Earnings Call Transcript - PKX Q2 2023

Jeong Ki-Seop, CSO

Good afternoon, everyone. I am Jeong Ki-Seop, CSO at POSCO Holdings. Before we begin today's earnings call, I would like to extend my deepest gratitude to all of our investors on behalf of the company for your trust and support to POSCO Holdings as well as our operating companies. Going forward, the company will strive further to promote balanced growth between steel and the new growth businesses and enhance the long-term corporate value of POSCO Holdings so that we can continue to meet the expectations of our investors. POSCO Holdings in the second quarter of this year recorded an operating profit of KRW 1.33 trillion. This is because the steel business, which had been impacted by the Pohang mill flooding and the economic downturn, quickly recovered its quarterly OP of KRW 1 trillion. Such profit recovery in our core business, the steel business, holds very important meaning for our company. It helps us to maintain global competitiveness in the steel sector as well as generate a stable flow of revenue. When this is coupled with our new business growth strategy, it will indeed create a virtuous cycle in enhancing our corporate value. POSCO is also striving for excellence in its steel-making business to meet the demand of the changing times, which is carbon neutrality. POSCO has placed low-emission steel production as its top priority, such as the early operation of the HyREX pilot plant in 2026. The company is also advancing its low-carbon product portfolio by boosting the high-grade Hyper NO production capacity for eco-friendly EV traction motors. To prepare for the commercialization of hydrogen-reduced steel in the future, POSCO Holdings has developed a 2050 phased hydrogen roadmap based on specific hydrogen demand outlook. In the short-term, we are working hard to deliver success by pursuing CCU and reforming hydrogen-enabled blue hydrogen on top of green hydrogen. Moving on to the secondary battery materials business, as communicated during the recent Value Day, the company keeps accelerating investment to gain a strong leadership position in the global market. Especially for lithium, the plan is to commercialize it by this year to deliver strong performance as an independent business. I am also glad to announce that significant progress has been made to secure nickel. With that, I will give the floor to the IR team Head, who will brief you on the 2023 Q2 results.

