Diamond state-owned monopoly ALROSA has finally released its financial results for 2010 under IFRS. The company’s statement shows how confident management and proper use of market conjuncture may turn almost a bankrupt company into a pace-setting industry leader in just two years. The company’s first quarter results look even more encouraging: higher output on the backdrop of price hikes for rough promises a good financial performance this year, while the company’s recently published data on reserves gives a prospect for many years ahead.
Higher prices, higher profits
Market movements in 2010 favored producers of rough diamonds: over the past year, prices for their goods rose by an average of 27% (and in separate categories even more). Therefore, even maintaining production at the last year's level, diamond miners are still able to secure a rise in revenues and profits.
In 2010, ALROSA was able to increase diamond production by 5% compared with 2009 - up to 34.3 million carats. In addition, taking advantage of growing demand, the company in the course of 2010 sold 5.2 million carats of its stocks accumulated in the previous year. As a result, ALROSA’s revenue growth was above the market: its sales increased by 45% to 113.394 billion rubles (about $4 billion in terms of current dollar exchange rate).
De Beers, ALROSA’s main rival, posted higher proceeds: about $5 billion having produced 32.3 million carats. The essential spread is only explained by the difference in rough produced. The average price of one carat sold by ALROSA in 2010 was $79 against $72 in 2009. De Beers did not disclose the average price of one carat, but comparing the company’s sales and its output gives about $150 per carat.
ALROSA’s new marketing system appears to be an essential booster to its sales. In the crisis year of 2009, the company switched to long-term contracts with contract prices linked to global prices. Due to this ALROSA was able to maintain guaranteed sales of its total rough stocks in the economically unstable period and managed to secure reliable and regular customers for a successful post-crisis period who are currently buying large amounts of rough from this company.
Meanwhile, the production cost of one carat of rough mined by ALROSA increased from $45 to $53, partly because of inflation and partly due to the company's ongoing transition to underground mining. This, however, did not essentially affect ALROSA’s business in terms of cost effectiveness: its EBITDA margin increased from 25% to 31% in 2010.
Favorable market conditions, established sales and cost reductions have allowed ALROSA to earn 11.788 billion rubles of net profit which far exceeded the company’s expectations.
In parallel, ALROSA performed extensive work on debt restructuring. If in 2009 its debt burden led the company almost to a breaking point (over $4 billion of debts on the background of loss-making production), the situation at the beginning of 2011 could be called completely stable. In 2010, ALROSA’s debt load reached 101.9 billion rubles (it was mostly restructured into long-term ruble-denominated loans) and the ratio of net debt to EBITDA was 2.8 compared with 5.9 a year earlier.
First quarter: growth against the backdrop of general decline
The recently published results of ALROSA for the first quarter are even more encouraging. In January-March, the company increased its production of rough diamonds by 16% up to 10 million carats compared to the first quarter of the previous year. This figure, albeit slightly, exceeds the company’s output in the 4th quarter of 2010, whereas all the other prominent industry players demonstrated a decline in production in the first quarter compared with the previous one. De Beers, compared with October-December, reduced its output by 13% (to 7.012 million carats) faced with a drop in production in South Africa due to heavy rains and fluctuations of diamond content in the ore. Rio Tinto diamond production fell by 22% compared with the 4th quarter (to 2.5 million carats) due to adverse climatic conditions in Australia, which led to introducing force majeure provisions in some of the company’s operations. BHP Billiton reduced its output by 18% compared to the fourth quarter to 770,000 carats mainly due to its deteriorating ore base.
If output volumes of Rio and BHP have never produced any significant effect on the market, we should pay due attention to the output posted by De Beers. In 2011, the company had ambitious plans to ramp up production to 38 million carats. Theoretically, if ALROSA will maintain its output at the current level, De Beers carrying out its plans could become the world leader in terms of production. But now, after the publication of the first quarter results, we can conclude that to achieve this De Beers will have to exert considerable efforts to make up for the widening gap.
The decline in production under the current market conditions means a loss of some of their profits for diamond miners. Only in the first few months of this year, prices for certain categories of rough increased by 26%, making the forecasts of market participants predicting a 20-percent annual growth look too conservative. In the first quarter, ALROSA increased its prices by an average of 10%, but it is possible that since then, following the market, the company increased prices further.
Billions under the earth
Experts agree on one thing: rough diamond prices continue to rise. Under such conditions, increasing production and expanding reserves is a goal for any company. ALROSA has demonstrated it commands a sufficient resource base for a long perspective. Recently, the company for the first time published data on reserves and resources of rough diamonds, which are estimated at 1.6 billion tons of ore containing 0.81 carats per tonne (totally about 1.3 billion carats). In particular, its proven mineral reserves contain 1.014 billion carats with an average grade of 1.09 carats per tonne. In terms of current annual production this amount is sufficient to provide some 40 years of work.
The presence of a fundamental ore base is particularly significant in light of the fact that in recent years there were no new major fields discovered anywhere in the world. This is also confirmed by ever decreasing funds for exploration in all major companies: there are no new targets for investments, so funds are spent only on follow-up exploration of existing diamond fields.
In light of these data, as well as taking into account the rapidly growing market the feasibility of ALROSA’s diversification project which involves the Timir iron ore deposit in Yakutia is questioned. ALROSA has already stated that it was ready to sell 49% in this project to a strategic investor, and has been negotiating with various companies, but still intends to retain control. Perhaps ALROSA should focus on its core business switching over to underground mining under a tight schedule and continue to build up its resource base, selling more rough at so far high prices to win a real leadership in the industry in this way. Implementing associated non-core projects in the industry where the company has no experience is fraught with distraction of a large amount of funds (Timir is estimated to be worth about 80 billion rubles), which could be used for instance to boost construction of underground mines or to repay the company’s debts.
Elena Levina for Rough&Polished
