Sociedad Química y Minera de Chile S.A. (SQM) Q4 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the SQM Fourth Quarter Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Gerardo Illanes, the Chief Financial Officer. Please go ahead.

Thank you. Good morning, everyone, and welcome to SQM fourth quarter 2018 earnings conference call. For your information, this conference call will be recorded and is being webcast live. You may access the webcast later on at our website, www.sqm.com. Joining me today, our speaker is Ricardo Ramos, Chief Executive Officer. Before we begin, let me remind you that statements in this conference concerning the company's business outlook, future economic performance, anticipated profitability, revenues, expenses or other financial items, anticipated cost synergies and product or service line growth, together with all other statements that are not historical facts, are forward-looking statements as that term is defined under federal securities laws. Any forward-looking statements are estimates reflecting the best judgment of SQM based on currently available information and involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those stated in such statements. Risks, uncertainties and factors that could affect the accuracy of such forward-looking statements are identified in the public filings made with the Securities and Exchange Commission and forward-looking statements should be considered in light of those factors. I will now leave you with our Chief Executive Officer, Ricardo Ramos, for brief comments before we move to Q&A.

Thanks, Gerardo. Last night we posted our results for 2018, our net income reached almost $440 million, this was a slight increase compared to earnings reported in 2017. Our highest sales volumes in SPN, higher sales volumes on price of iodine and higher average price in lithium contributed to our 2018 results. Lithium market is surrounded, as you may know, by positive news. Full electric vehicles penetration levels reach approximately 2%, and these rates are expected to grow rapidly in the future. Demand growth in 2018 surprised us again surpassing 27%, and is expected to grow by the rates above 20% in 2019. Beyond 2019, demand growth continues to look extremely healthy, making us believe that the 1 million ton per year lithium market that may happen sooner than originally anticipated. The lithium market is a dynamic one, and one of my main priorities is must match value in this space. As was expected, new supplies coming into the market, make it more difficult for us to capture the price premium that we had in 2018, as was stated yesterday. There are several lithium grades of different qualities available in the market and not all of the products are sold at the same price. We believe that our sale volumes in 2019 will be slightly higher than those reported in 2018, just under 50,000 metric tons. Bear in mind, it is very difficult to predict our sales volume in 2019 and 2020, it depends on supply and demand equilibrium, also the timing of the start and the ramp up of new projects is difficult to assess. The other markets in which we participate remain strong. In the iodine market prices reached almost $26 per kilogram in the fourth quarter 2018, exceeding expectations, and we report a record sales volume for the year. In fact, contribution to gross profit from the iodine business line were doubled in 2018 when compared to 2017. The gross profit also exceeded with the speciality plan nutrition business line increased by approximately 20% this year when compared to last year. Before opening the line for questions, I want to thank all our people in the north of Chile for the shell they have provided to the local communities as they recover from the impact of the heavy rains seen in the region in recent weeks. We thank you for joining our call today, and we will now open the line for – up for questions.

[Operator Instructions] The first question comes from Joel Jackson with BMO Capital Markets. Please go ahead.

Hi. Good afternoon and congrats Ricardo and Gerardo on your positions. I had a few questions on lithium that are little confusing. What is your current expected lithium production for 2019? We all thought it'd be about 70,000 tons. You said you will sell a little bit less than 50,000 tons. You talk about the inventory builds. So how much inventory would you build? And how much will you produce in 2019? And if it's a lot less than 20 – excuse me, if it's a lot less than 70,000 tons, would you let us know what's happening? Thank you.

Thank you, Joel. First of all, we stated in the count -- in the press release, we think our sales -- volume sales in 2019 will be slightly higher than 50,000 metric tons -- sorry, would be slightly higher than 2018, means close to 50,000 metric tons. And it -- really, we have a total capacity the one that we build during 2018 close to 70,000 metric tons. We know that part of our strategy is to have this spare capacity and it continues to grow, next step would be to have it at 120,000, that we are working as we speak today. With the procurement of -- some of the equipment is already done, we're working on it. And the third step would be moving forward to 180,000 metric tons. From the build of inventory, we don't know exactly what is going to be the total inventory of building inventory in 2019, but of course, we will produce more than our expected sales. It was part of our strategy, we want to recover some inventory, I think having some strategic inventory in the future is a way to have more flexibility. The same reason we want to have some spare capacity, not only in this year, in 2019, we expect to have spare capacity in every single year in the future in order to be ready and to have the flexibility today and certainty in the market. But certainly, this year, we will produce, we expect, more than 60,000 metric tons. The difference between sales and production will go to the inventory growth.

