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Edited Transcript of 010950.KS earnings conference call or presentation 23-Oct-19 1:00am GMT

Q3 2019 S-Oil Corp Earnings Call (English, Korean)

Seoul Oct 25, 2019 (Thomson StreetEvents) -- Edited Transcript of S-Oil Corp earnings conference call or presentation Wednesday, October 23, 2019 at 1:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Gwang-cheol Ko

S-Oil Corporation - Head of IR

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Conference Call Participants

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* Kang Dong-jin;Hyundai Motor Securities

* Oscar Yee

Citigroup Inc, Research Division - Director

* Rui Hua Ong

JP Morgan Chase & Co, Research Division - Analyst

* Young-chan Baek

KB Securities Co., Ltd., Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, and good evening.

First of all, thank you all for joining this conference call, and I will begin the conference of the fiscal year 2019 third quarter earnings presented by S-Oil. (Operator Instructions)

Now we shall commence the presentation of the fiscal year 2019 third quarter earnings presented by S-Oil.

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Unidentified Company Representative, [2]

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Good morning, everyone. Welcome to S-Oil's third quarter of 2019 earnings conference call. I would like to thank you all for joining us today. I am [Cho Young Ko,] the Treasurer of S-Oil Corporation.

I am glad to be here today to communicate with you through the earnings conference call. Your continuous support will be highly appreciated. IR team leader, Mr. Ko Gwang-cheol and other IR team members are with me here today.

Before Mr. Ko presents our third quarter's financial results, I would like to start with a brief review on business environment and our performance.

The company's third quarter earnings came in flat from the previous quarter's growth. The [company's purchase] operating profits of (inaudible) in the third quarter thanks to sharp rebound of refining margin backed by seasonal pickup as well as the early effects of IMO 2020. Not only the [pricing] market situations but also the company's (inaudible) operation of the major facilities including (inaudible) and #2 PX (inaudible) contributed to the company's earnings growth.

In the third quarter, (inaudible) in refining business would continue to be favorable. (inaudible) solid demand growth for [shipping] and inventory buildup in preparation of IMO 2020. The refining margins is likely to increase further (inaudible). However, in the petrochemical side, PX spread is likely to remain pressured under the circumstance we are (inaudible) PX plants are emerging in the region. PP&PO spreads are expected to have a slight recovery as downstream demand will be supported by seasonality as the year-end approaching. Moreover, lube base oil's spread will be widened due to the fall in HSFO prices owing to IMO 2020 implementation and stable demand for high-quality products. We are waiting to obtain good outcome of the megaproject.

Looking out to 2020, we strongly believe that the company will be one of the largest beneficiaries with its relatively high operating ratio under IMO's new regulation to cut the sulfur content of [fuel]. Given that HSFO price is falling sharply and its price (inaudible) gasoline is because it's [wide enough today.] We expect that RUC/ODC can make a meaningful earnings contribution in the first quarter and beyond.

In order to take full advantage of the (inaudible) favorable market conditions, we will put our best effort to operate the major production facilities at a maximum rate.

Lastly, I would like to underline that the recent hike in (inaudible) freight rate due to tensions on Chinese shipping companies will have a limited impact on the company's margins as we are [charter] investors from -- for crude (inaudible) contract where freight rates are fixed.

Again, thank you all for joining us today and keeping interest in our company.

From now on, Mr. Ko will take you through the presentation on the third quarter financial results and fourth quarter business outlook. Mr. Ko, please.

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Gwang-cheol Ko, S-Oil Corporation - Head of IR [3]

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Thank you, Mr. [Cho,] and welcome, everyone.

Before starting, I need to draw your attention to our cautionary statement. The company's third quarter financial results are provisional, and thus, the results are subject to change according to independent auditor's review. Also, during today's presentation, we will make forward-looking statements that refer to our current expectations, assumptions, estimates and projections. We caution you not to place undue reliance on any forward-looking statements which may involve risks and uncertainties.