Han Young-Ah, IR Team Head

Good morning, everyone. Let me share with you the 2023 second quarter earnings. In Q2, POSCO Holdings saw consolidated revenue of KRW 20.12 trillion, up 3.8% quarter on quarter, with OP up by 88% at KRW 1.33 trillion. Cumulative investment for the first half of the year was KRW 3.7 trillion on a consolidated basis, and the quarter-end net debt ratio was 13.3%. Let me explain by business areas. First, the steel business recovered to the average level of quarterly operating profit over the past 20 years in domestic and overseas combined, posting KRW 1 trillion in OP after a loss in 2022 Q4 and KRW 338 billion profit in 2023 Q1. This recovery occurred because all Pohang mills were back in full operation, recovering both production and sales volumes, and we had no additional restoration costs this quarter while the selling price increased slightly. Not only did the domestic business recover, but the overseas steel business also posted OP of KRW 93 billion. As for the green infrastructure businesses, revenue and OP all increased quarter on quarter by 9.6% and 16.5%, respectively. The revenue in the green materials increased by 2.7% Q-o-Q, but OP declined by 55%. POSCO Future M turned around from their previous quarter's lower profit with OP of KRW 52 billion, up 160% from the previous quarter. However, the initial costs were incurred for the new plant construction for newly established entities like POSCO HY Clean Metal, and there were inventory impairment losses. So this gap will reduce as the plant becomes operational and generates sales. POSCO HY Clean Metal began its first shipment at the end of Q2 and is gradually increasing its utilization rates. Now, the major business activities for Q2. The first thing to mention is the rollout of low-carbon steel products. In Q1, POSCO launched renewable energy steel with increased use of renewable energy like solar and wind power. In Q2, we launched a third-party verified low-carbon product called Green certified steel. Going forward, POSCO will secure electric furnace capacity by 2026, launch products using more scraps, and make products with hydrogen direct reduced iron by completing the HyREX facility by 2030. We aim to achieve 10.5 million tons in sales of low-carbon products annually by 2030. Building such a proactive low-carbon system is a process transformation for a more sustainable business and an effort to secure our market-leading position with technologies and products in the low-carbon product segment. We are also expanding our production for green industries. Currently, POSCO produces 100,000 tons of high-grade NO products annually for green vehicle motor cores in our Pohang mill. The expected increase in demand for high-grade NO due to the accelerated growth of green vehicles, coupled with the fact that only about ten steel makers in the world are capable of manufacturing high-grade NO due to manufacturing technology patent issues, means we plan to additionally expand our investment in Korea and abroad and build a plan to produce 1 million tons of high-grade NO by 2030. In April 2022, we broke ground for the construction of a 300,000-ton facility expansion in Gwangyang, which is almost completed, with operation planned for the fourth quarter of this year. Next, on the hydrogen business for hydrogen-reduced steel. POSCO Holdings-led global consortium has won a license to develop and operate the Green Hydrogen Project in Duqm, Oman. Renewable energy will be used to produce hydrogen and convert it to ammonia. Currently, POSCO Holdings has secured the project development license. The company will review project feasibility by 2024 and determine the final project scale. Hydrogen produced overseas will be sold locally as eco-friendly raw materials for steelmaking, and POSCO Holdings is looking into both green and blue hydrogen. The Duqm project is the first step in the company's journey to hydrogen-reduced steelmaking business. Moving on to the nickel dry and wet smelting business of Q2. POSCO Holdings signed a deal for a joint pyrometallurgical project in which the company has a 49% share in Halmahera, Indonesia. Under the project, nickel matte production volume is expected to reach 52,000 tons in June in Sulawesi, Indonesia. A hydrometallurgical JV project in which the company invested a 20% share was approved by the Board of Directors. This JV will lead to nickel MHP 62,000 tons generation. As the world's top nickel producer, Indonesia will help the company secure price-competitive nickel by smelting nickel locally. The construction of the two smelting plants is expected to be completed by 2025. In June, POSCO Holdings also signed a JV to build a refining plant in Pohang. In China's CNGR, POSCO Holdings owns a 60% and 40% share, respectively. The plan is to produce 50,000 tons of high-purity nickel under the JV, which will help complete a nickel precursor cathode value chain by 2025, ensuring supply chain stability. As a result, Q2 OP stands at KRW 841 billion with an OP rate of 8.2%. We saw slight recovery quarter on quarter. As noted, Q2 saw no additional flooding-related costs in Pohang Steel Works, such as recovery causing inventory loss, and crude steel production increased by 4.1% quarter on quarter, alleviating pressure on fixed costs. The selling price of carbon steel rose 4.6% quarter on quarter to KRW 1.06 trillion, boosting the profit rate. During Q1, S&P hit a low in January, then rebounded. However, despite the reopening in China, the pace of economic recovery is slower than expected, dragging down prices since June. The steelmaking market conditions for H2 remain uncertain. Many Chinese steel makers are struggling to generate profit despite slow demand, with attempts to raise steel prices ongoing. If Chinese steel makers reduce production in Q4, market conditions might recover. Moving on to Q2 overseas steel profit, the level recovered quarter on quarter, particularly for PTKP. The Indonesian JV started operation of new HR as of the end of last year. Previously, it was based on graphite, but it shifted to high-grade HR. High-priced HR sales expanded internally, pushing the domestic sales share of HR steel products to 77%. In May, PTKS suffered a fire, leading us to believe that domestic sales, which are highly profitable, will continue for the foreseeable future. However, PZSS Zhangjiagang remains in the red due to a sluggish market, while POSCO Maharashtra enjoyed improved profit due to competitive high-grade materials. Next, POSCO International. OP went up 27.5% quarter on quarter. The recovery of steel prices contributed to a 12% quarter-on-quarter increase in global business revenue, which drove up steel trading profit by 55% quarter on quarter. In terms of energy business, despite sales reductions due to the cyclone affecting the gas field in Myanmar, profit levels increased due to a higher payback rate of development costs. POSCO E&C's revenue increased 9.6% quarter on quarter, but OP rose only slightly, primarily due to winning more secondary battery plant projects rather than construction. POSCO Future M continues to post steady growth, particularly with the high-end N86 share increasing, leading to a 10.2% quarter-on-quarter rise in cathode revenue and an average selling price increase of 22% quarter on quarter. However, anode sales for EVs dropped by 15% quarter on quarter. This brings an end to the Q2 2023 earnings release presentation. We will now move on to the Q&A session. Thank you.

Operator, Operator

Now we will move on to Q&A. The first question will be from Park Canon from Hyundai Motor Securities. Please go ahead.

Unidentified Analyst, Analyst

Hello. I am Park Canon. First of all, thank you for sharing a good earnings report and the presentation. I have three questions for you. As it was explained in the presentation, the Chinese steel prices are showing a stable situation. However, there are lower expectations for the pickup of demand in the latter half of this year. How do you forecast the latter half of this year in terms of market conditions? Second, regarding lithium or secondary battery materials, you presented many details during the Value Day. However, for those who haven't attended the event, could you provide a forecast for lithium prices in the mid to long term? You also mentioned our lithium production capacity increased from 300,000 to 420,000 by 2030. Is this increase due to our improved capabilities or due to changing market conditions? Lastly, I wanted to discuss EBITDA margin, which is slightly lower than what was suggested last year. Is this related to the forecast for lithium prices? Could you explain a bit about the reasons for the lower EBITDA margin this year?

