY 108.9 billion. Next is Q2 market outlook for key products. For PE and PP, despite new and added capacities of some products entering the market, China's reopening and subsequent strong domestic consumption is expected to prop up the spreads. For PX, increased output from new PX capacity additions will be offset by new PTA capacities coming online during the same period. Polyester chain demand rebound bolstered by China's reopening is expected to sustain the spread uptick. Next, I will brief on lubricants, Q1 performance.
Despite increased sales and improved costs backed by retreating oil prices, sales prices adjustments due to fiercer sales competition and average FX rate decline quarter-on-quarter weighed on lubricants OP to record KRW 259.2 billion, down KRW 9.2 billion QOQ. Although rising oil prices could exert upward pressure on costs due to lubricant market is projected to maintain a sound spread, as base oil supply will remain tight over China's reopening and impending driving season. Next is E&P business performance in Q1. Although sales were up and SG&A was down, E&P operating profit dipped KRW 3.1 billion QOQ to record KRW 113.5 billion due to higher costs. Next, let me move on to the battery business.
Battery sales climbed KRW 429.7 billion QOQ to post a record high quarterly sales of KRW 3.3 trillion as plants that came online in 2022 ramped up their production. Although operating loss inched up as costs increased due to incentive payments and R&D costs, OP margin improved thanks to bullish sales and higher plant yields. In Q2, both the top line and bottom line are expected to improve with the ramp up of new plants overseas. Additional P&L improvement is projected as AMPC will be reflected in the accounting book post Q2. Please refer to the appendix for more detailed capacity expansion plans by region. Let's take a look at SK IET's Q1 performance.
SK IET's operating losses decreased QOQ to record KRW 4 billion as one-off costs faded, output increased and costs declined.
We expect sales volume to rise gradually in Q2 backed by higher demands from key accounts. Next, let me discuss the company's net zero strategy. The company has set a 2023 carbon reduction target that is in line with the 2050 net zero pathway. In order to achieve net zero prior to 2050, the company aims to cut emissions by 12% this year versus the baseline year, which will leave us with the remaining emissions of 10.91 million tons. Since drafting the 2021's net zero roadmap, the company has leveraged a wide range of options to cut emissions, including enhancing process efficiency, switching to green fuel, optimizing facilities, and transitioning to renewables. As a result, the company was able to continuously overachieve its reduction targets.
Likewise, the company will explore diverse options in 2023 to meet the annual reduction target. Please note that SK Innovation's net zero targets and results will be disclosed transparently in detail to all stakeholders via our ESG report to be issued in the first half of this year. This is the end of our presentation. We will now start the Q&A session. Please note, the Q&A session will be conducted with consecutive interpretation. Prior to today's earnings call, the company has collected questions via our website for around two weeks. Before we open up the floor today, we would like to provide answers to some of those questions first. The first question will be about the various activities that the company is engaging upon to improve the yields of the battery business.
The answer will be provided by SK On. Yes. Good morning. I am the CFO, Kim Kyung-hun, and maybe I can address this question. In order to improve our overall yields, what we're currently doing is to try to expand and spread the know-how that we have accumulated in our best practice sites, by dispatching seasoned personnel, to our new sites and also engaging in various activities , that will enable us to improve, the overall productivity on a continuous basis. As a result of that, if you look at, most of our sites, on a QOQ basis, our first quarter yields have improved.
If we look at the overall productivity improvements of our global sites, in particular right now, we are putting a top priority in improving the yield that we have, because this is directly related to the profitability. As a result of that, we are in the process of redefining the key items, around the overall process that we have in place, also putting in various management measures and plans and also, try to standardize the overall process for process analysis that we have for each of the processes and also, double-check the manufacturing and quality that we have, so that, at the end of the day, the overall yield can improve.
Based upon these activities, for the overall progress that is made and the key issues that we are identifying, this is something that we are looking at very closely. For the best lines that we have, that are already stabilized, the improvements that have been made on these, on these sites, on these lines have been also taken over to new sites that we have. As a result of that, for the existing sites, we are trying to maximize the overall yields, and also focus on ensuring that the overall quality by each of the process stages is stabilized.
The second question that we have would be the overall view that the company has about the IRA and also the new emission rules announced by the EPA and also what the outlook would be on the North American market. This again will be answered by SK On. This is Ryu Jin-suk, the Head of the Battery Business Strategy Office from SK On, and maybe I can take this question. As mentioned, the U.S. government has recently put in full force and started to fully implement the IRA . The U.S. Environmental Protection Agency, they have announced new emissions related regulations.