Now I will start with financial results on Slide 4. Sales revenue was flat quarter-on-quarter as sales volume and average sales prices both changed marginally from the previous quarter. However, operating income recovered by KRW 321 billion from the second quarter loss, for KRW 231 billion of gain. Main contributors to that growth were sharp rise of Singapore refining margin and return to normal operation of major production facilities after maintenance. (inaudible) the continued fluctuation of crude price incurred inventory-related loss of KRW 65 billion partially [failing] third quarter earnings.

On other operating income line, FX loss on net liabilities extended to KRW 109 billion from KRW 67 billion in the second quarter due to (inaudible) in won-dollar exchange rate. As a result, third quarter pretax income recorded KRW 74 billion of gain, improving by KRW 270 billion quarter-on-quarter. We move on to the next slide, the financial status.

In the third quarter, the company's financial status did not change much on the whole. Our average cash balance was about KRW 1.2 trillion, increased by KRW 131 billion quarter-on-quarter. [indiscernible] net, excuse me -- [debt balance] increased by [KRW 212 billion,] mainly because of short-term [borrowing] increase. As a result, net debt balance remained around KRW 6.1 trillion, while net debt-to-equity ratio was flat at around 95%.

Meanwhile profitability index such as ROE and ROCE improved quarter-on-quarter. ROE and ROCE recorded 0.4% and 1.7%, respectively. Total debt average interest rate was [still] below 2.5% per annum as of end of third quarter, although debt balance has significantly expanded for a few years.

Now turning to the performance by business segment on Slide 6.

Sales revenue in refining business reduced a little by 3% quarter-on-quarter while its operating income [saw a gain,] recording about KRW 100 billion. Strong rebound in Singapore refining margin led to earnings growth following the normal operation of a major operating unit after a second quarter planned maintenance.

Meanwhile, inventory-related loss in refining business is estimated at about KRW 53 billion. Also, petrochemical sector's operating income meaningfully improved to KRW 79 billion from KRW 4 billion in the previous quarter despite of [an increase] of PX-naphtha spread. It was mostly because #2 PX started normal operation from August after 5 months maintenance [but only] increased production rate of ODC plants. Also, lube base oil sector expanded its earnings consecutively, posting KRW 52 billion of operating income with about 13% operating margin ratio.

Turning to capital expenditure and refinery operation. For the first 9 months, the company executed a CapEx of KRW 393 billion, about half of annual volume. Depreciation was KRW 423 billion for the same period. Most of the CapEx went to planned maintenance across the refineries and minor construction. Meanwhile, the company made a land purchase contract with POSCO PLANTEC in August to acquire more site near the incumbent Onsan complex for future potential projects. So amounting to KRW 55 billion.

In the third quarter, the company completed the #2 PX plant maintenance work in July while starting the #1 RFCC turnaround from mid-September. The #1 RFCC maintenance is the final planned one for this year and it is scheduled to finish this week.

Looking at third quarter utilization rate, most of our unit plant production quarter-on-quarter. RFCC and hydrochemical production rate in the combined [rolled] to 92% and [therefore] PX plant increased to 81%. As of now, except for #1 RFCC, all the units, including RUC and ODC, are operating normally.

Next, let me explain third quarter market environment along with fourth quarter outlook by [activities] at Slide 8.

Singapore refining margin sharply rose close to $4 per barrel on average. (inaudible) was supported by driving season and the early impact of the new IMO regulations, while supply was tight due to concentrated planned maintenance in the region. We think refining margins will go up further in the fourth quarter. Regional demand will be strongly driven by the start of [shipping] season and more active inventory build-up for [component] (inaudible) [pure] oil ahead of IMO 2020. [Thus,] new capacity coming [onstream] will be [benefited] quarter-on-quarter.

Moving to petrochemical sectors. (inaudible) over naphtha continued to fall quarter-on-quarter amid the rising concerns of oversupply due to startup series of new PX plants in the region. The [net] spread became considerably wider as market balance improved by [healthy] import demand from U.S. and the delay of operation of new benzene plants in Asia.

In the Q4, this spread will continue to remain pressured as the ramp up of new sizable PX plants will increase the regional supply despite operation cuts by marginal players.