Jeong Ki-Seop, CSO

Regarding the demand forecast, Han Dong Ng from the Market Strategy Office will respond. Lee Kyung-seop, who oversees lithium materials businesses, will address the outlook for lithium prices. Tom Bong Su from the Steel Production & Technology Strategy Office in Pohang will provide the answer to the third question about HyREX. First, I will share the market conditions outlook for the latter half of the year. Until June, prices were constantly declining, but following July, global steel makers began to increase prices due to cost pressures. In Europe, the 12-week streak of price declines came to a halt. There are also efforts to raise prices in other markets. Since July, distribution prices have rebounded in both China and Europe. On July 18th, steelmakers in China committed to pursuing price recovery and restructuring. The latter half of this year will heavily rely on the effectiveness of China's economic recovery plan and reductions in steel production. The foreign exchange factor is also significant for the next semester. The low value of the Japanese yen affects our exports to Japan, though domestic market conditions will be less impacted. Sales in the automotive sector are expected to rise, suggesting strong demand for steel plates. In the shipbuilding sector, new ship prices are also increasing. Overall, if the construction and household appliance sectors show some recovery, we expect their impact to diminish over time.

Lee Kyung-seop, Lithium Materials Business Head

I would like to share the response regarding lithium. You asked three questions. First, regarding the lithium price outlook for the second half and mid to long term, based on FX market and McKinsey forecasts, lithium prices are expected to range from $40,000 to $50,000 this year and next year. However, by 2030, we anticipate a decrease to between $27,000 and $30,000. Given the market's volatility, it’s quite challenging to provide a long-term outlook. There was a drastic downturn in EV sales due to economic conditions and reduced subsidies in Europe and China. Nevertheless, EV sales increased by 40%, with 480,000 sold by the end of May. Battery sales rose by 50%, suggesting a growing trend in EV demand, expected to reach around 15 million units this year. However, the fluctuations in lithium prices in the Chinese market make it difficult to predict stability, as demand is projected to push prices to around $40,000 to $50,000. The increase in our lithium capacity to 420,000 by 2030 reflects our improved confidence and commitment to the business, aligning with global competitors who have also adjusted their targets upwards due to market trends.

Unidentified Company Representative, Steel Production Technology Head

Hello, I am Tom Bong Su from Pohang. Regarding the question about different paths for hydrogen or reduced iron techniques, many global companies are focusing on low-carbon products and accelerating their hydrogen-reduced iron projects. However, our method involves using an EAF type as compared to the shaft type commonly utilized by the EU. The main difference lies in the quality of iron ore used; the shaft type requires high-quality iron ore, leading to limited reserves. In contrast, our method allows for the utilization of lower-quality ores, thus securing a broader supply foundation. Understanding our know-how in both electric arc furnace operation and FINEX utilization creates synergy. When considering HyREX, we have developed technology that is not only leading but also enables us to streamline costs and accelerate advancements.

Yi Hyun-soo, Analyst

Hello. My name is Yi Hyun-soo. I have about three questions. First about POSCO. You mentioned sales recovered to about 8.3 million, and the volume will reach about 9 million. Do you think that the sales will recover in H2? Do you have specific sales volume numbers? Also, while you discussed the recovery in quarter two, how do you see H2 performing relative to Q2? About lithium for secondary batteries, with brine lithium production capacity at 100,000, how are you navigating the share between brine production versus ores? Recently, we’ve observed a rise in POSCO Holdings’ share price. You mentioned it's around 70%. Do you have plans to adjust the shares, considering the acquisition cost changes in affiliates?

Jeong Ki-Seop, CSO

Thank you for the questions. For the first question regarding H2 sales volume outlook, Mr. Kim Seung-Jun from the finance team will provide insight. For lithium related queries, Lee Kyung-seop will address those. POSCO International's aspects will be tackled by Jeong Dae-Hyung, Head of the Corporate Strategy team.

Kim Seung-Jun, Finance Team Head

As for H2 sales volume outlook, in Q1, operations did not fully recover, leading to a lack of normalization; however, it normalized in Q2. In Q3 and Q4, we anticipate a slight uptick in sales volume compared to H1, due to fewer facility repairs. If we take into account China's production reductions and anticipated economic recovery, the sales volume for H2 is likely to improve. With the stabilization of raw materials prices, there is potential for profitability to drive an upward trend in sales. In summary, we believe in improved performance for H2 relative to H1.

Lee Kyung-seop, Lithium Materials Business Head

Regarding lithium and its price, our target production is about 100,000 tons for brine lithium as well as 220,000 for various ore types, and we have 30,000 for recycling. The brine lithium share is arguably the most profitable. The Argentine projects aimed for smaller mines due to lower lithium content but do not offer ample opportunities for large-scale mining. Our focus remains on Australia for optimal opportunities. The mix ultimately aims for 420,000 by 2030, reflecting our realistic expectations in the LTC perspective.