Across the mid to long term, we do believe that in the North American market, we do see a more positive environment being created for battery growth, probabilities and possibilities and also profitability. First to talk about the growth potential in the North American market, we do think that there will be an acceleration of the overall transition to electric vehicles that will be taking place. As a result of that, of course, demand for batteries also to grow very rapidly. If we currently look at the situation at OEM companies, we do see an increasing demand coming from, for a local supply chain to be put in place. To be able to meet those overall demands, if you look at the suppliers that are available, it is a limited number.
As a result of that, we do believe that there will be an increasing number of opportunities for us to win more orders in the North American market. If we look at the current situation, in addition to Ford and also, Hyundai Motor Company or HMC, and the JVs that we have with them in North America, we are currently discussing possibilities of cooperation with a wide variety of other clients. In terms of the overall profitability, tax credit of $35 per kilowatt hour per cell and also $10 per kilowatt hour per module, that is defined in the IRA, we do believe will enable us to enjoy a significant improvement in the level of profitability that we are able to generate.
As a result of that, we do believe that the investments in the North American market will become more efficient. For the company, of course, we already have a large capacity in the U.S. in Georgia, which represents around 22 gigawatt hours. From this year, as a result of that, we immediately would be able to enjoy benefits under the AMPC credit available. In addition, from 2025, when, you know, we will have our JVs with Ford and also HMC up and running, at that time, the capacity in the U.S. will approach 180 gigawatt hours or more. As a result of that, we do think that that will represent, again, a significant level of tax credit that we would be able to enjoy.
If you look at the recent announcements, in the regulations by the U.S. Environmental Protection Agency, in actuality, it is forecasting that by 2035, the EV portion of the automobile market in the U.S. would represent 67% of new cars sold. If you compare that to the overall outlook that or the overall target, that was released by the Biden administration in 2021 of having a conversion of 50% by 2030, we do think that it represents a much stronger level of EV presence. It also reflects, we believe, the overall commitment that the U.S. government has to transition to clean vehicles.
If you look at the actual regulations and if they do go into force, we do believe that it will be an impetus to drive further demand in the North American market and for the company across the mid to long term, in line with the overall trends of demand that we see for EV vehicles in North America. This is of course something that we will continue to monitor and also try to preemptively address so that we can further solidify our already strong position within the North American market. With this, we would like to conclude our pre-submitted questions and now take questions live. Before you ask a question, we do ask that you will announce your affiliate and also name before you ask the question.
Now Q&A session will begin. Please press star one, that is star and one if you have any questions. Questions will be taken according to the order you pressed star and number one. For cancellation please press star two. That is star and two on your phone. The first question will be presented by Jin-ho Lee from Mirae Asset Securities. Please go ahead with your question.
Yes, thank you very much for the opportunity to ask questions. First I would like to congratulate you about your strong performance in the first quarter. The question that I would like to ask you is about the AMPC under the IRA. You did not reflect this into your Q1 numbers. Is this something that you will start to reflect from the second quarter? If so, will it come retrospectively into the first quarter? During the previous conference call, I do believe that you had said that you expect that the benefits under the IRA would represent around KRW 4 trillion across 2023-2025. In terms of the guidance numbers.
If that is the situation, what do you expect the overall benefits that you would be able to enjoy for 2023 to be? Yes. This is Kim Kyung-hun from SK On, and maybe I can take your question. If you look at the guidelines that were announced on March 30th regards to the IRA, as you have mentioned, the details with regards to the AMPC are something that have not been included in that announcement. As a result of that, we did not include that overall benefit in the Q1 numbers. However, going forward, once we do have more details about the guidelines with regards to the AMPC, we do think that we would be able to maybe reflect that from the second quarter after discussions with our account.
In addition to that, of course, in terms of size, because we don't have the specifics about the details yet, I don't think that that is something that we would be able to share. If we do start to reflect it from the second quarter, then naturally it would be applied retrospectively to the Q1 numbers also. In terms of our overall forecast for the full year, I think that at the end of the day, it would be based upon our sales volume, which we expect to be around 10-15 gigawatt hours.
The next question will be presented by Parsley Ong from J.P. Morgan. Please go ahead with your question.
Hi. Thank you for the chance to ask questions. I have two questions on your battery division. The first question is, if I look at page 10 of your slide pack, you mentioned that sales volume improvement contributed to the quarter-on-quarter margin improvement for your battery division, but there was also negatives coming from cost increase. Could you share what were the details behind this cost increase? I saw that you also revised your fourth quarter operating profit number from negative KRW 256.6 to negative KRW 338.1. What was behind that revision in your fourth quarter operating profit? The second question is on your Hyundai potential Hyundai joint venture in the U.S. I see that you haven't included that project in your PPT yet.