Benzene spread will fall slightly as the [year's] input demand is expected to slow down after driving season and new capacities are coming onstream.

Looking at olefins markets on next slide. PP continued to decline due to ongoing trade disputes between U.S. and China which further hurt Chinese import demand along with weak Chinese currency. On the other hand, PO spread bottomed out slightly on the expectations of a recovery in Chinese construction industry.

In the Q4, PP spread is expected to rebound on the concentration of maintenance as well as increased demand for home appliances and packaging ahead of year-end. Also, PO spread will gradually improve due to delays in capacity extension.

Lastly, turning to lube base oil market on Slide 11. Lube base's spread moved down further affected by weaker demand in Asia, but supported at this [level] by solid demand for high-quality product in the U.S. and European markets.

In Q4, the spread would be wider, thanks to the fall in HSFO prices ahead of IMO 2020 and consistent demand growth of high-quality products.

With that, I would like to conclude my prepared presentation. Thank you for listening. Now we are moving on to Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question will be given by Mr. Baek Young-chan from KB Securities.

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Young-chan Baek, KB Securities Co., Ltd., Research Division - Analyst [2]

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[Interpreted] I have 2 questions. In the third quarter, we've seen some fluctuations in the FX, and you said that the fluctuation has positively impacted the company's operating income in Q3. Could you elaborate a little more on that?

And my second question has to do with the early benefits of the IMO 2020 which you said you saw in Q3. I would like to ask for a little more details about what you meant by the early effect and when do you think the shipping companies and the shipowners will start to purchase the marine gasoil? And are you seeing some signs of the full purchase by the shipping companies and the owners?

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Unidentified Company Representative, [3]

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[Interpreted] Thank you for your question. On your first question, the FX impact on the Q3 operating income was about KRW 55 billion. And about your second question, well, it's difficult to give you a clear answer on how much the shipowners have started to [stockpile and purchase] MGO starting from Q4 and what is the benefit of the IMO 2020 -- what was the benefit of the IMO 2020 in Q3. But we are obviously seeing a big increase in the LSFO spread. We saw that in Q3 and -- which was a very big benefit for the company. And from -- through that, we were able to feel that shipowners are preparing for the IMO 2020. And coming into Q4, the HSFO prices plummeted and the gasoil crack, as you know, is going up, which is an indicator that the shipowners are disposing of their HSFO and stockpiling IMO-compliant fuel.

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Operator [4]

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The following question is by Kang Dong-jin from Hyundai Motor Securities.

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Kang Dong-jin;Hyundai Motor Securities, [5]

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[Interpreted] I know that you did a good job in the LBO business in 3Q, and I heard that the refiners are adjusting their production volume of the middle distillates, like the heating oil and diesel in preparation for the IMO 2020. Please tell me if this is, in any way, related to the lube base oil business?

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Unidentified Company Representative, [6]

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[Interpreted] Well, I wouldn't say that because the lube base oil is much more profitable compared to the gasoil profitability, we are not really thinking about an option to lower the production of LBOs so that we can supply more gasoil in preparation for the IMO 2020. So for our company, I wouldn't say the IMO 2020 is having any impact on our production of the lube base oil -- our production activities in the lube base oil business. But for the less complex refineries, there could be a possibility that they were lowering the production in the middle distillates so that they can produce more gasoil in preparation for IMO.

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Operator [7]

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The following question is from [indiscernible] from Nomura Securities.

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Unidentified Analyst, [8]

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[Interpreted] You said that the RUC/ODC will start to contribute to the company's business performance from next year. Can you tell me how much it will contribute to your company's operating income in terms of the numbers? And I understand that S-Oil is reviewing the crude to chemicals process that will be applied to the new project, but my -- according to my market intelligence, Saudi Aramco tried to apply this process as one of -- in one of their plants in the Middle East but it had to -- grinded to a halt. So given that certain stance, do you think it will continue to be the same for S-Oil?