Okay. That's helpful. Do you feel the need this year to balance the markets? Is that based in your projection that you can't produce -- let me try this again, could you produce 70,000 tons this year if you want to? But you choose to produce a little bit more than 60,000 to balance the market in view of your -- the new supply coming on.

First, I don't want to confuse production with sale. Our decision to sale the volumes has already explained, it means it's slightly higher than the year 2018. It is -- this decision is not efficient, in fact this is quite what we expect to be in equilibrium between supply and demand. And as you know and we stated in the press release and we state it now, we're very optimistic about the demand of lithium in the long turn. And anyway, I want to be very clear that we think we have very good estimates about the different new lithium projects coming on the market, either the under development and the ones under study. And we follow all the announcements relative to projected capacity increased from current players. But again, we strongly believe in the long-term demand projection. Even if it's somewhat strange, our projections of the sales volumes in a relatively short term increase in the next 30 months is more difficult than long-term projections. That's something very difficult because even though we have good estimates about potential capacities of the different lithium projects. There are significant uncertainties about the date, the initial quality and start of the -- those volumes of those projects. As you know, even the industry has really a negative track record in the projected dates and volumes of their initial production, now that is a fact. Anyway, I'm really proud of our lithium target in that market. That's the reason why -- even though we said that we expect a slightly higher sales volume, it will depend what's going on in the second semester of this year, it's difficult to know because it depends on these new projects. But again, this estimate is the -- what we think is that reasonable supply and demand equilibrium for all the different players that are today on the market. Yes, we can produce more and that's the reason why we are going to produce more and we're going to increase our inventory.

Okay. And just a final question on price guidance. You talked about some erosion in price premium. Should we expect lower average pricing in the first half of the year versus the fourth quarter? And how does hydroxide versus carbonate mix play in that? Thank you.

Certainly, the -- when I think about the difference between hydroxide and carbonate, it's the difference in between the margins for SQM. That's what is important for us. And the margin side, not so different in terms of what we are getting from different products. Certainly, at the beginning, the pricing of lithium hydroxide and lithium carbonate, mainly, two years ago on some of projects last year was quite different. Not anymore, almost similar products in terms of the marketing and the way they are selling them in the market. And their margins are quite similar, it depends on the cost of production for us. As we explained in the conference call, during last year we had what we call this preview the main explanation of this extraction of difference is related with the different commercial strategy. On the one hand, SQM sold its products mainly through spot pricing, and on the other hand, our main competitors mainly through long-term contracts agreed during the previous years, that explains the main difference. If we consider our main competitors lithium average prices, their average prices. In 2018 that's the market price of the previews, market price of 2018, we believe it is reasonable to project that the market price for 2019 will be similar or slightly higher than the average price of the year before, of this market price, that is the average price of the -- our main competitors. In 2019, it really -- we do not expect important differences between our prices and the market average price, it means we don't expect this type of premium pricing in SQM. Therefore, we think that it -- what we call the average market prices of the fourth quarter, it's -- the average prices of fourth quarter would be similar to the first quarter this year, considering the market price, the average prices of the main competitors in the market. It's important to consider that we do not follow in detail what is the cheap China price, I know there is a lot of questions regarding what is the sales price of the lithium carbonate and lithium hydroxide inside China. We don't have reliable sources about the pricing in China -- internally in China. We are not exporting now, as we speak, products to China. We don't know exactly the quality of the different products that is traded internally in China. But of course, we compete with the lithium carbonate produced in China in different markets in the world because most of the lithium produced in China is coming from -- is exported in from Australia. It means all the -- not all but most of the new projects and the current projects in Australia use the facilities in China that is the lithium carbonate, that is the lithium that is export from China, and is the all way -- also is the product that is sold in China. We compete all around the world with them, but we don't know internally China, a reliable source about the pricing, we don't have an answer about that. The only pricing that is already coming to you, everything is what we call ex-China situation.