Maybe could you share with some color on the expected CapEx capacity and chemistry type? Thank you.
This is Jin Sun Mi, the Head of Battery Strategy and Planning Office at SK On, and maybe I can take your first question. The first question that you asked was about the details of the cost increase that we saw in the first quarter, which of course was in line with the overall top line growth that we saw in that quarter. At the beginning of the year, across all of the SK Innovation companies, there were incentives that were provided to employees, and that was some of what we recognized as the cost increase. This was initially something that had not been planned, but was incurred. That was one of the items that would drive that specific line. In addition to that, there were other items that also contributed to the cost increase.
There is R&D that we are executing for new product development. Also there was a slight increase in our overall SG&A. You also asked why the 4Q numbers in terms of our operating profit were adjusted. What we can say to that point was that when we did the presentation on the Q4, of course, it was before we did finalize our full year numbers in terms of the book closing. Of course, if there are any material findings that we have thereafter, it is something that we will reflect into our numbers to update them.
At that time, there was of course thereafter the Ford fire that took place and the overall loss amount related to that we would need to bear with was something that had not been determined as of that time. However, for the issues that we found with products that were manufactured in 2022, we did set aside an allowance or a provision for that. That provision was recognized at a later time into the Q4 numbers, which led to the adjustment. This is Kim Kyung-hun , and maybe I can answer and address your second question about the details of the Hyundai JV that we are currently contemplating.
Right now, the expected CapEx that we are planning to build out would represent around 35 gigawatt hours, and the necessary CapEx to build that facility is expected to be about $5 billion in total. The overall, once the facilities are available, the plan as of now, in terms of production chemistry or product type, would be NCM batteries. That would be a pouch type battery. The next question will be presented by Jae-Sung Yoon from Hana Securities. Please go ahead with your question.
Hello.
Thank you for the opportunity to ask questions. There are three questions that I would like to ask you. The first question is about your battery yields. This is something that you have mentioned and addressed before, but if you could break it down by each of your production sites, for example, for China, the U.S., and also Poland, if you could mention what your current yield levels are, and in terms of your target yields for the future, if that is something that you can share, that would be appreciated.
The second question that I would like to ask you is that if I remember correctly, I think that for your battery business, the overall profitability related targets were to be at a break-even point in terms of your EBITDA for this year, then next year to turn into the black on the operating profit line level. Since we now have the AMPC going into force, would there be any change in your guidance in terms of the overall timing? The third question that I would like to ask is about your refining business. It does seem to be that on the diesel side, and the diesel margins, there seems to be a weakening taking place there. What is the drivers behind that?
As a result of that, do you actually believe that that could have implications on your lubricant base oil business also? This is Kim Kyoung-hoon from SK Innovation., and maybe I can address your first question and your second question. In terms of the overall yields that we have, as mentioned before, across all of the production sites, we have seen an improvement in the first quarter. To break it down by quarter and to break it down by the different regions, first, if we look at our Chinese production facility and also the production facility that we have in Hungary, and in Europe right now, versus the target levels that we have, we have seen an improvement.
However, in the case of the US, we did have new capacity that went online in the beginning of the year, and as a result of that, there were slight issues with some of the productivity as a result. In actuality, because of that, we were not able to reach our target levels in Q1. Maybe just my one correction. In the beginning of the year, it was not because of new capacity, but because, we did have some capacity that was suspended. That having been said , that suspended capacity is back online as of March. As a result of that, in the second quarter, we do believe that the overall situation will improve.
In addition to that, please understand that we're not able to share with you the details in terms of specific numbers. To address your second question about our yearly guidance, I would have to say that the guidance that we have shared with you still stands valid. Of course, we do believe that there will be some improvement from the IRA. However, in terms of the specific size that that would represent, as of now, I don't think that we have any specific numbers. Yes. This is Shin Mun-Kwon, the performance management team leader from SK Energy, and maybe I can address your question about diesel.
If you look at the reason why or the dynamics that are surrounding the diesel marke t, it is that on an industry basis, the overall demand has been dampening because of a weak economic environment. In addition to that, the regulations or actions, sanctions that we're taking against Russia, has also led for the Europeans to stock up in terms of their inventory and also in terms of Russian diesel exports, there are indirect routes that are being used. As a result of that has led to a weaker environment. That has been said. If we look at the situation going forward, there are regional turnarounds that are expected in the region.