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Unidentified Company Representative, [9]

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[Interpreted] Yes, about the contribution of RUC and ODC to S-Oil's operating income in 2020, well, it's difficult for me to give you the exact number for now but I can tell you that we have the turnaround for the #2 RFCC this year and the gasoil crack at the beginning of the year was very low. But given the [latest] on gasoline spread and also PP, PO spread, we do believe that the RUC/ODC will become a much bigger contributor to the company's performance next year. And also because we do not so far have any plans for a major [transition] or a turnaround, so we do think it will contribute significantly to the company's performance in 2020.

And with regard to your second question about the TC2C, it's about the commercialization issue, at the moment, we are doing the feasibility study of this technology. And once we have the study findings, we'll make an internal review and come up with the final decision-making which will be around the first half of 2021. But let me tell you that this is -- although this is a new technology, it has already been well developed. And we are only verifying if this will be an applicable technology to our new plant. But even -- but to a new plant. And we are very optimistic that we'll be able to embed it in our new plant.

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Operator [10]

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The following question is by Ong Parsley RH from JPMorgan.

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Rui Hua Ong, JP Morgan Chase & Co, Research Division - Analyst [11]

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Thank you for the update. Can you check, given your plans for the crude to chemicals project, what is your dividend guidance or your expectations right now? Can you expect less than the lower end of the 40% to 60% payout ratio this year and maybe for first half as well as the [rate -- the additional] 40% payout? And secondly, can you just give me an update on your 2020, are you expecting to prioritize with paying debt or giving dividend? And if you want to kind of repay a bit of debt in 2020, potentially how much are we expecting?

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Unidentified Company Representative, [12]

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[Interpreted] Yes, about the TC2C investment and how this could impact our dividend, I will not say that this will have a big impact on our dividends because -- on our dividend payout ratio because this investment is only part of the [ethylene] cracker and downstream project. However, since this (inaudible) downstream [SCMB] project is a megaproject, there could be a pressure on our dividend payout ratio in the future. But the dividend policy and the dividend payout ratio's final decision is made by the Board of Directors of the company. So please excuse me for not being able to give any further comments about our dividend payout ratio in the future.

And second is about -- I think you're raising a possible concern that our priority on debt repayment could impact the dividend payout ratio and also the fact that we have a fairly high debt-to-equity ratio at the moment. However, we expect the business environment in 2020 to be quite in our favor, of the business. So we will be able to lower the debt, at the same time, we'll also be able to keep to our dividend payout ratio at the same level.

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Operator [13]

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The following question is by Oscar Yee from Citigroup.

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Oscar Yee, Citigroup Inc, Research Division - Director [14]

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I had 2 questions. First is that I noticed recently the gasoline [plant stock,] the high-quality ones, like alkylate, MTBE, have seen quite a significant spike in terms of the prices relative to the normal gasoline. Could I ask what's the reason behind? And do we expect the same trend to continue into 2020? Second question is could you provide the positive FX impact in 3Q for your OP line?

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Unidentified Company Representative, [15]

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[Interpreted] Yes, so your first question is about the sudden price hike in the alkylate and MTBE. Well, we still could not put our fingers on what is causing the sudden spike in the alkylate and MTBE, but I think the fact that we're seeing a strong demand for gasoline these days is having an impact on the prices of alkylate and MTBE.

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Unidentified Company Representative, [16]

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[Interpreted] Well, again, to answer the FX impact on the Q3 operating income on a Q-o-Q basis, quarter-to-quarter basis, the average FX went up which had a positive impact on the company's operating income of around KRW 55 billion.

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Operator [17]

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The following question is by [indiscernible] from Shinyoung Securities.

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Unidentified Analyst, [18]

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[Interpreted] I have 3 questions. I would like to know how much of an LSFO you sold in Q3, some of your intelligence about your contracting agreements with the -- supply contracts with the customers? And how much of an inventory -- LSFO inventory you're stockpiling? Second is I would like to know your price forecast of LSFO, HSFO and MGO. And third is if you could open and share with us how much RUC contributed to the Q3 operating income, that would be appreciated.