Okay. Thank you very much.

The next question comes from Danniela Eiger with Bank of America. Please go ahead.

Hi, good morning and thank you for the question. Let's see, I have two questions. The first, you mentioned that your main competitor uses actually long-term contracts, and that allows them to have, like, more stable pricing. May be in 2018, that wasn't a good was because it was actually lower than spot prices, but again, they won't have much volatility in terms of prices. Just wanted to understand your strategy regarding long-term contracts from what we have been hearing, OEMs are looking for long-term contracts, even their potential supply gap and we should see we are in -- moving forward in 2022 more or less. So just wanted to understand your strategy regarding long-term contracts. And my second question, just on the heavy rains that you experienced in Chile. You mentioned that it shouldn't have a long-term impact. But just to understand, should we expect any impacts on volumes in Q1? And that's it. Thank you.

Hi, Danniela. First of all, the long-term contracts are not. First let me say that we -- I think today that our strategy -- commercial strategy in 2018 was the right one. It was the right one because it's -- the starting market is difficult to know what is the long-term agreement, you need to understand the market before having this long-term agreement. Happens to be that it was very good in the economic point of view this study for SQM, but -- not even considering the economic situation of the pricing that was good. I think was good to wait and see in order to start having this long-term agreement. We are more than open for long-term agreements. We are in different conversations with different clients and different potential buyers in the future to long-term agreements. We're -- as we speak, we're doing so. Probably, we will have a long term -- significant long-term agreements in the near future, yes, we will, and we are working on it as we speak. It's very important. I think that today, we understand better and our clients understand better the market. And it's better -- we're in both sides in better positions to agree in the terms and conditions in a very productive way for both sides for long-term agreements, and we are working on it now. I don't think it's a bad strategy, it's a different one, and it's the right moment to go ahead with the strategy and we're working on it. About your question of the raining and all, no, yes, there were significant rains in some of the areas of the north, we’re working very hard to help all the communities close to SQM, and we have been very successful, I’m very proud about that. Our people working with the communities helping them, I’m very proud that our facilities were prepared for this kind of situation, either in the nitrous business, on the Sociedad Química, we had a very good preparation in our fixed assets and operations to have this kind of climate situation. I don’t expect significant impacts in our production process, we have some issues. Of course, we stopped our production during the week, maybe more in some areas, less than a week in other areas. The north of Chile is very big. We have different production facilities all around the north. And these heavy rains were very focused in different areas. And yes, some production will be affected, but nothing that will affect our capacity to go to the market in the short term. Keep in mind, our previous question regarding the spare capacity and inventory, we want to have and we will have possibility in our main business. We have inventory of our year-end, we have inventory of nitrate. We have a spare capacity for iodine. We have a spare capacity for nitrate. We have some inventories, I want to have more inventories of lithium, and we have some spare capacity, and I want to have more spare capacity in lithium, I believe, has been the historical strategy of SQM, it will continue to be our operational and business strategy in order to face our main markets.

That’s perfect. Thank you so much.

The next question comes from Ben Isaacson with Scotiabank. Please go ahead.

Thank you and good morning. First question is on iodine. You talked about closing the fourth quarter at around $26 per kilogram. Can you talk about at what price does new supply start to come back into the market?