We do think that some of the supply in terms of the utilization will be cut back. As a result of that, we do think that overall supply in the second quarter will be less. In addition to that, we do see a recovery on the economic backdrop taking place in the US and also in China. We do think that that will lead to stronger demand. As a result of these dynamics, we do think that diesel crack will show a rebound. In addition to that, we are going into a overall high season for various transportation and mobility uses. We do think that there will be more jet fuel that will be required. As a result of that, we do think that kerosene also will improve.
Yes, maybe I can take the part about the overall impact on the lubricant business that we see. This is Ho Jong Wook, the Head of Corporate Planning Office, from SK Enmove. Of course, if there is a weakening on the diesel side, that does lead to our overall cost decrease for us on the lubricant base oil side. That would be something that we would be able to enjoy on a temporary basis, but not only on the cost side, but of course, other dynamics are also very important. For example, global demand is something that drives the overall profitability. That is important to margins also.
If you look at the overall, global situation in terms of supply and demand, we do think that there is a balance, that the current market represents. As a result of that, we do think that the market will remain strong. Taking all things into consideration, for an overall view, what we do believe is that under the current backdrop, that we will continue to enjoy strong performance in the second quarter.
The next question will be presented by Oscar Yee from Citi. Please go ahead with your question.
Hello. Yeah, hi. Thanks for the chance to ask question. My question is about your sort of CapEx funding plan. Given the new sort of Hyundai JV, your CapEx number obviously going to go higher. You know, can you share with us, you know, how you plan to fund this increase in CapEx? Could you also provide a little bit more details about, you know, the CapEx, I mean the revised CapEx number for 2023 or maybe even 2024 and 2025 with this new sort of battery build plan? Second question is, would you be able to share in terms of your SK On sort of cost increase, roughly, how much is related to the one-off sort of incentive that has been booked in 1Q?
This is Kim Yang-seob, the CFO of SK Innovation, and maybe I can address your first question. If we look at the overall CapEx guidance for this year, we did share with you a KRW 10 trillion number, and this number actually includes the JV that we are expecting with Hyundai. When we came out with the CapEx numbers, we had believed that this is a JV that would go through. As a result of that, we had included it into the CapEx numbers. Because that is already included, we will not need to change our overall guidance numbers. In terms of the funding for the CapEx going forward, as we have said before, there will be a wide variety of sources that we would be able to fund through.
For example, there are various policy funds that are available in the production locations that we are going to build out in. Debt financing is available. We also have partners that will be providing equity. At the end of the day, if you take all things into consideration, the portion that we need to fund will not be very large. Lastly, for the CapEx, beyond 2023, I think what we can say to that point is that, if you remember, during Story Day in July of 2021, we did say that the CapEx up until 2025 would represent around total KRW 30 trillion. I still think that that is the overall assumption that you should be working upon for the future.
there are continuous new orders and also other types of forms of cooperation that we have with our clients, that is something that we will continue to reflect and also manage. So this is Jin Sun Mi, Head of the Battery Strategy and Planning Office at SK On. I think that the question that you asked as a second question was the amount that the incentives in the Q1 actually represented. For SK On as a company last year, we did have an operating loss. So as a result of that, the overall incentives based upon our performance are something that were not incurred or were not generated.
That have been said, though that was the overall situation, we did want to recognize the efforts that our overall employees have been making to date. In addition to that, we did want to incentivize them, and we also took into consideration the composition levels at our competitors within the overall market to determine the size of incentives that were provided in the Q1. That have been said, unfortunately, we would not be able to share with you a specific number.
The next question will be presented by Hyun Yul Jo from Samsung Securities. Please go ahead with your question.
There are two questions that I would like to ask you, thank you for the opportunity to ask questions. The first question is with regards to the AMPC recognition. You said that the reason why you did not recognize the benefits that you would enjoy under the AMPC in the first quarter was because the details of the guidance were not something that were provided. If that's the situation, if the U.S. government does not come out with guidance in the second quarter, does that mean that, you know, for the time being, until you know the details, this is something that you would not be recognizing? i.e, that means that it's not a de facto, it's not something that is going to automatically take place in the second quarter. I just wanted to recheck if that's the situation.
The second question that I would like to ask you is about SK geo centric. For SK geocentric , I do believe that there is a recycling JV that you are going to create. As a result of that, how much investment in CapEx would you require? For your portion of that JV, how are you planning to fund that CapEx? Yes. Maybe I can take your second question. This is Kim Yong-soo, the head of the corporate planning office at SK geo centric. For SK geo centric, as you have mentioned on the plastic recycling side, we have multiple projects that are currently ongoing.