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Unidentified Company Representative, [19]

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[Interpreted] On our LSFO sales volume in Q3, please excuse us for not having the exact data for that. So if you inquire about that question -- inquire about that later on, we will get back to you and give you the right -- give you the data.

Well, it's tricky to make an outlook on the LSFO, HSFO price, but we have a data on that. If you go to the appendix 3, you will see the price outlook of the major products. For LSFO, the outlook is $15 in Q4 and $20 in Q1 2020. For HSFO, it's minus $20 in Q1 2020.

We don't break down our contribution to operating income by facility to facility. But in Q3, the HSFO crack against Dubai benchmark was minus $20. And for gasoline, the -- it recovered to some extent and recording about $8 versus Dubai benchmark, but again, the PP & PO, the spread was squeezed because of the U.S. and China trade war. So in Q3, although things were better than Q2, the feedstock price was still relatively higher. And as you know, the profitability and the contribution of the RUC comes mainly from the differential between the feedstock price and the finished product prices. So in Q3, we do not expect the RUC to have made a significant contribution to our operating income given the fact that the feedstock price is high. However, we're seeing the market turning around from October this year with the HSFO [crack] at minus $14 versus Dubai and the gasoline at around $9 versus Dubai, which is making the spread between the 2 at above $20. So that gives us the hope that the RUC will become a bigger contributor to our operating income from Q4.

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Operator [20]

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The following question is by [indiscernible] from HSBC.

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Unidentified Analyst, [21]

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[Interpreted] I have 3 questions. I know that S-Oil had a big maintenance up to -- in the first half of the year, up to Q3. But in Q4, you still have CapEx of about KRW 400 billion. Could you tell me where this will go to?

And second is about the product slate. From the data, it shows that your heavy oil slate, which is mostly LSFO, is about 4% of the production. Is this mostly the 1% sulfur content or is this the IMO regulation -- IMO-compliant sulphur content of 0.5%?

Number three, you have the maintenance for the RFCC this year. Did you do this in consideration of the IMO 2020? I mean, did you have to do some reconfiguration of the facilities or change the products? Or is there any plans for you to adjust the yield in line with the changes in the business environment?

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Unidentified Company Representative, [22]

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[Interpreted] To your first question about our Q4 CapEx, our balance is about KRW 400 billion, and you asked about how much we're going to spend and to where in the last quarter. At the moment, we are doing the maintenance for the #1 RFCC. And so we are executing part of our CapEx for the #1 RFCC maintenance.

And second is land purchase. For this, we said that we earmarked about KRW 96 billion is the budget. And out of that, our actual execution so far is KRW 50 billion. And the remaining will also be executed as we will be paying for the land purchase on a phased basis.

And third is we have some small and minor construction. So these will make up our CapEx, but we do not expect -- given our progress, we do not expect all the KRW 400 billion to be executed in Q4.

On the -- our LSFO, let me just clarify that out of 4%, LSFO represents about 2% and the remaining is HSFO. And most of the LSFO is not for [indiscernible] but for power plant generation. And since we have a strong demand in the power sector, even with the IMO 2020, we are going to produce this portion of LSFO going forward. And for HSFO, we are supplying -- we're using the [slurry] for the HSFO and supplying them as VLSFO.

On IMO 2020 possibly changing the company and production yield, so far, we're setting the production plans for 2020 so we cannot give you the details about whether we are going to change the production yield. However, let me tell you that the yield adjustment is driven by the economics. And if there -- if the IMO can bring some changes in the economics of our products, then there could be a change in the yield. But given the fact that we already have a set configuration in our plans and our units are running -- up and running at 100%, I don't think there will be a meaningful change in the production -- in our product production yield, but only -- if there is, it will only be a marginal one.

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Unidentified Company Representative, [23]

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If there are no further questions, I would like to wrap up today's conference call, and I would like to thank all the investors and the analysts for showing your keen interest on to S-Oil, and we'll get back to you in the fourth quarter. Thank you.

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Operator [24]

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This concludes the fiscal year 2019 third quarter earnings reported by S-Oil. Thanks for the participation.