Hi, Ben. First, I don’t think that a significant amount of iodine went out of the market in the past. I think that if you considered all the different producers, they maintain their production, most of them, there’s no big ones or important or significant ones that shutdown their facility. The reason why we’re increasing volumes and the price is being increased, is that the volume – the money has been increasing, that’s the most important issue here to consider not the shutdown of all of producers. The second situation you should consider is the cost of producing iodine. For most of our competitors, their cost is increasing, they don’t have by-products as we have. They don’t have this economy of scale as we have and the technology as we have, that’s why cost is going up. I think, the reason – the question here is not if they will come back to the market, some producers, because it’s not relevant. What’s is relevant is the current produces, they will increase or not their capacity. And probably they will. And I don’t think there’s a clear price, a price that says, in excess of this price that you will have more producers or below this price will you have a shutdown of some producers. I think it’s more important to focus in the market and the demand. I really focus now – more focus in the elasticity of the demand. We need to be very careful not to damage the long-term growth of the amount of iodine. If you have a strong iodine market growing, let suppose 3.5% per year, it means close to 1,000 metric tons of additional iodine per year, if you go to that direction, that’s great, that’s very good for us. What I don’t want to do is to put the pricing away that some of the demand will be affected and the increase will be instead of 1,000 built, 200 tons or 300 tons. That’s why my most relevant point today is the elasticity of the demand. What I want to say is that we have been looking very hard and in detail about potential elasticity of the demand of different pricing. And we think that today, price environment and the prices that we’re working now during 2019, we think that we will face a very strong demand, that’s my first statement, we think so. That’s the most important issue we’re facing and we will continue to check the situation in the iodine market in the near future, of course.

That’s great. Next question is on the potassium nitrate market. Can you just give an update in terms of what that market looks like right now? You talked about a bit of new supply coming on. What type of impact will that have? When does it come on? Who’s brining it? And what does that mean for you?

Yes. Assuming no one of the main competitors, main producer of potassium nitrate in the world is Haifa Chemicals in Israel. And they have had, in the past, some issues regarding their production from environmental issues, different issues. Probably you can check in the internet, there’s a lot of information regarding the situation going on and nothing in the Haifa production. We think that they are more – they are coming back in – with some tonnage to the market. As expected, there’s nothing new about that. It’s not addition or production, its recovery some of their production. Even though, we continue to estimate and believe that this year 2019, we are going to increase our volumes in the specialty plan nutrition business. Our budget for this year is having an additional tonnage as the same as we have last year than additional tonnage, probably in the last three or four years, we will continue the same trend, and that’s good. Pricing, we maintain a very healthy price environment. The only question mark in the pricing is the situation of the euro exchange rate in Europe. An important portion of our sales goes to Europe on countries related with the euro exchange rate. You know that today, nowadays, the exchange rate in Europe is not as good as quite used to be one-year ago. And in some ways, this will affect our pricing in U.S. dollars in the Europe. But that’s one thing you have to consider in the speciality nutrition business, but the other thing that in some way affect this business is the price of the MOP. In the last few weeks, news of MOP market is slightly better-than-expected in terms of pricing, that’s good. Because this part is one of the main cost of production for potassium nitrate, that’s why it will help us to maintain healthy price environment. About the solar salt, did you – what’s the question about solar salt? No, no. Okay, okay, only potassium nitrate. Okay. That’s it Ben, do you have any follow-up question?

No, that’s helpful. Thank you so much.

The next question comes from Javier Martinez with Morgan Stanley. Please go ahead.

Hello, Ricardo. Starting to ask, again, about lithium. Ricardo, I mainly need to slow this morning, I want to make sure that I understood it well. So two questions. First of all, you mentioned in the release that the demand – you expect the demand to be growing more than 20%? And you say that your delivery will be just slightly higher, so that means that SQM will lose market share in 2019, right?

We – I want to be very clear that our main focus in the lithium market in the short term is not market share, it means market share is not an objective at all. We have a long-term strategy. If you think in the long term, and we – when I say long term – sorry, when I’m thinking 2025. Why 2025? Because I strongly believe there’s a fair chance on a significant – I expect that the demand 2025 will be close to 1 million tons. I consider it to be 300,000 metric tons, we’re talking about 700,000 metric tons of additional demand of lithium carbonate and lithium hydroxide whatever in the market in the next six years, that’s a lot. And we have been preparing SQM to be ready to take a big portion of this and get advantage of this additional demand. Of course, as you may know, and everyone knows, and we follow, we are in some projects and we know every single project, we study them, we follow them, the new projects, the one that are in development and the ones that are in study of lithium carbonate, and most of them in Australia. We follow those projects. And as expected, during this year and during next year, we will have some new projects that we already know, go into the market with additional capacity. And at the end, you have in the short term in the next 30 months, that’s why I put the next 30 months, that’s where we are going to have most of the new employers go into the market. This balance between supply and demand. And this – I prefer – I really prefer to be 10% of that 5 million tons market that’s been 90% of our 500,000 metric tons market. It means, market share is not my target volume, it’s my market in the long term margins, it’s my target in the long term. And we are even bigger position today, in my opinion, in terms of my projections about competitors and my projections about the market, where I’m going to be in 2025. Today, I’m more optimistic than what it used to be 1 year ago, and that’s my target. Credit volumes, strong increase in volumes and having a strong increase in margins. If the market instead of being 1 million tons its 1.5 million tons. And we have a lot of new chemists, who cares, it mean I don’t care having 20% or 10% of the market share, it’s not my target, it’s not what I’m looking for. What I’m looking forward for margins, I’m looking forward for volumes, that’s the one that we expect to have in the future.