As a result of that, if you look at the overall CapEx investments that we are contemplating up until 2025, and this number does include the maintenance CapEx that we have, that would represent around KRW 3.5 trillion in total. In terms of how we will fund this CapEx for the future, of course, we do think that there is a wide variety of options that is available. If you look at the petchem market backdrop, last year was one of the most difficult years that we had or the worst years, and the market does seem to be recovering. As a result of that, we do think that our operating cash flow going forward will be stronger, which is something that we have taken into consideration. We also will be issuing some corporate debentures.
However, the lion's share of the overall funding is because we do have various partners with the overall projects that we have, whether it be a local partner or an overseas partner. We do think that of course, the partners will contribute and also there can be debt financing that we would raise under the current structures that we have. Those would be the plans that we are engaging upon as of the current time. The next question will be presented by Jin Myong Lee from Shinhan Securities. Please go ahead with your question. Yes, thank you for the opportunity to ask questions. There are two questions that I would like to ask you. First is about SK geo centric.
For SK Geocentric, I do think that you had mentioned that in the second quarter you do think that the PX market will remain strong. What about the overall second half of the year? How do you think that that would play out? On the aromatics side, do you think that we would be able to enjoy a better second half? In addition to that, on the polymer side, how do you think the market dynamics will be moving? There is additional capacity additions will be taking place. Regardless of that situation, do you think that the second half of the year would provide a better or more positive market backdrop than the current situation? The second question that I would like to ask you is about SK Enmove.
Of course, Move right now is showing very strong performance. On the greener side of your business portfolio, so for example, for more environmentally friendly business initiatives, what type of projects are you engaging upon? If you could provide an update about those activities, that would be something that would be appreciated. Yeah. Yes, maybe I can take your first question. This is Kim Yong Su, the Head of the Corporate Planning Office at SK geo centric. First, to talk about the overall aromatics market and the market dynamics there. It is true that on a Y-O-Y basis the current market does represent a very strong level, and we do think that even versus the first quarter, if you look at the current situation, spreads have been widening.
If you look at the overall reasons why, of course, as we have mentioned before, at the end of the day, it's all, you know, it all comes down to the supply and demand dynamics that are existing within the overall market backdrop. At the end user demand level, as of right now, in actuality, it's not a very strong situation. However, because of the overall supply situation and supply issues that we had mentioned before, if you look at the supply situation, the supply is tight. As a result, spreads have been widening. This is something that we see happening now even versus the Q1 spread levels.
As you may have seen in various press reports, as the Labor Day overall holidays take place in China, we do see a surge in the amount of travel that is taking place. As a result of that, we do think that in the second half of the year, the reopening effects that we see from China will be a big driver behind stronger market dynamics. As a result of that, in the first half of the year, if the main driver behind the strong market backdrop was the tight supply or supply-demand dynamics. In the second half, we think that the big driver will be the recovery of actual end user or consumer demand that we see taking place, driving the overall market.
On the polymer side, it is true that for NCC-based capacity right now, you know, it is a very challenging situation. Even if we look at it on a Y-O-Y basis, the current time does represent a improved situation. That having been said, it's still not very strong. If we look at supply-demand dynamics here, on the supply side, there is a lot of supply that is coming in. As of now, I think that the expectations are heading towards China, and also the reopening demand and the overall situation there. Towards the second half of the year, again, we do think that the reopening effects will improve the overall market backdrop. As a result of that, we also believe that polymers have room to improve in the second half.
Yeah. Yes, maybe I can take your second question. This is Ho Jong Wook, the Head of Corporate Planning Office at SK Enmove. To discuss the overall new business areas that we have identified and are trying to pursue, I think that there are two right now. The first would be that, similar to what SK geo centric is currently doing, we are trying to upcycle the waste lubricant oil that is available. Right now on that recycling side in Ulsan, we're targeting commercial production from next year. In addition to that, we do have an existing brand that is called ZIC, this ZIC is of course oil, engine oil that is used for IC, internal combustion engine cars.
Similar to that, with regards to our lubricant base oil business, we are trying to pursue a e-Fluid business that would be a dedicated oil that could be used for EV batteries. In addition to that, we also have additional technology that we will be using for our high quality base oil side and new products that would be available in that area as new initiatives. In the area of liquid energy cleaning, of course, we have made a investment into a startup called GRC in the U.S. in the first quarter. Based upon this technology, this is a business area that we do want to expand going forward. Going forward, the overall commitment is that we do want to recreate ourselves as a energy saving company.
Under that overall target, we will continue to move forward.