Jeong Dae-Hyung, Corporate Strategy Team Head

Regarding your question about potential share adjustments, while we have been working on stock governance and response to share price changes, there are currently no plans to adjust the shares considering our ongoing evaluations.

Kim Sang-hoon, Analyst

I have a few questions. Earlier this month, you mentioned investing about KRW 121 trillion by 2030. What percentage of this has been invested and can you provide a breakdown? Secondly, regarding lithium sales, do you have specific milestones set for mid-term targets? Lastly, how do renewables factor into your overall revenue? Can we expect further acceleration in these projects?

Jeong Ki-Seop, CSO

For the first question about CapEx, Jeong Dae-Hyung, Head of the Corporate Strategy team, will address it. For lithium production inquiries, Lee Kyung-seop will respond. Regarding offshore projects, Han Dong Ng, the Group Leader of the marketing strategy office, will provide context.

Jeong Dae-Hyung, Corporate Strategy Team Head

Regarding CapEx, the KRW 121 trillion can be divided into three categories: steel (35%), secondary materials (46%), and green infrastructure (15%). Breakdown of steel investments includes 20% for green steel initiatives and the remainder for growth and recurring investments.

Lee Kyung-seop, Lithium Materials Business Head

In Gwangyang, we are targeting production of about 43,000 tons by October, marking Phase 1. Next year, we aim for another 25,000 tons, and for recycling, 2,500 tons is ramping up. Our projections for 2026 include an additional 60,000 tons, as the ramp-up process takes 12 months after construction completion. We expect that production will stabilize by 2025, thus reaching the target of 166,000 tons sold.

Unidentified Company Representative, Energy Steel Materials Head

The energy steel market is vital to our strategy, and we have a dedicated entity overseeing the energy materials business. Currently, we produce 1 million tons, with forecasts of tripling our wind power production by 2030, while PV targets aim to achieve twofold expansion within the same timeline. Collaboration with major wind power manufacturers will strengthen our foothold in this promising sector.

Jeong Ki-Seop, CSO

Are there any additional questions? Next will be from Eugene Securities, Mr. Lee Eu-gene.

Lee Eu-gene, Analyst

Hello. I have a couple of questions regarding recycling. You mentioned handling black powder, projected at 10,000 tons. Does this fit into the 30,000 tons by 2030 goal? Also, what can you tell us about the recycling margin? For Li-Ni, the nickel content stands at approximately 70%. I would like to inquire about the sales structure and margin details you have. Thank you.

Jeong Ki-Seop, CSO

For your inquiries about recycling, Mr. Lee Kyung-seop will address these questions.

Lee Kyung-seop, Lithium Materials Business Head

On recycling targets, the goal of 30,000 tons includes plans for battery recycling, which encompass nickel, cobalt, and other materials initially. Our hurdle rate for recycling margins presently is around 9.98%, and in conjunction with new business facets, approximately 15% to 20% is the targets we are aiming towards, though prices are highly variable.

Operator, Operator

Next question will be from Morgan Stanley, Kim Young-ha.

Unidentified Analyst, Analyst

Thank you for the opportunity. I have questions regarding the Gwangyang lithium business with Pilbara. Can we expect an update on ore price negotiations and the timeframe for completing these discussions? Also, regarding the Argentinian lithium business, any updates on margin and price structure would be appreciated, as well as the profit levels you are targeting in the next two to three years.

Jeong Ki-Seop, CSO

Regarding the Pilbara PPS, we established the initial pricing structure in 2021, but due to the recent surges in lithium ore prices, negotiations are currently in process. We anticipate concluding by mid-August, as this affects the initiation of product construction. Margin structures are subject to final negotiations but are expected to remain relatively stable compared to initial proposals.

Sean Jou, Analyst

Hi, this is Sean from Marshall Wace. I have a question concerning the precursor self-sufficiency target by 2030. I understand there’s a JV with CNGR, but how self-sufficient will you be for total expected output in precursors? Additionally, regarding the KRW 121 trillion CapEx, could you clarify how much internal cash flow versus debt will fund this? Thank you.

Lee Kyung-seop, Lithium Materials Business Head

For precursor self-sufficiency, we target approximately 460,000 tons by 2030, equating to about 50% self-sufficiency, which allows for external contracts to supplement based on market demands. We have secured the necessary raw materials for nickel and other components.

Kim Seung-Jun, Finance Team Head

When discussing CapEx, approximately 4 trillion is held by POSCO Holdings, and about 9 trillion by POSCO, totaling 13 trillion in reserves. Currently, we don't foresee the need for external funding or additional debt, although future liability options remain a priority as conditions develop.

Jeong Ki-Seop, CSO

If there are no further questions, we would like to conclude. Thank you for your participation today. We will keep in mind all the questions and comments so we can foster a better future for POSCO. Thank you once again for joining the second-quarter earnings call. Goodbye.