Understood. That’s clear. Ricardo, second question please, if you don’t mind. So you say that the premium you get this what competitors will converge, this is because your prices will go down? This is because competitor prices will go up to converge or both?

I don’t know what my competitors are doing in detail. But they – as far as I know, they say publicly that they expect prices for them to be similar or slightly higher. That I know they said something like that. And I think that it sounds reasonable considering that today my anticipation is my saying expectation of the market. And I say you before, we had this additional premium prices in 2018. And I think that I will get more close to their pricing, our competitor prices in 2019. Therefore, of course, my prices, SQM pricing premium will decrease. The average SQM sales prices in 2019 will be – I expect to be lower than the year before. But keeping in mind, not because the price of the market itself is going down, it’s mainly because SQM premium prices is not – I don’t think it’s reasonable to expect that we’re going to have this additional pricing in 2019. For the reasons that I already explained you in the conference. Thank you.

Very clear. Thank you, Ricardo.

The next question comes from Josh Falcao with HSBC. Please go ahead.

It’s all good. Just following up on Javier’s call, lithium, sorry to keep following on with him. Is there any problem – when you guys announced the expansion and the fact that you couldn’t get there. Is there anything you should do in this premium going away? Is there anything you should do with the purity, the quality? I know that there is range of quality of material and where you can send and where could you produce. But is there something you should do with that? That’s question number one. And question number two is, talking to some of your competitors, they say that there is softness in the Chinese market that [Audio Dip] there’s "premium" is a result of that [Audio Dip] but at least stock market seems to be a little bit softer. Is that what you referred to or is it something else? Thank you.

Josh, Ricardo. First of all, the first question, I have some doubts about the second question anyway, but let’s go to the first question. As I explained before, the main reason of these premium price in the year 2018 as compared to our main competitors is related to this commercial strategy, where we have the spot sales and they had this long-term contract, and that’s the main reason. Of course, our geographical sales, our customer base is probably different customer base, it is different. Maybe we asked to have this premium price, maybe. But again, I want to be very clear that I think that the most important reason was this commercial – different commercial strategy. This is the one. The second question, if I’m not wrong because we had some connection problems with your call. It’s regarding the China situation and I think I explained before that we’re not selling in China. We are – we don’t have reliable information. We have a lot of information every day coming from China, people say that the price is whatever, I don’t remember. 1 year ago, some people say that in China, lithium was close to $30 per kilogram. I’m not even sure it was true or not. And we didn’t sell our $30 lithium, not in China, nowhere. But now, of course, there’s some people that say in China that – in China are selling very low prices. But again, I’m selling, as we speak, lithium everywhere in the world, and China can export the lithium everywhere in the world. That’s why I think that it sounds strange for me that prices in China are so low, good quality pricing, if the price is so low, why they don’t export this high-quality lithium to other markets. I don’t know, means I don’t know what kind of lithium they are trading these low prices that I don’t know are real low pricing. And I prefer that somewhere we felt real experience on selling, real selling lithium in China can answer this question. I really cannot answer the question, what’s going on in the China internally. But I think, I don’t foresee any reasons to believe that the pricing that we expect today or whether we are looking at the market today would be quite different in the near future. I don’t have information in order to show something like that.

Super clear. Thank you.

This now concludes our question-and-answer session. I would like to turn the conference back over to Gerardo Illanes for any closing remarks.

Thank you. Thank you, all, very much for joining us today. And we hope to have you with us in the next conference call. Goodbye, everyone.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.